Southeast Asian super-app Sea Limited (SE 0.05%) was a darling of the pandemic, with shares reaching as high as $372.70 in late 2021. But a post-pandemic hangover in e-commerce and video games combined with increased Chinese competition led this former darling to lose more than 90% of that value at one point.
Yet, the stock saw strong gains after its fourth-quarter earnings release on Monday, March 5. Still, even after this recent surge, Sea's stock remains 85% below those all-time highs.
Sea's fourth-quarter report showed all three of its businesses either stabilizing or growing strongly. With a recovery in sight, is it possible for Sea to reach its 2021 highs ever again?
Sea's biggest profit center is turning up again
The biggest discrepancy in business trajectory between the pandemic era and the current one lies in Sea's mobile games or "digital entertainment" division, Garena, especially its hit mobile game Free Fire.
Free Fire was released in December 2017 and became the most-downloaded game globally by 2019. Unsurprisingly, gameplay rocketed to new extreme heights during the pandemic when people were stuck at home. However, the post-pandemic reopening, along with the game's ban in India in February 2022, conspired to plunge Garena's post-pandemic revenue and earnings.
Garena's quarterly bookings plunged from a peak of $1.2 billion in the third quarter of 2021 to a trough of just $443 million in the second quarter of 2023. Given that Garena is Sea's highest-margin business, it's no wonder the company's stock felt the pressure.
However, Free Fire isn't going away. In fact, it appears to be an "evergreen" brand that could bring in recurring revenue for years. While people aren't spending as much on the game as they were a couple of years ago, Free Fire was still the most downloaded mobile game in 2023, according to Sensor Tower. And it appears this high-margin revenue is stabilizing now, with Garena's bookings growing sequentially each of the last two quarters.
On the conference call with analysts, management noted it's currently seeing improved user acquisition and retention in Free Fire and now forecasts double-digit growth in active users and bookings in 2024. Moreover, since Sea developed Free Fire itself, it's higher margin than other games it publishes for third parties.
Not only that, but Sea's chief corporate officer, Yanjun Wang, noted that this outlook doesn't incorporate the return to India. Yet, Free Fire was cleared to return to India after data security changes were made last August. Wang noted Sea is still making changes to the localized content for Free Fire India, so if the game is rereleased this year, there could be upside to that growth outlook.
To be sure, Garena's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) is down from $2.8 billion in 2021 to just $921 million in 2023. But if that is the trough of this downturn, Garena should get a growth multiple on those profits. Even putting a 15 to 20 multiple on perhaps $1 billion of 2024 EBITDA would make for half to two-thirds of Sea's entire value today, ignoring the high-growth e-commerce and fintech segments.
Image source: Getty Images.
E-commerce finds the right balance
Like Garena, the Shopee e-commerce segment has also been on a roller-coaster ride. After burning cash but growing really fast through 2021, securing the market lead across Southeast Asia, and penetrating Brazil, Shopee impressively became profitable in late 2022 as management cut marketing expenses and slowed growth. But as competition from Chinese entrants like TikTok made inroads in 2023, Sea pivoted back to investing in growth, especially new features such as live-streaming, in Q2 last year.
But that move looks like it's paying off. Shopee saw its second straight quarter of strong gross merchandise volume (GMV) growth in Q4, growing 15% quarter over quarter and 29% year over year. Meanwhile, while Shopee achieved profitability in early 2023, management's reinvestment led to a sizable segment loss in the third quarter. But in Q4, that EBITDA loss narrowed by a significant 35% and 43% on a per-order basis.
Shopee noted that the reinvestment in live streaming and shipping subsidies had led to a "meaningful gain in market share" in 2023. That's important, as Shopee had already been the market share leader in the region. E-commerce leaders tend to benefit from network effects, as more volume gives them the ability to reinvest in quicker shipping and logistics. Quicker delivery and customer service tend to lead to greater purchase frequency, making for a nice flywheel effect.
Management now says it's seeking balanced ground between growth and profitability, forecasting high-teens growth in 2024, with adjusted EBITDA flipping back into positive territory in the second half of 2024.
Digital financial services are fast-growing and highly profitable
Meanwhile, the most underrated part of Sea could be its digital financial services arm, which grew 24.3% on 27% loan growth last quarter. This segment is also showing really high operating leverage, with Q4 adjusted EBITDA of $148.5 million growing 96.3%, significantly faster than revenue.
Consisting primarily of consumer and small business loans fed by Sea's proprietary data on its Shopee consumers, Sea's underwriting has been excellent, with loans past due by 90 days or greater at just 1.6% of loans outstanding.
For the full year, SeaMoney grew segment revenue by 44%, while profits flipped from a $277.2 million operating loss in 2022 to $490 million in operating income in 2023. Loans grew 27% to $3.1 billion in the year, meaning an average $2.77 billion loan pool for the year. Taking operating earnings and dividing by average loans, Sea was able to make a 17.7% return on assets last year, even while growing very fast.
If, say, the digital financial services wing slows to 20% growth but earns a 20% return on assets, that's still a really good business deserving of a high multiple, too.
Sum of the parts is likely higher
Despite increased investment in Shopee and declines in the gaming business, Sea still made $1.2 billion in adjusted EBITDA last year overall. But in 2024, all three of the businesses seem likely to grow by at least double digits and perhaps by greater than 20%. Moreover, all three businesses look to be gaining operating leverage, with profit growth inflecting higher than revenue growth.
In that light, Sea's $30 billion market cap seems far too low. While getting back to a $200 billion market cap as it did in 2021 may be a stretch, Sea is likely to climb a good deal higher from these lowly levels going forward.
