Is the Worst Over for Sea Limited Stock?

Sea Limited (SE 0.05%) has been a problem child for investors over the last two years as evidenced by the 88% decline in the stock price from its peak of $367.

Investors are concerned about whether Shopee can be a profitable business long term and whether Garena can stem the decline in its revenue. While these concerns are real, Sea delivered an encouraging third consecutive quarter of net profits.

So can investors finally declare that the worst is over? Let's explore that further.

Shopee delivered another profitable quarter, but growth declined materially

One of investors' biggest complaints about Shopee, the e-commerce segment, was the company's aggressive use of shipping subsidies and discount vouchers to grow its marketplace during the pandemic.

Such a tactic led to massive revenue growth, up 160% and 136% in 2020 and 2021, respectively. But at the same time, Shopee's strategy resulted in enormous losses with adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) coming in at negative $1.3 billion in 2020 and negative $2.6 billion in 2021.

To curb its excessive losses and prove it can be a viable business, Shopee pivoted its strategy from growth at all costs to emphasizing profitability and self-sufficiency. And so far, it has delivered some encouraging results.

For example, Shopee's adjusted EBITDA turned positive in the fourth quarter of 2022 and has remained so since then. In the second quarter of 2023, revenue grew 21% year over year even though sales and marketing expenses declined 36%. While three profitable quarters may still be insufficient to fully gain investors' confidence, Shopee has demonstrated significant progress.

Still, the strategic pivot did take its toll on Shopee's growth. For instance, the 21% revenue growth last quarter marked a steep decline from 51% growth in the same period last year. To address this slowdown, the management team has started to invest more aggressively again, especially now that Shopee has proven the viability of its business model.

In short, Shopee has shown over the last three quarters that it can be profitable. And while the management team is ramping up growth investments, it will likely balance its priorities to make that growth sustainable.

Garena's revenue continued to fall, but critical metrics stabilized

Unlike Shopee, Garena had no issue with the viability of its business model. It was already hugely profitable, and the pandemic gave its business another massive boost as hundreds of millions played its flagship game Free Fire during the lockdown.

But after the gaming company reported peak bookings at $1.2 billion in the second and third quarters of 2021, bookings went south in the next two years. Last quarter, bookings totaled $443 million -- less than 40% of its peak bookings and down 4% from the previous quarter. Revenue also declined 41% year over year.

While Garena's financial metrics continued to weaken in the latest quarter, there were signs of stabilization. Quarterly active users improved for the second consecutive quarter to 555 million after hitting a multi-year low in the fourth quarter of 2022. In addition, quarterly paying users grew 15% quarter over quarter, resulting in a 0.2% increase in the quarterly paying user ratio to 7.9%.

In other words, Garena has improved its engagement levels in the last two quarters. And if these operational metrics continue to strengthen going forward, its financial metrics will likely track this trajectory accordingly.

Investors may finally see some light at the end of the tunnel for Garena.

So, is the worst over for Sea Limited?

Overall, I think Sea Limited's turnaround remains a work in progress.

While Shopee has delivered its third profitable quarter on an adjusted EBITDA basis, Garena still struggled to halt its revenue decline.

Still, there are early signs that Sea Limited has reached the bottom and may deliver improving numbers in the coming quarters. For example, I'm hopeful that Garena's engagement metrics will strengthen from here on, which could lead to improved financial performance.

In short, investors still need a few more quarters of sustainable improvements to declare that the worst is over for Sea Limited.