Sea: Leading Digital Economy Player In Southeast Asia's Fragmented Market

Summary

• Southeast Asia’s digital economy is on the rise, but navigating this fragmented market of various cultures, languages, and rules is relatively tricky.
• Sea has successfully tackled the market through a localization strategy.
• E-commerce, games, and digital financial business are the three main businesses, and all three are firing on all cylinders.
• Growth is expected to continue. E-commerce is still underpenetrated, mobile games is expanding into e-sports, and financial businesses is just getting off the ground.

Sea Ltd (NYSE:SE) has grown tremendously over the past few quarters, and its stock price has jumped six-fold in 2020. Yet, for this Southeast Asian internet company which can be described as Amazon (AMZN), Activision Blizzard (ATVI), and PayPal (PYPL) rolled into one, the growth story is just beginning with all three of its core businesses, namely gaming, e-commerce, and fintech poised to benefit from structural uptrends in Southeast Asia; Southeast Asia has a youthful tech-savvy population with the median age being 30 years, and of the region’s 649 million population, four hundred million are online, 90% of them mobile-first which plays very well into Sea’s highly popular mobile game - Free Fire, and its e-commerce platform - Shopee, both of which were developed with a mobile-first approach from the get-go.

Source: The Straits Times

Southeast Asians are also avid internet users; of the top 10 countries in APAC region by average daily time spent using the internet, six are in Southeast Asia namely Philippines, Malaysia, Indonesia, Thailand, Singapore, and Vietnam. These countries beat out developed nations such as Australia, South Korea, and New Zealand.

Consumer spending in the region is also on a growth path; by 2030, two-thirds of Southeast Asia’s consumption growth is expected to come from increased per capita spending, and the rest from population growth according to McKinsey.

Covid has accelerated Southeast Asians’ shift to digital for both businesses and consumers alike, with more than one in three consumers of digital services using a new online service due to Covid.

With 94% of them intending to continue using the online service post-pandemic, this Covid-induced digital transition is likely to outlast the pandemic, signaling a long-term behavioral evolution rather than a temporary adjustment.

Southeast Asia therefore has several ingredients to support its nascent digital economy. The region’s digital economy is expected to hit USD 300 billion in 2025, tripling in size from USD 100 billion in 2019, representing a CAGR of more than 20% during the six year period 2019–2025, according to a report by Google, Bain & Company, and Temasek.

Sea Ltd. started as a gaming company but having expanded into other sectors namely e-commerce, and fintech, the company has morphed into a major player. With Sea’s three major businesses growing rapidly but offering plenty of runway left for growth, Sea is poised to continue growing and with the company showing indications of combining these disparate businesses into one platform as part of its strategy to dominate Southeast Asia’s growing Super App battle, Sea Ltd. is a player to watch in this space.

Gaming

Sea’s gaming unit, Garena, is a dominant player in Southeast Asia, and the company has been a major beneficiary of Southeast Asia’s blossoming games market where revenues reached USD 4.4 billion in 2019, a 16% growth year-on-year according to Newzoo.

Sea’s gaming unit has seen a consistent increase in user numbers and paying users with its latest quarter seeing quarterly active users for its gaming unit reaching 610 million, a 72% increase while quarterly paying users jumped to 73 million, a 120% increase.

Source: Sea Ltd

This in turn helped boost the company’s gaming revenue which jumped 71% to USD 693 million in Q4 2020, from USD 404 million the same period a year earlier.

A major part of this growth stems from its highly popular battle royale mobile game Free Fire which was the most downloaded mobile game worldwide in 2020 for the second year in a row (it topped the list in 2019 as well), according to App Annie.

The success of Free Fire, which is Garena’s first self-developed mobile game, is partially due to Garena’s local knowledge and understanding of the Southeast Asian market, as well as strong execution. The majority of Southeast Asian gamers play games on mobile, and of the USD 4.4 billion game revenues generated in Southeast Asia in 2019, mobile accounted for more USD 3.1 billion – just over 70% according to Newzoo.

Source: AnimationXpress

Having understood this, Garena’s Free Fire was developed solely for mobile, right from the beginning. Additionally, a major reason for Free Fire’s success in the region has been attributed to the game’s ability to run on almost any mobile device, particularly on low-end handsets that tend to be widespread in less developed regions in Southeast Asia which are not capable of running competing battle royale titles such as PUBG Mobile or Fortnite which require higher end phone specs.

All of the games designs and product features were made specifically for mobile users, clearly aiming for the emerging markets where mobile was dominant, and Garena’s strategy has clearly paid off.

For each market, Garena has a local operations team to understand the market and design future products and features tailored to that market. Garena’s localization strategy is a competitive advantage, which should serve the company well going forward.

Garena, however, is not resting on its laurels. Having carved out its position in this market, Garena is now tackling the challenge of scaling their mobile game beyond this core userbase and towards those with higher end phones. Garena Free Fire “Max” is Garena’s answer to this opportunity. It is currently in testing phase and an official release date has yet to be announced.

