Is This The Right Time to Buy Sea Limited Stock?

Share prices of Sea Limited (SE 2.03%) fell by 18% on Tuesday after the Singapore-based e-commerce and gaming company posted its first-quarter report. Its revenue rose 5% year over year to $3.04 billion, but it came up $20 million short of analysts' consensus estimate.

On an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) basis, Sea posted a profit of $507 million, compared to a loss of $510 million a year ago. On a generally accepted accounting principles (GAAP) basis, it generated a net profit of $87 million, which was also a vast improvement from its net loss of $580 million a year earlier. Unfortunately, its GAAP earnings of $0.15 per share still significantly missed the consensus forecast.

Image source: Getty Images.

That earnings miss was disappointing, but Sea's stock now trades about 80% below its all-time high. Is it a bargain at these depressed levels, or is this the wrong time to buy this out-of-favor growth stock?

When a growth stock stops growing

Sea provides e-commerce, digital entertainment, and digital financial services. Its e-commerce segment houses Shopee, the largest e-commerce marketplace in Southeast Asia and Taiwan. Its digital entertainment segment owns Garena, a video game publisher which generates most of its revenue from the hit battle royale game Free Fire. 

During the first quarter, Sea generated 70% and 18% of its revenues from Shopee and Garena, respectively. The rest mainly came from its digital financial services segment, which handles its SeaMoney digital payment, banking, and fintech platforms.

Investors can gauge the health of Sea's business through two core metrics: Shopee's total revenue, which includes its transaction, advertising, and logistics fees; and Garena's bookings, or the value of all the digital purchases made within its video games. Here's how those two businesses fared over the past year.

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

Shopee lost momentum throughout 2022 as consumers generally shifted back toward their pre-pandemic shopping behaviors and made fewer online purchases. As its growth cooled off, Sea scaled back its overseas expansion plans and reined in its loss-leading subsidies for customers and merchants.

Garena's bookings plummeted as the pandemic-driven tailwinds for video games dissipated and interest in Free Fire, which was launched in 2017, waned. Free Fire also faced intense competition from other games and was banned in India -- one of its fastest-growing markets -- in early 2022.

Cutting costs to stabilize its business

Garena's slowdown raised red flags for investors last year because it was Sea's only profitable business unit (in adjusted EBITDA terms). Sea had been subsidizing Shopee and SeaMoney's persistent losses with Free Fire's slim profits. In other words, the company had been balancing its entire business on the shoulders of a single video game.

Management realized this business model was unsustainable, so it aggressively cut costs at Shopee and SeaMoney. As a result,  both segments finally turned adjusted-EBITDA positive over the past two quarters. Sea's entire business also stayed profitable on both adjusted EBITDA and GAAP measures during those two quarters. That result puts to bed the bearish notion that Sea can't turn a profit, but Garena's declines will likely continue to offset Shopee's gains. 

Garena has been developing other video games to diversify its portfolio, but we shouldn't expect those new titles to arrive anytime soon. During the latest conference call, Chief Corporate Officer Yanjun Wang said all of Garena's efforts were still "being directed at making Free Fire into a long-term franchise" through updates and gaming events. 

Is Sea stock a buy?

For 2023, analysts expect Sea's revenue to rise 8% to $13.47 billion as its adjusted EBITDA improves from negative $878 million to positive $1.58 billion. It's also expected to generate a full-year net profit of $708 million on a GAAP basis, compared to its net loss of $1.65 billion in 2022. Based on those estimates -- which we should take with a grain of salt -- Sea's stock trades at 3 times this year's sales and 28 times its adjusted EBITDA.

By comparison, its Latin American peer MercadoLibre (MELI -1.79%), which is growing at a much faster rate and doesn't have a video game arm, only looks slightly pricier at 5 times this year's sales and 30 times its adjusted EBITDA. Alibaba (BABA 2.92%), which is growing slower than Sea and faces persistent delisting threats in the U.S., trades at just 2 times this year's sales and 8 times its adjusted EBITDA.

Compared to those peers, Sea's stock isn't a screaming bargain yet. It's taking some steps in the right direction, but it will likely remain out of favor until Garena's bookings rise year over year and it rolls out new games to reduce its dependence on Free Fire. As such, I believe it's still a bit too early to bet on its long-term recovery.