- Sea's three operational areas of online gaming, online shopping and digital financial services are favorable in this virus emergency environment.
- Short-term indicators of company are satisfactory and long-term indicators are very promising.
- Q4 results showed continuing financial improvement but online shopping subject to continuing cost increases.
- Application for Digital Banking Licence in Singapore a promising further revenue possibility.
- There are other companies where forthcoming developments in China might make them Buys at this stage but Sea is the lowest risk in my estimation.
The old mantra is "sell in May and go away". Those who adopted "sell in February and remain very wary" will be pleased with themselves. The best advice in this viral epidemic may well be just to hunker down and wait for the epidemic to come under control.
For those of a more adventurous bent there are options. The best Asia play I know would be for Sea Ltd. (NYSE:NYSE:SE). Its triple focus on online gaming, online shopping and digital financial services is about as good as you can be in this crisis. There is likely to be a "stay at home" economy for months to come.
Its recent results have been impressive. Its "Garena" gaming platform and its "Shopee" platform have gained a lot of traction around Asia.
It has applied for a digital banking licence in Singapore. It is one of 21 companies to do so and it is expected that 5 will be chosen. The company hopes its existing financial services division will be a persuasive factor. Its Singapore domicile may also help.
There are other possible COVID-19 plays with Chinese connections which I mention briefly below, but Sea is the most promising.
Sea the Company
My article in January emphasized how the Q4 earnings would tell us a lot more about progress towards profitability on its loss-making shopping platform. The article also detailed the advantage the company has through its focus on the growth areas of S-E Asia in particular. Its backing from Chinese giant Tencent (OTCPK:TCEHY) is a great source of financial strength and future growth. This should not be under-estimated.
As elsewhere around the world, Tencent and Alibaba (NYSE:BABA) are fighting it out through client companies. This is a bit like the colonial empires of old dealing through client States. Tencent seems to be winning this one through the Shopee and Garena platforms. Shopee is the largest such platform in S-E Asia. Last year it was the world's fifth most downloaded shopping app according to Sea management. Alibaba is competing through its wholly-owned "Lazada" arm.
On the gaming side, Sea has a close partnership with Tencent and a Right of First Refusal Agreement for Tencent developed games in S-E Asia. The two are co-operating closely on the very rapid rise of e-sports around Asia.
The two Chinese giants are competing for the 500 million consumers of S-E Asia. The e-commerce market in the region is calculated to be worth US$100 billion now, increasing to US$300 billion in the next few years. The COVID-19 virus may have given this figure a short-term boost as people stay away from shopping centers.
Sea has also been expanding successfully in gaming across geographical areas. This expansion has been centered around its mega-hit "Free Fire" game. This is one of the top five most downloaded games globally. It has seen especially strong growth in India in recent quarters. Management has stated that the game has done a lot to drive the company's Latin America growth. Half of the game's revenues now come from a combination of Latin America, India, Russia and the Middle East.
A third string to the company's bow has been developed in recent years through their digital financial services division "Sea Money". Their popular app brands comprise "AirPay", "ShopeePay" and "Shopee PayLater". They provide e-wallet services to consumers and to small businesses, payment processing and micro-lending. The monetization efforts of this division have been bearing fruit in Q3 and Q4.
Sea Q4 Results
The stock price has shown great returns for investors. The last year is illustrated below:
The stock price rose 247% in calendar year 2019. However to me this does not mean investors are too late to join the party. Future potential is always more important for investors than past performance. The long-term future looks bright for Sea, despite the likely economic recession that COVID-19 will engender.
In Q3 Shopee had shown a growth in orders of 103% year-on-year. The big concern then was how general & administrative expenses and R&D expenses would play out going forward. In fact, in Q4 these did continue to increase, as illustrated below:
On the gaming side, in Q3 SE had launched "Call of Duty: Mobile" in conjunction with Tencent and Activision Blizzard (NASDAQ:ATVI). This seems to have become another strong driver of growth.
The Q4 results continued Sea's history of beating analyst expectations in both revenue and profitability. The full results can be studied here. Main points to note are:
* Revenue at US$909.1 million, up 133.5% year on year. This beat analyst expectations by US$35.36 million. The figures are shown here:
* For 2020, the company is guiding for digital entertainment revenues to reach US$1.9 billion to US$2.0 billion and for e-commerce revenues to reach US$1.7 billion to US$1.8 billion.