Targeting players with top dollar (or at least high spec) handsets could potentially result in greater revenues for Free Fire as they would be relatively easier to monetize than gamers with low-end phones.

It is infamously challenging to convert mobile players into paying players particularly Android users, which is the dominant OS in many emerging markets. However, increasing engagement is likely to lead to higher revenues, and Garena appears to be working on strategies to build its gaming ecosystem and thereby boost user engagement through esports which are growingly increasingly popular in Southeast Asia. According to Niko Partners, “esports is the leading driver of growth” in the games industry in Southeast Asia and with a number of Southeast Asian countries including Philippines, Thailand, Malaysia, and Singapore adopting favorable regulations to incentivize the nascent esports industry, Garena’s strategy of riding on this expanding market to increase user engagement and develop its games ecosystem could pay off.

E-commerce

Sea Ltd. operates Shopee, a leading e-commerce platform in Southeast Asia. Sea’s e-commerce division is the fastest growing business segment with revenues increasing 204% YoY to USD 822 million in 2019, and e-commerce’s share of revenues amounting to 37.8% of total revenues for the year (up from 32.7% in 2018, and 11.04% in 2019). The momentum continued in 2020 with e-commerce revenues jumping 2.5 times to USD 2.2 billion in 2020, according to their earnings call.

Like its gaming unit Garena, Shopee also follows a localization strategy, with the platform rolling out products, marketing promotions, and campaigns that are tailored to the shopping preferences and user behavior of each market in Southeast Asia which varies widely from country to country. For example, during the National Day Sale in Singapore, Shopee launched localizes games and in Thailand where consumers have a general preference for celebrity endorsements, Shopee had nine pop stars as part of the company’s 9.9 campaign (which could be described as Shopee’s version of Alibaba’s (BABA) Singles Day).

The company’s deep understanding of shopping behaviors and consumer culture of each local market in Southeast Asia is a competitive advantage as it works to capitalize on the region’s growth story.

E-commerce penetration still has tremendous room for growth in almost all of Shopee’s markets in Southeast Asia; online retail accounts for just 1% of Southeast Asia’s total retail sales, compared with about 6%-8% in Europe and North America. This indicates ample room for growth for Shopee going forward.

Direct product sales is another area of opportunity for Shopee. Similar to Amazon which owns more than 100 private label brands spanning a broad range of categories from food and beverage, clothing, and electronics, Shopee too also branched out to procuring and selling products directly to consumers having observed an insufficient number of sellers or product variety on the platform.

Based on customer intelligence, Amazon has several private label brands, and its continuing dominance and network effects enable it to gather even more customer intelligence to create superior products that are of value to customers.

Although there have been concerns about Amazon competing against its own merchants, it could be argued that retailers having private label brands is really nothing new, and the motive behind those private label brands is about increasing variety and price ranges on its platform thereby creating a better shopping experience for customers. In any case, it is clear that Amazon’s platform advantage opens new growth opportunities in the retailing space. And as the dominant e-commerce platform in Southeast Asia, Sea Limited is building a similar advantage and market position. Results have already been positive; Sea reported a 129.4% YoY increase in “Sales of Goods” which represent sales of products owned and sold by Shopee, i.e., direct product sales in 2019, and this business segment has seen its revenue share grow from almost 0 in 2017, to 10% two years later in 2019. More noteworthy is that during this period, direct product sale revenues rose a staggering 13,624%, equivalent to a CAGR of 1,071% during the period 2017 – 2019. Although the growth started off from a small base, it is noteworthy that the rapid rise is indicative of the company’s success in identifying products for which demand is unmet and strategically capitalizing on that opportunity.

Fintech

Southeast Asia is following a trend similar to that of China where fintech, notably digital payments, flourished by riding on an expanding e-commerce sector.

Cash is still king in Southeast Asia where as much as 74% of e-commerce transactions are carried out through cash on delivery.

This however is partly because 70% of Southeast Asians are underbanked or unbanked, meaning they have no access to bank accounts, credit services, or other financial services.

Southeast Asia’s digital payments sector is on the cusp of expansion as the governments of several Southeast Asian countries are keen to address to increase financial inclusion and have an encouraging stance towards fintech platforms and solutions.

While Southeast Asia’s fintech landscape is crowded with e-wallet players vying for a slice of the growing pie, given that e-wallets by their nature offer relatively little in the way of differentiation, it is more likely than not that players with e-wallets that are tied to ecosystems that are deeply entrenched among consumers will find greater probabilities of success compared to standalone e-wallet players. The digital payments market in China for instance, followed a similar development with its two leading mobile wallet players riding on existing ecosystems that were widely used; Alipay rode on the growth of Alibaba’s e-commerce platforms while WeChat Pay rode on the back of widely used messaging platform WeChat.

