It has been a terrible few months for investors in Sea Limited (SE -1.02%), with the stock now down just below $100 after topping out at $372 last November. That's a shocking decline, but while Sea was likely ahead of itself at nearly $400, I think the stock has far overshot to the downside today -- by a lot.
As Warren Buffett once said, "You pay a high price for a cheery consensus," and "The market is there to serve you, not instruct you."
With the price now falling below where I first purchased Sea Limited back in 2020, here's why I bought more after its recent earnings report. As Motley Fool trading rules allow, I might buy more in the coming days and weeks as well.
Profitability and cash concerns are overblown
Sea seems to have been a victim of the rapid sentiment shift away from any company that loses money and toward more-profitable value stocks. To be sure, Sea Limited is losing money and probably will for the next couple of years. Last year, the company had an operating loss of $1.6 billion, which was 21.5% higher than the previous year. However, operating-loss margins declined, as revenue grew 128% and gross margins grew an even higher 189%.
One big concern is that losses could grow this year even beyond 2021's figures because the company's cash cow, the Garena mobile games division, is projected to see bookings decline this year from about $4.6 billion in 2021 to roughly $3 billion in 2022, or about the same level as 2020. Of note, bookings take into account deferred revenue, so it's higher than revenue when the company is growing, but below revenue when that figure is declining.
The Garena declines are the result of "moderating online activity" as the world emerges from the pandemic, according to management. Additionally, India just banned Sea Limited's hit game Free Fire on concerns over Chinese companies. But Sea isn't a Chinese company; it's based in Singapore. So perhaps that gets resolved in time. In any case, there's basically no India revenue incorporated in that guidance.
Yet even if gaming bookings return to 2020 levels, that produced nearly $2 billion in adjusted EBITDA in 2020. Yes, that would be down from $2.8 billion last year, but still not a disaster.
Additionally, management smartly raised money last year by selling equity and preferred stock at much higher prices. The company sold about $3.5 billion in stock at a price of $318 and another $2.5 billion in preferred convertible stock last September, fattening its cash coffers. Even after the continued cash burn, Sea ended 2021 with $10.2 billion in cash and investments.
So with $2 billion in profits from Garena this year (which might be conservative) as well as $10.2 billion in cash on the balance sheet, it appears Sea will have no problems funding its business for the next few years at least.
Shopee and SeaMoney are on fire and becoming more profitable
While Garena's near-term outlook was disappointing, management outlined some promising guidance on its e-commerce platform Shopee and associated fintech platform SeaMoney.
Shopee grew revenue 89% in the recent quarter, and management guided for a very strong 76% growth in the upcoming year on top of those impressive comparisons. Keep in mind, Sea handily beat its initial 2021 e-commerce guidance, bringing in $5.1 billion in revenue in 2021 compared with its initial guidance a year ago of $4.6 billion. So it's possible this recent guidance was conservative, impressive as it is.
But what about profits? Management was quick to forecast that Shopee will have positive adjusted EBITDA by the end of this year in its core markets in Southeast Asia, before costs for its headquarters (overhead not attributed to a specific segment). Although EBITDA isn't true earnings, and ignores stock-based compensation, that's a big deal from a cash perspective, especially since these markets are still growing so fast.
Yes, Shopee will still lose money on an EBITDA basis overall, but that is due to the rapid growth in Brazil, which is earlier in its development. Shopee lost nearly $2 per order in Brazil last quarter, compared with $0.15 in Southeast Asia; however, Brazil orders grew a whopping 400% last quarter, and those losses per order were down 40%. Since Brazil is the sixth largest country in the world by population, it makes sense for Shopee to double down on its momentum there.
Also encouraging was that management expects SeaMoney to become cash-flow positive in 2023. And by 2025, management expects both of these businesses to be self-funding, even including capital expenditures. So even if Sea burns $2 billion per year in 2022 through 2024, it will still have more than $4 billion in cash left over. Meanwhile, Garena should still be generating profits.
Is Sea a value right now?
After its precipitous fall, Sea now trades at just a $54 billion market cap. That's a little over four times this year's projected sales. If you take out the cash on the balance sheet, that is a little over 3.3 times this year's sales.
In terms of sum-of-the-parts, consider this: In 2020, the profitable Garena platform generated nearly $2 billion in adjusted EBITDA; when factoring in depreciation and all of the company's HQ costs, that figure came to about $1.65 billion in operating income. With Garena bookings said to revert back to 2020 figures, let's say that it will generate $1.5 billion in operating income this year (an even more conservative figure). So all of Sea is trading at 36 times next year's Garena operating income, and 22 times the past year's Garena operating income.
That would be an expensive valuation, but not totally crazy, for Garena alone, if it can resume growth after a post-pandemic hangover. Free Fire still has a very engaged audience, and Sea has a track record of publishing and developing popular games. So it's pretty pessimistic to think Garena is a declining business. And keep in mind that the India ban could be reversed, which would only take 2022 numbers higher.
Meanwhile, Shopee and SeaMoney, will likely be much more valuable businesses than Garena in the future, even though they are generating losses now. That's because Southeast Asia is rapidly digitizing, with e-commerce and fintech platforms just starting to take off in the region.
The bottom line is, while there's a lot of pessimism in Sea's stock right now, it looks very cheap based on the sum of its three different businesses and its ample cash cushion. Meanwhile, management has a strong track record of success. That's why I've recently increased my stake in Sea, and if it goes down due to marketwide pessimism, I'll likely buy more.