Is It Too Late to Buy Sea Limited Stock?

Sea Limited's (SE 0.05%) stock sank 29% to a new 52-week low on Aug. 15 after it posted a disappointing second-quarter report. The Singapore-based gaming, e-commerce, and fintech company's revenue rose 5% year over year to $3.1 billion, which missed analysts' estimates by $150 million.

It posted a net profit of $331 million, compared to its loss of $931 million a year ago, as its earnings of $0.54 per share beat the consensus forecast by $0.08. That marked its third consecutive quarter of profitability on the basis of generally accepted accounting principles (GAAP), but its soft sales growth overshadowed that progress. Let's review Sea's biggest challenges and find out if it's too late to bet on its long-term recovery.

Image source: Getty Images.

Why is Sea's sales growth slowing down?

Sea owns Shopee, the top e-commerce marketplace in Southeast Asia and Taiwan. It also owns Garena, a video game publisher that generates most of its bookings from Free Fire, a popular battle-royale mobile game launched in 2017.

Both businesses flourished during the pandemic as people shopped online and played video games more frequently. Shopee's revenue rose 160% in 2020 and 136% in 2021, while Garena's bookings grew 80% in 2020 and 44% in 2021.

However, both businesses faced a tough slowdown as the pandemic-induced tailwinds dissipated. Shopee struggled with slowing demand for online shopping and fierce competition from Alibaba's Lazada and other regional competitors.

Garena's Free Fire was banned in India, one of its fastest-growing markets, in early 2022, while the gaming market's post-pandemic slump and competition from similar titles exacerbated its difficulties.

That's why Shopee's revenue only rose 42% in 2022 as Garena's bookings fell 39%. Garena's rapid deterioration was a red flag, since Sea had been largely subsidizing Shopee's loss-leading strategies with Garena's profits. In the second quarter of 2023, Shopee's growth decelerated again as Garena's bookings plummeted.

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

Why are Sea's profits rising?

Sea's sales growth is slowing down, but its profits are rising as it implements aggressive cost-cutting. It laid off thousands of employees, froze salaries, and reduced its bonuses.

At Shopee, it hiked its seller fees while reining in its loss-leading subsidies, promotions, and marketing campaigns. It shut down several of its overseas marketplaces in Latin America, India, and Europe.

On the gaming front, it focused on monetizing Free Fire's existing players instead of growing its user base or developing new games. It also curbed its investments in its smaller fintechs.

Yet all of those cost-cutting moves could also narrow Sea's moat against its top competitors. Its commitment to reining in Shopee's spending coincides with Alibaba's increased investments in Lazada, which only fell behind Shopee in Southeast Asia during the pandemic.

Garena's commitment to propping up Free Fire instead of launching fresh games could also weaken its competitive position in the cutthroat mobile gaming market.

Lastly, cutting its fintech investments -- which had been aimed at expanding its SeaMoney digital wallet and other payment services -- could erode its defenses against Lazada's HelloPay, which is integrated with Ant Group's AliPay and other digital payment platforms.

Its past mistakes are becoming easier to see

Sea's slowdown and abrupt cost-cutting suggests it didn't capitalize on its growth spurt during the pandemic to set up the foundations for its future. Unlike the Latin American e-commerce leader MercadoLibre, which pumped a lot of its cash into the expansion of its own fulfillment network to solidify its control of the region, Sea spent a lot of its excess cash on Shopee's expansion into other saturated overseas markets. As a result, Shopee remains heavily dependent on third-party logistics services and partners across its core markets in Southeast Asia and Taiwan.

But throughout the first half of the year, Sea gradually ramped up its investments in Shopee's first-party logistics network. These improvements include hundreds of new self-service lockers as well as new delivery scheduling and tracking features. Still, the bears will say it should have implemented those sweeping changes several years ago.

Is it too late to buy Sea's stock?

For the full year, analysts expect Sea's revenue to dip 2% to $12.2 billion as it generates a net profit of $671 million, compared to a net loss of $1.7 billion in 2022. Based on those estimates, Sea looks cheap trading at less than two times this year's sales.

Unfortunately, the company's mistakes are tough to ignore. It balanced its entire business on a single hit video game for far too long, neglected the expansion of Shopee's logistics network in Southeast Asia while pursuing a costly (and largely unsuccessful) overseas expansion, and it's focusing on boosting its profits when it should be far more worried about its long-term growth.

So Sea has a lot on its plate as it works to regain investor confidence. In light of these struggles across its entire operation, investors should hold off on buying this beaten-down stock as a turnaround play.