Shopee is adopting a strategy similar to Alipay in that its e-wallet aims to solve a major pain point in e-commerce – trust, or rather the lack of it, between buyer and seller. Shopee’s ‘Shopee Guarantee’ feature essentially offers and escrow system where money from the transaction is released to the seller only upon the buyer confirming receipt of goods, failing which the funds are refunded back to the buyer’s ShopeePay e-wallet. Unlike standalone e-wallet players, Shopee is banking on its organic userbase in Southeast Asia to expand its mobile wallet share, and if China is any guide, Shopee’s strategy could pay off in the longer run.

The company also stands to gain from the synergies among its financial services business and Sea’s other businesses which could potentially increase their userbase and monetization as well.

Sea is going beyond digital payments with SeaMoney having applied and being granted a digital banking license by the Monetary Authority of Singapore. Sea was one of just four players that were granted such a license in Singapore. However, Sea Ltd. was one of just two that were granted a full banking license, the other being granted to a consortium led by ride-hailing startup Grab and Singaporean telecommunications giant Singtel.

The other two digital banking licenses – which are digital wholesale banking (DWB) licenses – were awarded to Ant Financial, and a consortium of Chinese companies namely Greenland Financial Holdings, Linklogis Hong Kong and Beijing Co-operative Equity Investment Fund Management.

Unlike Digital Full-Banking (DB) licenses which allow entities to serve both retail and non-retail customers, Digital Wholesale Banking licenses only allow non-retail banking activities.

The licenses are valid for Singapore only. However, the company shows no signs of stopping; after being granted a digital banking license in Singapore, Sea Ltd. acquired Indonesia’s PT Bank Kesejahteraan Ekonomi Bank (Bank BKE), which are indications of a bigger ambition to expand its digital banking footprint to the rest of Southeast Asia.

Super app

Sea, a consumer internet behemoth which combines games, e-commerce, and payments is among the frontrunners in Southeast Asia’s super app battle. Competition is heating up in this space. However, Sea appears poised to emerge as a major player in Southeast Asia’s rising super app battle, following in the footsteps of Tencent (OTCPK:TCEHY), which is one of its largest shareholders with a more than 20% stake.

Sea has a tremendous advantage in Southeast Asia’s Super App race as it is one of the few players with extensive local knowledge and reach in Southeast Asia, which is a fragmented market of varying cultures, languages, and regulations. With a population of about 600 million people, Southeast Asia is a major opportunity. However, the lack of homogeneity makes it a relatively tricky market to navigate, which poses a barrier to entry.

Risks

As Southeast Asia's digital economy grows, Sea may face potentially meaningful competition. Notable contenders in the super app battle for instance include ride-hailing giants Grab (Singapore-headquartered) and Gojek (Indonesia-headquartered), both of which have a significant presence in Southeast Asia, and are expanding their ecosystem of services beyond ride-hailing and into food delivery, and payments. Unlike Shopee, both lack a meaningful e-commerce business. However, industry consolidation may mean Sea may not have this advantage for long (Gojek and Indonesian e-commerce giant Tokopedia for instance are reportedly in advanced merger talks).

However, it is unclear whether a merger deal could actually materialize as regulatory hurdles, boardroom egos, and other factors can get in the way of a merger (Grab and Gojek for instance were also in merger talks before the deal fell through). Even if it does, Sea's Shopee is still slightly ahead in Southeast Asia's e-commerce race in that Tokopedia is largely Indonesia-based while Shopee has a major presence across all Southeast Asian markets. Shopee's localization strategy has helped it understand nuances related to language, culture, and other factors in Southeast Asia's vast but fragmented market, and it would take quite a while for competitors to catch up.

Financials

Clearly benefiting from Southeast Asia's digital economy growth story, Sea has delivered solid top-line growth, and shows no sign of stopping; revenues soared 163% year-on-year in 2019 to USD 2.1 billion, (compared with 99% YoY growth the previous year when revenues jumped to USD 826 million from USD 414 million a year earlier). According to the latest full year results presented in their latest earnings call, revenues rose 101.1% YoY, registering another year of triple-digit revenue growth rates.

Although net losses have been increasing, it is encouraging to note that Sea's operating margin and net loss margins have been consistently improving over the past few years. Operating loss margins dropped from 121% in 2017 to 40.9% in 2019, and net loss margins dropped from 135% in 2017 to 67% in 2019. The company's improving profitability is likely to be the result of improved business fundamentals as a result of approaching critical mass.

Valuation

Please take note, valuation can be highly subjective so this is not addressed. However, it is worth pointing out that with Sea's stock price being driven up sharply over the past year, Sea may be better suited for long-term investors willing to hold the stock and ride on growth arising from fundamental growth opportunities in the long run.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Please take note this is only one aspect in weighing the attractiveness or non-attractiveness of the companies mentioned as an investment and should not be used independent of other factors. This article examines one segment of the companies' businesses, and other factors such as valuation are not addressed. This article is not a recommendation to buy or sell any stock mentioned.