Sea Limited's (SE -0.27%) stock soared 22% after it posted its fourth-quarter earnings report. The Singapore-based gaming, e-commerce, and fintech company's revenue rose 7% year over year to $3.45 billion and exceeded analysts' expectations by $400 million.

It posted a net profit of $423 million, compared to a net loss of $616 million a year ago, while its earnings per share (EPS) of $0.72 easily beat the consensus forecast by $1.27 and represented its first-ever quarterly profit. Its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) also improved from a loss of $492 million to a profit of $496 million.

That bottom line growth was impressive, but Sea's stock still trades nearly 80% below its all-time high in October 2021. Let's see if it's resolving its biggest problems and becoming a worthwhile investment again.

Person playing a smartphone game.

Image source: Getty Images.

Why did the bulls abandon Sea?

Sea operates two main businesses: Shopee, the largest e-commerce platform in Southeast Asia and Taiwan, and Garena, a video game publisher that generates most of its revenue from Free Fire, a hit battle royale game released in 2017. Both of those businesses generated explosive growth throughout the height of the pandemic as more people shopped online and played more mobile games. Its revenue rose 101% in 2020 and grew another 128% in 2021.

But in 2022, Sea's revenue only increased 25% to $12.4 billion. That slowdown was caused by the simultaneous deceleration of Shopee's gross merchandise volume (GMV) and Garena's bookings over the past year.

Metric

Q4 2021

Q1 2022

Q2 2022

Q3 2022

Q4 2022

Shopee GMV growth (YOY)

53%

39%

27%

14%

18%

Garena bookings growth (YOY)

7%

(27%)

(40%)

(45%)

(39%)

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

Shopee's growth cooled off in a post-pandemic world as people bought fewer products online and faced inflationary headwinds, but it also shut down several of its money-losing marketplaces across Europe, Latin America, and India. Garena's growth cooled off as Free Fire attracted fewer players, faced tough competition from newer games, and was hit by an unexpected ban in India -- which had been one of its highest-growth markets.

The bears claimed that Garena's slowdown was a bright red flag, since the company usually subsidized Shopee's unprofitable business (as well as its associated fintech business) with Free Fire's profits. That's why on an annual basis, its adjusted EBITDA loss still widened from $594 million in 2021 to $878 million in 2022.

Is Sea finally stabilizing its business?

Free Fire's slowdown forced Sea to aggressively cut costs at Shopee and its fintech business to stabilize its margins. As the following table illustrates, it seems to have finally regained that balance in the fourth quarter.

Metric

Q4 2021

Q1 2022

Q2 2022

Q3 2022

Q4 2022

Shopee adjusted EBITDA margin

(55%)

(50%)

(38%)

(24%)

9%

Fintech adjusted EBITDA margin

(76%)

(53%)

(40%)

(21%)

20%

Garena adjusted EBITDA margin

43%

39%

37%

32%

27%

Total adjusted EBITDA margin

(15%)

(18%)

(17%)

(11%)

14%

Data source: Sea Limited.

Sea expects Shopee's margins to improve further as it focuses on its EBITDA-positive markets across Asia, slows down its margin-crushing overseas expansion, and continues to expand its logistics network. Economies of scale should also kick in at its fintech segment as SeaMoney, a leading digital payments platform in Southeast Asia, gains more users.

Unfortunately, Garena -- which saw its quarterly active users decline 15% year over year to 485.5 million in the fourth quarter -- could continue to struggle until it diversifies its portfolio with more games.

For 2023, analysts expect Sea's revenue to rise 11% to $13.8 billion as it narrows its adjusted EBITDA loss from $878 million to $361 million. We should take those estimates with a grain of salt, but they imply that Sea's near-term profits might remain unstable as it balances its cost-cutting measures with its long-term investments in this tough market.

Is Sea's stock worth buying again?

Sea's surprise profit in the fourth quarter was encouraging, but I'd like to see Shopee's and Garena's margins expand for a few more quarters before I accumulate more shares. Its stock seems cheap at three times this year's sales, but Amazon -- which generates more stable growth with its diversified mix of e-commerce and cloud services -- trades at less than two times this year's sales. The Latin American e-commerce leader MercadoLibre -- which is growing faster and is more profitable than Sea -- trades at five times this year's sales.

Sea is worth keeping an eye on, but its upside potential could be limited until the macro headwinds wane, it launches new games to succeed Free Fire, and it shows that it can stay ahead of tough rivals -- like Alibaba's (NYSE: BABA) Lazada -- in the Southeast Asian market. Until it checks those boxes, it will remain a highly speculative investment.