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Sea Limited Reports Steep Losses: Is the Opportunity Worth the Risk for the Stock?

By Nicholas Rossolillo - Mar 13, 2021 at 8:52AM

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The pandemic made Sea into the leading tech platform of Southeast Asia -- but its stock is not for everyone.

Share prices of Sea Limited (SE 3.60%) soared nearly 400% higher in 2020, and though tech stocks have taken a hit in recent weeks, this video game and e-commerce giant is still sporting a nearly 15% gain since the start of the year. Not a bad performance, Sea.  

Nevertheless, not all is perfect as losses mounted again during the final months of 2020. Sea is using its highly profitable video game platform (powered by international free-to-play hit Free Fire) to seed new business. If this story reads familiar, it is. Amazon (AMZN 0.25%) did something similar with its early lead selling books -- and now it's a premier tech platform.

Sea's path forward likewise won't be free of bumps in the road, so gun-shy investors might want to look elsewhere. But if you have some money and a decade to wait, Sea could still be very rewarding. 

A woman in thought with a bag of cash in a thought bubble over her head.

Image source: Getty Images.

Video games are Sea's not-so-secret superweapon

Sea Limited breaks its business into two basic segments: digital entertainment as well as e-commerce and other services. For the sake of brevity, its digital wallet and foray into tech-powered banking are lumped into e-commerce.

As other e-commerce platforms have demonstrated, digital retail and ancillary services are highly profitable. They can even operate in the black in developing markets. Alibaba Group Holding in mainland China and MercadoLibre in South America are proof the template works. So there's promise for Sea on its home turf in Southeast Asia and across the Pacific in South America, where it made a recent jump. But Sea's digital commerce platform isn't there yet on the bottom line. Adjusted EBITDA losses increased to $428 million in the fourth quarter (ended Dec. 31), worse than the $306 million loss a year ago. In the meantime, video games are paying the bills.

Metric

Digital
Entertainment

E-Commerce and Other Services
and Sales of Goods

Revenue

$2.02 billion

$2.36 billion

YOY change

78%

127%

Gross profit

$1.31 billion

$35.3 million

YOY change

88%

N/A

Adjusted EBITDA

$1.98 billion

($1.86 billion)

YOY change

94%

N/A

Data source: Sea Limited. YOY=year-over-year.  

Granted, this is a study in unit economics. Though Sea's e-commerce losses were bigger in 2020 than they were pre-pandemic, they were a smaller percentage of the revenue total than in 2019. In fact, e-commerce gross margin was actually negative in 2019, so the meager $35.3 million in 2020 was a big improvement. That trend should continue, especially as the company builds on the infrastructure it has now built out. Sea expects bookings for its video game segment to increase another 38% in 2021 (sooner or later, I expect another in-house developed title will join Free Fire) and e-commerce revenue is forecast to more than double once again, growing 112% to $4.5 billion to $4.7 billion. Digital commerce in Southeast Asia and South America is still a single-digit percentage of total retail, so suffice to say there's room for Sea to accelerate the adoption of its services by spending cash generated from Free Fire

Losses? Who cares about losses?

This is a growth business through and through, and the non-existent e-commerce bottom line will create some wild swings in Sea's valuation. If volatility doesn't sit well with you (or you don't have the ability to purchase more shares over time on those inevitable dips), take a pass on this one.

Nevertheless, Sea did swing to overall profitability last year. Twelve-month free cash flow was $556 million after the latest quarterly update. Sea is launching more growth initiatives (it acquired Hong Kong-based Composite Capital Management to establish its new investment arm Sea Capital and separately launched Sea AI Labs), so free cash flow could reverse course again. But on its journey to breakeven, Sea ended 2020 with $3.22 billion in cash and short-term investments offset by convertible debt of $1.36 billion. This company is not at risk of running out of liquidity any time soon as it rapidly expands its reach.  

Given this dynamic, Sea still looks like a long-term growth stock worth owning if you can be patient with the e-commerce platform's development. Eventually, it will reach a profitable scale, but in the meantime, Sea will subsidize those losses with video games as it eyes a bigger slice of the global commerce pie.

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