Shares of Sea Limited (SE 4.34%), southeast Asia's leading internet company, continue their wild ride. The stock is trading down 75% in 2022 with just over a month left to go. However, following the third-quarter earnings update, shares rallied some 40% before giving back some gains as management promised to slash expenses. After a spate of heavy spending to support unprofitable expansion in 2020 and 2021, the company's new goal is to get operations running self-sufficiently as soon as possible.
Sea's e-commerce business Shoppee is expected to reach breakeven by the end of 2023, but its profitable video game segment Garena (led by the global hit Free Fire) still struggles as many gamers return to work or school. With a long and hard road ahead of it, is now the time to buy Sea stock?
Sea's big shift in thinking
At times in 2020 and 2021, Sea actually started to turn free-cash-flow positive. But as the pandemic boom in online business activity returned to normal in 2022, Sea's free cash flow turned negative -- to the tune of negative $1.68 billion over the last 12-month stretch.
Data by YCharts.
The digital entertainment segment is still a moneymaker, though not as much as before. Adjusted EBITDA (or "earnings before interest, tax, depreciation, and amortization," which measures the profitability of business operations) was $290 million on revenue of $893 million, compared to adjusted EBITDA of $334 million on revenue of $900 million in Q2 2022. Engagement in video games, in particular, the main breadwinner Free Fire, remains challenging as the world slowly reopens from early pandemic effects.
Issues with video games aside, e-commerce is the real glaring issue for Sea. Led by the Shoppee app in southeast Asia, adjusted EBITDA losses were $496 million in Q3, though that was an improvement from the $648 million adjusted EBITDA loss in the previous quarter. The closely related SeaMoney digital finance segment likewise lost less money in Q3. Adjusted EBITDA was negative $67.7 million, down from the loss of $112 million in Q2 2022.
Efforts to further trim the fat include tightening the budget on servers and computer equipment. Office space expansion and remodeling are also taking the backseat, likely due in part to some 7,000 employee layoffs in recent months (reportedly about 10% of the company's workforce). Rather than grow e-commerce as quickly as possible like what was happening over the last two years, the focus for Shoppee in particular will now be getting the existing operation profitable, which is expected by the end of 2023.
The result is likely a deceleration in growth for Sea overall going forward. Total revenue was up just 17% year over year in Q3 2022, a far cry from the triple-digit percentage growth reported less than a year ago.
Is this the right move for Sea?
This shift in focus is absolutely the right decision for Sea. The market stopped rewarding the company for its rapid expansion a while ago. The business traded for well over 20 times trailing 12-month sales this same time in 2021. Now the stock trades for just 2.5 times sales, even as Sea continues to report double-digit percentage expansion. CEO Forrest Li acknowledged this, as he stated on the last earnings call:
We believe our strong focus on cash flow and achieving self-sufficiency as much as possible is the right strategy to pursue at this stage, even though we may see no growth or even negative growth in certain operating metrics in the near term. To be very clear, we remain highly confident about the compelling long-term growth prospects of our businesses and the market. Once we achieve self-sufficiency, we will be in a position to decide to reaccelerate growth again in a much more efficient and a long-term sustainable manner.
The company's phase of hypergrowth was nice while it lasted, but it wasn't sustainable. As an era of extremely easy money ends with interest rates back on the rise, Sea needs to figure out how to make its online marketplace profitable without the need to tap shareholders for additional cash.
Given the market's punishment of Sea in the last year, even a no-growth business would be fine. Investors now only care about profitability. The good news is there's a plan to get there, and meaningful progress is being made toward the breakeven goal within another year's time. And in the meantime, Sea's balance sheet is still in decent shape. Cash and short-term investments totaled $7.3 billion, offset by convertible debt of $4.1 billion.
Is the stock a buy? If Sea can indeed get itself out of the red, shares might be really cheap right now at just 2.5 times sales. After all, the company's addressable markets in southeast Asia and Latin America are huge and have really only just begun to adopt many e-commerce services. If Sea can figure out how to make this business sustainable, this might once again be a great long-term investment. But until that happens, this should still be viewed as a high-risk stock. Tread lightly for now after the big post-Q3 earnings rally.
