Sea Limited Is A Good Asia Play In The Time Of COVID-19

Summary

• SE is in the right arena of online commercial activity in a time of lockdown.
• The strong backing of Tencent cuts investor risk of investing in SE but allows an investor to avoid exposure to high-risk China.
• Recent results were well received by the market.
• Long-term debt seems manageable for a company investing in long-term growth.

Sea Limited (NYSE:SE) hits the right buttons short term in this time of COVID-19. Its main product areas are online gaming and online shopping with future growth earmarked for digital financial services.

In the long term as well, these are organic product growth areas. Being mainly focused on Southeast Asia, it is operating in a macroeconomic growth area.

The recent results were well received by the market even though net profitability looks to be some way off.

The backing of Tencent (OTCPK:TCEHY) is key, in my opinion. SE is a rapidly growing high debt company, but it has the financial and product backing of the world's largest gaming company. My article in March detailed what the company does and how it benefits from the tie-up with Tencent. Investors have an Asian opportunity backed by Chinese money but without the higher risk profile of a China play as the U.S. election looms.

Stock Price

The one-year stock chart shows how profitable SE has been to investors:

Source: Charles Schwab

The year-to-date stock chart shows how the company has not been derailed by the pandemic:

Source: Charles Schwab

Of course, a prospective investor may always wonder if they have missed the boat after such a strong stock rise. Its market cap in 2016 was US$3.8 billion. Now, it is US$36.8 billion. Additionally, it should be noted that some of the rise in the stock price may have been caused by a short squeeze.

For me, there is a lot of future upside over a period of years making the stock still a long-term investment. One way to play the stock for a cautious investor might be to wait for any generalised COVID-19 induced sell-off in stock markets in which SE would be collateral damage and buy then.

The main analysts covering the stock are positive. Seven have a Buy rating and one has a Hold rating. However, their consensus price is below the current stock price. That is another case of analysts playing catch-up and does not help investors much really.

Q1 Results

The earnings presentation can be viewed here.

Year-on-year Q1 revenue rose 58% to US$913.9 million. This was on the back of a very strong gaming performance led by their "Free Fire" game.

Year-on-year Q1 gross merchandise value on their "Shopee" platform rose 30% to US$512.4 million.

Digital financial services had adjusted revenue up 278% at US$10.7 million.

Net loss rose to US$280.8 million.

This loss was on the back of strong investment in new growth with concomitant increased expenses:

Source: SE

The cash position was fairly stable:

Source: SE

It should be noted that much of the debt is long term, with a healthy current ratio and quick ratio, as illustrated here:

Source: Charles Schwab

The fact that SE is on the NYSE exchange might be seen as an advantage to U.S. investors. Many of them may have doubts about the clarity of results from Asian companies, especially those from China.

Subsequent to the results, the company confirmed a US$1 billion convertible senior note at favourable rates due in 2025. This will be partly used to pay a 2023 Notes Exchange obligation and partly used for business growth and possible acquisitions. It was obtained at a favourable rate of 2.375% reflecting confidence in the company. It is believed, but not confirmed, that Tencent took up part of the offering.

This offering may not be unconnected with SE being one of the applicants to get a Digital Banking licence in Singapore. SE is quite favoured by the market to be one of the successful applicants. It is understood there were 21 applicants for 5 licences and a decision had been expected in June. This may have been delayed due to the pandemic.

A successful outcome would presumably be positive for the stock price and for the company's credit indemnity barriers when it comes to financing merchants. If it were successful, SE would need to set aside S$1.5 billion (US$1.1 billion) by the 5th year of setting up the business. The possibility, and it is only a possibility, is certainly another potential positive for the stock price.

Reaping The Tencent Advantage

Fast-growing leveraged companies making a loss are not every risk-averse investor's favourite. SE has a lot of security built in by its relationship with Tencent. It also has a lot of future business growth built in from this relationship. Optimistic SE bulls regard it as Asia's Amazon (AMZN) with long-term growth to reward stockholders.

My article in March detailed the strengths of Tencent. This Chinese behemoth has performed quite well since my article considering the pandemic and trade tensions between the U.S. and China:

Source: Charles Schwab

Tencent itself is a darling of bond investors. This month, it had the largest non-bank bond sale in Asia, raising US$6 billion in offerings rising up to 40 years. It is reported that investors expressed interest to a value of US$36 billion.

Tencent has enormous advantages as the world's largest gaming company. It has its tentacles into an amazingly wide range of Chinese business activities. Much of this is through its platform of 1.16 billion "WeChat" users. However, short term, there are macro risks in any Chinese company as the Trump administration ramps up anti-Chinese rhetoric ahead of the election in November.

A policy of taking minority stakes in overseas companies for what is already quite a low-profile company is advantageous to Tencent. Indirectly, it is an advantage to SE in these days of US-China tension. The gaming side for Tencent includes investments in Activision Blizzard (ATVI) and ownership of the very successful Riot Games. This becomes an advantage for SE as well.

