Shares of the technology giant Sea Limited (SE -0.91%) have been on a roller-coaster ride in 2021. After reaching a high of $372.70 on Oct. 19, the stock tanked by almost 41% to close at $219.60 on Dec. 27.
Much of this fall can be attributed to the general tech stock sell-off, triggered by rising concerns surrounding global economic recovery amid a surge of COVID-19 infections, as well as the U.S. Federal Reserve's planned interest rate hikes for the coming year. The Fed's slowing pace of bond-buying to clamp down on rising inflation was also a factor in the sell-off. The company is still not profitable, something that assumes greater importance in the minds of investors during times of economic uncertainty.
Despite these challenges, there are a lot of factors that can make Sea a winning stock in 2022. Let's look at a few important ones.
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Focus is on high-growth Southeast Asian market
Sea mainly operates in three high-growth industries -- digital entertainment (Garena), e-commerce marketplace (Shopee), and digital financial services (Sea Money). All of these markets are witnessing solid adoption trends across the world, especially in Sea's targeted Southeast Asian market.
According to the Sea Economy Report 2020, the internet economy in Southeast Asia is expected to triple from $100 billion (3.7% of the region's GDP) in 2019 to $300 billion (8.5% of the region's GDP) in 2025. With internet penetration in Southeast Asia at 69% in 2021, significantly lower than 90.8% in the U.S., there is much room for Sea to grow in this market.
Garena continues to generate healthy profits
Sea's only profitable business, Garena, continues to ride on the success of its battle royale mobile game, Free Fire. Ranked by App Annie as a top mobile game on Alphabet's Google Play globally based on average monthly active users, Free Fire was also the highest-grossing mobile game in Southeast Asia, India, and Latin America in the third quarter (ending Sept. 30, 2021).
Sea has introduced Free Fire Max to enhance the quality, animation, and graphics for its customer base. These developments can help boost the game's quarterly paying user base, which accounted for only 12.8% of its total quarterly user base in the third quarter.
Sea's Q3 digital entertainment business revenues were up 93% year over year to $1.1 billion, while adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) soared 22% year over year to $715 million. Yet, some analysts are questioning the company's over-reliance on Free Fire.
While Free Fire is undoubtedly a big portion of Sea's business, the company also distributes several of Tencent's (TCEHY -1.66%) popular games such as Call of Duty and League of Legends. This distribution activity helps expand the company's gaming user base.
Shopee is well poised to benefit from the increasing penetration of e-commerce
Shopee currently accounts for almost 57% of the Southeast Asian e-commerce market. Despite this, there is still much opportunity here; the e-commerce penetration rate in this region is estimated to grow from 27.4% in 2021 to 40.4% in 2025. Sea is also making its presence felt in the Latin American market, considering that Shopee has already become the No. 2 e-commerce app in the region based on monthly active users.
Shopee has been growing its top line at a fast clip, with third-quarter revenues soaring at 134% year over year to $1.5 billion. Sea is following in Amazon's (AMZN -0.58%) footsteps in prioritizing market-share growth over profitability for its e-commerce business, especially in Latin America and Europe. To that effect, the company has been opting for aggressive marketing spending in the form of discounts and subsidies. However, Sea will most likely reduce its spending once Shopee becomes even more established in these markets. Increasing orders coupled with reduced spending will help pave a path to Shopee's profitability.
Although currently more of a third-party marketplace, Sea is also gradually shifting its e-commerce business model toward more profitable first-party sales. In the third quarter, first-party sales (purchasing goods and services from wholesalers and then selling them to customers) resulted in revenues and gross profit of $279 million and $30 million, respectively.
Sea Money will soon emerge as a major growth driver
Although the smallest of Sea's operating segments, Sea Money has been reporting excellent results in the past few quarters. In the third quarter, the company's mobile wallet services reported a 111% year-over-year jump in total payment volume to $4.6 billion. This helped drive the segment's revenues up by 818% year over year to $132 million.
To increase the adoption of its mobile wallet, Sea is partnering with several major online and offline merchants in its target markets. The company has also launched other digital financial services such as a digital bank, buy now pay later, and insurtech, which will further drive the penetration of Sea Money's services.
The recent pullback has provided an entry opportunity
In the Q3 earnings release, Sea has guided for fiscal 2021 e-commerce revenues of $5 billion to $5.2 billion, a significant improvement from the previous guidance of $4.7 billion to $4.9 billion. The company has also maintained its fiscal 2021 revenue guidance for Garena of $4.5 billion to $4.7 billion. Analysts expect the company's average fiscal 2021 revenues to be around $9.51 billion, implying year-over-year growth of 117%. Analysts also expect Sea's average fiscal 2022 revenues to rise around 50% to $14.26 billion.
Based on these forecasts, Sea is trading at 12.7 times fiscal 2021 revenues and 8.5 times fiscal 2022 revenues. The company's price-to-sales ratio, although not very low, has declined reasonably compared to its level in early October 2021.
Against the backdrop of robust secular tailwinds, an improving business model, and a reasonable valuation, Sea seems to be an attractive pick for 2022.
