Share prices of many gaming, e-commerce, and business communication stocks soared in 2020 and early 2021, then tanked dramatically in the later part of 2021. Tech stocks have come under intense pressure as investors remain concerned about high and sticky inflation, labor shortages, and the resurgence of COVID-19 cases associated with the omicron variant.
However, there are a few stocks, such as Sea Limited (SE -2.20%) and Twilio (TWLO -1.49%), that have been excessively punished despite having a healthy business model and delivering strong financial results. While the short-term trajectory is discouraging, there remains a high possibility of a solid correction in these stocks in the long run. Let's see why Wall Street is valuing these stocks at a significant premium to their current share prices.
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1. Sea Limited: Implied upside of 121%
With the U.S. Federal Reserve planning interest rate hikes for 2022 (which will reduce the availability of cheap capital), investors are concerned about Sea's high cash burn rate for its e-commerce segment, Shopee, and subsequent lack of profitability. Investors are also worried about the over-reliance of the company's only profitable business, the digital entertainment segment Garena, on the continued success of its battle royale mobile game, Free Fire. While these challenges cannot be ignored, a share price drop of over 50% from a high of $372.70 on Oct. 19, 2021, seems to be an overreaction.
Sea is mainly focused on the booming Southeast Asian internet economy, where the gross market value (GMV) is expected to grow from $170 billion in 2021 to $360 billion in 2025. Shopee has already established itself as the largest online marketplace and accounts for almost 57% of Southeast Asian e-commerce market's transaction volume. Shopee has also become the leading e-commerce mobile application in Latin America, within just two years of launch. These statistics highlight the success of Shopee's business strategy of prioritizing market-share growth in terms of the number of customers and sellers over profitability. While this entails heavy spending on discounts and advertising in the initial years, it should create robust network effects for the company's e-commerce business in the long run. As Shopee becomes better entrenched in these markets, the company can reduce its spending, thereby paving a way to profitability.
Sea's only profitable business, Garena, has managed to foster solid customer loyalty for its Free Fire game. Thanks to this and the launch of the Free Fire MAX version, there is still much scope to grow the game's quarterly paying user base (which accounted for only 12.8% of the total paying user base in the third quarter ending Sept. 31, 2021). The company is a distribution partner for Tencent Holdings' (OTC: TCEHY) famous games like League of Legends and Call of Duty.
Finally, Sea has been successfully leveraging its e-commerce and digital entertainment business to push the adoption of its mobile wallet services. Although currently a small part of the company's business, fintech segment SeaMoney is expected to emerge as a major growth driver in the coming years.
Sea is a diversified business poised to benefit from several secular tailwinds in attractive target markets. So, despite Sea's shares being in a downtrend since late 2021, the company's average target price of $377.75 seems to be well within its reach for 2022.
2. Twilio: Implied upside of 90%
Shares of leading cloud-based communications platform-as-a-service player Twilio are down by around 53% from their high of $457.30 on Feb. 18, 2021. Despite the recent tech stock sell-off, this decline seems overdone especially since the company, which enables businesses to securely communicate with their clients, has been reporting robust top-line growth since 2014. Twilio offers application programming interfaces (APIs), which are used by many top-notch companies to easily embed messaging, voice, video, and email communication services in their applications.
In the third quarter (ending Sept. 31, 2021), the company's revenue soared by 65% year over year to $740.2 million. The third quarter year-over-year organic revenue growth of 38%, although a deceleration from the previous quarters, is still a respectable figure considering the higher revenue base in 2020. Twilio's 30%-plus year-over-year organic annual revenue growth rate target for the next four years also seems quite achievable.
In the past two years, Twilio has also maintained a dollar-based net expansion rate exceeding 130%. This implies that in every quarter, existing customers are spending over 30% more on the company's services as compared to the same quarter of the prior year. A healthy dollar-based net expansion rate (exceeding 100%) is indicative of the company's pricing power and successful cross-selling strategy.
Twilio served over 250,000 customers across industries at end of the third quarter. The company boasts of a diverse customer base including prominent names such as Amazon, PayPal Holdings, and Shopify. In the third quarter, international markets accounted for almost 33% of the company's total revenue, a significant jump from 27% revenue exposure in the same quarter of the previous year. Since 2019, the company has also been successful in reducing revenue exposure to top-10 customer accounts. A well diversified customer base across clients, industries, and geographies has helped strengthen the resilience of Twilio's business model.
Twilio is not yet profitable. The company also generated negative free cash flow in the first nine months of 2021. However, this may soon change considering that the company has entrenched itself in the ecosystems of several big players. Against this backdrop, the company's average target price of $408.59 doesn't seem out of reach in 2022.
