Sea Limited's Shopee Turnaround Remains a Work in Progress

Investors were delighted when Sea Limited's (SE 0.05%) e-commerce business, Shopee, reported its first quarter of positive earnings before interest, tax, depreciation, and amortization (EBITDA) at the end of 2022, affirming the validity of its business model.

But just three quarters after the company reached that significant milestone, Shopee plunged back into the red again in the third quarter of 2023, dashing investors' hope of continued profitability.

Shopee proved that its business model works

When the pandemic hit in 2020, Shopee was well-positioned to benefit from the surge in e-commerce demand. Not only that, Sea went all-in by investing heavily in subsidies and promotions to grow its market share. That year, revenue jumped 160%, followed by another 136% jump in 2021.

Shopee could invest heavily thanks to the enormous cash flow from its sister company, Garena, and its access to cheap external funding. Unfortunately, both sources dried up by 2022 as Garena faced a massive decline in revenue and profitability in the face of reopening economies, and external funds became scarce and expensive.

Without funding, Shopee had to change its course from growth at all costs to survival. And it had to execute its plan quickly since it was burning vast amounts of cash. For instance, Shopee's EBITDA loss for 2021 was $2.6 billion when Sea had $10.2 billion of cash on its balance sheet.

Fortunately, Shopee's pivot to profitability and self-sufficiency has been quite successful. It reported a positive adjusted EBITDA of $196 million in the fourth quarter of 2022, compared to a loss of $878 million in the year-ago period.

Moreover, the EBITDA turnaround occurred just two quarters after the strategy shift. Shopee continued to deliver positive EBITDA in the following two quarters.

Shopee's three consecutive quarters of positive EBITDA prove two things. One, the management team can execute quickly on new priorities and initiatives. Two, Shopee's e-commerce marketplace business is viable.

But the competition brought it back into the red

The e-commerce industry in Southeast Asia has always been competitive with companies like Lazada, Tokopedia, and Shein trying to grow their market share at the expense of Shopee. Lately, the competitive landscape has intensified further as massive and well-funded players like TikTok and Temu entered the scene.

In particular, the growth in livestreaming e-commerce, led mainly by TikTok, has become a massive threat to incumbents like Shopee and Lazada. According to Momentum Works, TikTok's market share in 2023 could reach 13.2%, tripling its share of 4.4% the previous year. And while Indonesia recently banned TikTok's livestreaming e-commerce business, the tech company will likely reenter the Indonesian market in other forms such as partnerships with existing players.

As the leader in this region, Shopee is not sitting idle. After a few quarters of cost-cutting, the e-commerce company is again investing to grow its market share. For instance, it roughly doubled its sales and marketing expenses from $432 million in the second quarter to $862 million in the third quarter.

The considerable investment resulted in stronger growth. For instance, gross orders were up 13% year over year and 24% quarter over quarter. Similarly, gross merchandise value (GMV) increased 5% and 11%, respectively. The downside was that EBITDA turned negative again, down from $150 million in the second quarter to negative $347 million in the third quarter.

In short, Shopee is investing aggressively to defend its turf against competitors like TikTok. While we cannot predict how the competitive landscape will evolve, we can be sure that it will be costly for Shopee. Worse, this situation could last for a while.

What it means for investors

Shopee's recent financial performance suggests its turnaround remains a work in progress.

While the e-commerce industry prospects remain bright in Southeast Asia and Brazil, Shopee must demonstrate it can sustain its market leadership as competition intensifies. Hence, the next few quarters will be crucial for the company to prove that it can sustain or grow its market share and revenue while keeping its losses in check.

Investors should monitor Shopee's key metrics like GMV, number of orders, revenue, and EBITDA. Ideally, we want to see positive progress on all fronts, or at least respectable growth in GMV and revenue, which is commensurate with the investment size.

Besides, investors should keep an eye on potential red flags like a massive decline in its cash balance or a jump in losses at Sea's group level, a signal that Shopee's elevated spending may not be sustainable.