Tencent has over 150 investments overseas, and its total investment value is said to be in excess of US$59 billion. The broad sweep sometimes means it is competing with itself: for instance, it has a stake in Vietnamese gaming company VNG.

The other Chinese giant in this area of activity is Alibaba (BABA). Alibaba and Tencent are fighting it out for domination not just in China but all-around Asia.

SE is Tencent's proxy in this battle and SE can only benefit from it. China's largest gaming company in partnership with Southeast Asia's largest gaming company is a formidable combination.

Some analysts have questioned SE being too reliant on just a few high-selling games. This seems to me to miss the point. SE has a guaranteed stream of new games to choose from coming from its Chinese partner, in addition to those it develops itself. Of course, the success or otherwise of future games is never knowable.

On the gaming side of the company ("Garena"), SE has the right of first refusal in Southeast Asia for any games developed by Tencent. The agreement was signed in 2018 and, initially, set for a 5-year period. It refers specifically to the countries of Indonesia, Taiwan, Thailand, the Philippines, Malaysia, and Singapore. In practice, it expands out to other countries where SE has a meaningful presence. There is no reason to think that Tencent would not want the relationship to continue long into the future. It first took a stake in SE in 2010, long before the company debuted in New York in 2017.

A recent example of fruitful collaboration has been the success of "Call of Duty: Mobile". Previous games in their agreement included "Arena of Valor", "League of Legends", "Honour of Kings", and "Ring of Elysium".

Their "Free Fire" offering has a peak active daily user base of over 80 million people. It is the highest-earning mobile game of its type in Southeast Asia.

eSports is another area growing very rapidly around the region in which SE and Tencent are both strongly invested. To show the way this is going, a "Global Sports Federation" was set up in December 2019. This is to eSports what FIFA is to football. Its aim is to grow and regulate the sport. The organisation is based in Singapore and its main backer is Tencent and its vice-president, a Tencent employee.

There are over 500 million consumers in the Southeast Asia region. SE's gaming products do though reach out to several other markets around the world. The company is focused on Latin America, India, Russia, and the Middle East. This is seen, for example, by its success in bringing Tencent game "Speed Drifter" to Latin America. It has South American football stars James Rodriguez and David Ospina as eSports ambassadors there.

On the shopping side of the company ("Shopee"), SE has strong backing from Tencent while Alibaba backs the rival "Lazada" brand. As I detailed here, Shopee works on a different basis from Lazada and Amazon in the region. It is a virtual retailer that connects customers to third-party retailers. The fact that it does not hold inventory may lead to higher areas of profitability in future years.

Shopee's sales rose to almost US$1 billion in 2019. That represented 224% revenue growth. According to management comments, they have naturally seen more customers coming online during the lockdown in various countries in the region. Management admitted time would tell whether this surge was a permanent or a temporary feature. It would, however, suggest that Q2 figures for Shopee will show further strong growth. They were encouraged by the fact that shoppers had been active across the whole range of merchandise types.

A negative feature of the pandemic has been cross-border logistics problems. The ASEAN grouping has got virtually nowhere in its theoretical objective of being a free trading zone without barriers.

The Shopee division is, of course, still some way off being profitable. Some have criticised the company for using its gaming profits to subsidise its shopping division. This seems a fair strategy as long as there is a long-term viable road to profitability. Bulls would say that Amazon received similar commentary in its early days.

One might also question the rapid rate of spending Shopee continues to build up. Some of these seem potentially overambitious, as illustrated below:

Source: Shopee

One could question whether a US$37 billion company can afford, or need, the world's second highest-earning sportsman to promote online shopping

It is fair to question whether the company has a clear path to profitability in its Shopee division. For me, this is the biggest negative factor for the company amongst many positives. If it makes it though, then it would be a very substantial revenue driver for years to come.

The "SeaMoney" digital financial services division is seen by the company as the natural third leg of growth. It comprises several services specialising in e-wallets, payment processing, and micro-lending.

As detailed by Group Chief Corporate Officer Yanjun Wang at the analyst call, its integration with the Shopee platform has been put in place in the past year. Wang referred to "the three core businesses" of online gaming, online shopping, and digital financial services.

In Southeast Asia, as a whole, there is fast-growing young population in growth economies that promises rapid increasing numbers of potential online customers.

Conclusion

For me, SE ticks all the right boxes for a growth company. It is in the right product areas of the digital world. The vertical integration across their three product areas is a bonus. It is concentrated in the right geographical growth area of Southeast Asia. My article here detailed some of the macro growth factors of the region. It looks like Asia is recovering better from the economic effects of the pandemic than Europe and North America, though it is a fluid situation. The only major long-term doubt is a clear route to profitability for its Shopee division.

SE has strong financial and product backing from Tencent. This is key to their future growth and stability. It provides a way to invest in Asian growth without the current China risk. Of course, COVID-19 makes any stock investments more uncertain than usual at the present time. That does not impact the long-term growth prospects of the company. Changes in people's way of life because of the pandemic may just enhance such prospects.

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.