* Q4 GAAP EPS of -US$0.53 beat analyst expectations by US$0.05 cents.
*Total gross profit at US$264.9 million compares to a loss of US$8.00 million in Q4 2018.
* Digital Entertainment showed an adjusted EBITDA of US$266.4 million, up 152% from the US$105.2 million of the previous year. The growth of users has been spectacular as the illustration below shows:
* Shopee showed an adjusted EBITDA loss of US$306.2 million. This compared to a loss of US$277.5 million year-on-year. Gross margins improved but Sales & Marketing expenses increased 38% to US$254.7 million. The company has still to rein in the high upfront expenses of Shopee before the market can be sure that this is going to become an overall profitable business. In Q4 the division did become gross profit positive. Management put this down to economies of scale and improved operating efficiencies. The improvement in turnover and gross margins should re-assure investors that the increased costs have a purpose and an end in view. The favorable stock price reaction seems to evidence this.
* Digital entertainment increased QAU (quarterly annual users) by 64.1% to 354.7 million.
* Full year total adjusted revenue was up 178.1% to US$2.9 billion.
* Full year total adjusted EBITDA was -US$178.6 million compared to -US$694 million in full year 2018.
At the analyst call Chairman and CEO Forrest Li summed it up as follows:
"We believe that our core businesses of e-Commerce, Digital Entertainment and Digital Financial Services represents the three largest opportunities in the digital economy of our region."
Other Possible COVID-19 Plays
To me, Sea is a good Asian play with or without the COVID-19 virus. There are some other plays where events in China will be the key influence during this epidemic.
* Tencent is a Chinese giant which I have written about before. It is the world's largest gaming company. It has a strong focus on music. It is a giant of the Internet payment system through its over 1 billion subscribers on WeChat. My article in August last year detailed this. The company is of course at the epicenter of the virus in China. It can however be seen as a possible Buy for two reasons. Firstly, it can be argued that China has seen the worst of the outbreak. Of course that is an unknown, and we should listen to epidemiologists rather than writers on SA to get a better idea of that. Secondly, it is similar to Sea in that its main strengths are online, and we are likely entering a period of a "stay at home" economy. Its link with Sea is part of its international expansion and move away, perhaps, from over-reliance on its domestic market.
*Gilead (NYSE:GILD) is a Pharma giant which has not been very kind to its shareholders in recent years. Its 3 year chart is illustrated below:
It has certainly under-performed the sector. It can be seen as on some ways a victim of its own success in bringing out drugs that have cured long-standing conditions, in particular hepatitis C.
Its "remdesivir" anti-viral drug is seen as a possible vaccine for COVID-19. The drug has had promising indications for ebola, for MERS (Middle East Respiratory Syndrome) and for SARS (Severe Acute Respiratory Syndrome) as well as for COVID-19. Its action in blocking an enzyme needed for the virus to replicate is being tested around the world. The drug has not however been approved in clinical trials for use anywhere in the world as yet. The company is said to be ramping up supply and some stocks have been provided overseas for use on an emergency and free of charge basis. Testing is being accelerated in China where testing regimes are very different from those adopted by the FDA (Federal Drug Administration) or EMA (European Medicines Agency). So further news on any efficacy is likely to come from China. Analysts have been arguing as to whether such a vaccine would in fact be net positive for the company's profitability.
* Generex Biotechnology (OTCQB:GNBT) is a small pharma development company which has also not been kind to investors in recent years. The 3 year stock chart illustrates this:
It has however received a contract from Chinese authorities for testing of the company's li-Key peptide vaccines for the virus. These have been previously tested against other potentially pandemic viruses. The contract includes an upfront fee and royalty payments if a successful vaccine is developed in China. There will no doubt be other such companies making similar arrangements. Investors can draw their own conclusions as to the likelihood of success.
Sea has a possible short-term benefit compared to other stocks in a tough time for stocks. 2020 is likely to be a "stay at home" economy in many ways. For me it has an undoubted benefit long term in the quality of its business. It is focused on key geographical growth areas. It has a further potential for rapid growth if it is successful in its efforts to garner one of Singapore's digital banking licensees. E-shopping, gaming and digital banking in the rising market of S-E Asia is a heady cocktail.
This article was written by
Analyst’s Disclosure: I am/we are long SE TCEHY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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