Sea Ltd.: It's Not Growth At All Costs - Buy On Market Overreaction

Summary

• Sea Limited posted a decent FQ4 card. However, the market was disappointed with Garena's FY22 guidance.
• But, these investors may have also missed out on management's commentary on its path towards profitability. It's getting closer.
• We discuss why investors should add SE stock given the market's overreaction over Garena's numbers.
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Investment Thesis

Sea Limited (NYSE:SE) reported its FQ4 earnings card yesterday. Unfortunately, what seemed like a decent card with robust e-commerce and FinTech momentum was overshadowed by its FY22 guidance.

Sea guided Garena bookings to decline to $3B (midpoint) in FY22, from $4.6B in FY21. It represented a marked 34.8% YoY drop. Sea attributed it mainly to growth normalization trends from post-pandemic reopenings. It also highlighted the uncertainty caused by the recent Free Fire ban by the Indian regulators on "security concerns" linked to China.

Nevertheless, the company also unveiled notable commentary on its path to profitability for its Shopee e-commerce and its SeaMoney FinTech segment. Investors had been concerned whether Shopee would continue to burn cash "unsustainably" in its bid to gain market leadership. Furthermore, the company also discussed in detail Shopee's robust momentum in Brazil for the first time. Previously, Sea has been reticent to share insights on its foray into MercadoLibre's (MELI) most prized geographical market. But, Shopee's nascent gains demonstrated that Sea has a viable and formidable market penetration strategy even when facing a dominant incumbent like MercadoLibre.

Therefore, Sea was reminding investors that it's still growing fast and is achieving self-sustainability in its core markets. We discuss why investors should capitalize on the market overreaction to add exposure now.

SE Stock Key Metrics

SE stock valuation metrics (TIKR)

SE stock consensus price targets Vs. stock performance (TIKR)

SE stock has been marked down significantly from its all-time high of $372 in October. Notably, Sea investors have experienced a significant collapse in its stock price, as it lost 66% of its value over the last three months. Beset by the reopening headwinds, Tencent's (OTCPK:TCEHY) divestment, and its recent India ban, early SE investors seemed to have cashed in on their gains rapidly.

But, we think the steep sell-off has also presented long-term investors with a significant opportunity to add exposure. SE stock is trading at less than 5x NTM Revenue (5Y mean: 8.5x). Nevertheless, its weak FCF yield demonstrates that Sea Limited has not been calibrated for FCF profitability yet. But, the company has also indicated a viable path towards profitability in 2022 for its core markets. Therefore, we think its profitability guidance is material and highlights the strength of Sea's long-term execution prowess.

Nevertheless, we agree that the consensus estimates and price targets (PTs) have been too optimistic. Sea wasn't affected by the reopenings headwinds initially as its core markets have not accelerated their reopening cadence. However, the accelerated reopenings in Q4'21 resulted in significant headwinds on Garena's growth and profitability. As a result, the market has been spot on while the average and conservative PTs have gotten it wrong recently. Given the decline in Garena's growth and profitability, we expect SE stock's PTs to be further revised downwards in the near term.

Where is Sea Limited Heading in 2022?

Garena Bookings (Company filings)

The focus on Sea Limited was obviously on Garena. Garena reported an underwhelming FQ4, in which it posted Bookings of $1.1B. Moreover, while its full-year Bookings of $4.6B were up 44.3% YoY, it guided for just $3B (midpoint) in Bookings for FY22. Therefore, it represented a significant and unexpected decline of 34.8%.

Garena adjusted EBITDA share of Bookings % (Company filings)

Furthermore, Garena's adjusted EBITDA margins (share of Bookings) have also been trending downwards. Therefore, Garena has certainly been hit by weaker overall engagement, which has also significantly impacted monetization. As a result, Garena reported 54.8% in adjusted EBITDA margin in FQ4 compared to 65.5% in the previous year. Therefore, investors were justifiably concerned whether Sea Limited can still support its high-growth Shopee machine as its main cash cow slows down considerably moving forward.

Shopee GMV (Company filings)

Shopee take rate % (Company filings)

But, when we thought all hope was lost, Shopee came along to save the day this time. Why? Even though we have witnessed a sharp decline in e-commerce growth in the US, the growth in Shopee's core e-commerce markets remains robust. Furthermore, it is also making significant headway in LatAm, particularly in Brazil, where it has garnered significant traction. As a result, Shopee posted $18.2B in gross merchandise value (GMV) in FQ4, up 52.9% YoY. Notably, the company has also been raising its take rate considerably as it gains market leadership. It has become the #1 shopping app across most of its core markets. Therefore, Shopee is now ready to monetize for profitability. And, we think that's awesome news! CEO Forrest Li emphasized (edited):

We currently expect Shopee to achieve positive adjusted EBITDA before HQ costs allocation in Southeast Asia and Taiwan by 2022 and SeaMoney to achieve positive cash flow by 2023. As a result, we believe that by 2025, cash generated by Shopee and SeaMoney collectively will enable these two businesses to substantially self-fund their long-term growth. We are also very excited to see Shopee fast gaining traction in Brazil. Just two years after entering the market, Shopee Brazil recorded more than 140M gross orders in FQ4, growing at close to 400% YoY. (Sea Limited's FQ4'21 earnings call)

We think that's a significant development. Notably, Brazil's contribution towards Shopee's topline is less than 5%. Therefore, the company can channel its resources to compete more effectively and gain share in Brazil. In a previous MercadoLibre article, we also shared that LatAm is a fascinating region because of its high take rates. We emphasized: "Readers can easily observe the incredible monetization opportunities that are available in LatAm, and we can easily understand why Sea Limited is so keen to carve out MercadoLibre's leadership there because it's just so attractive."

Notably, management also took the opportunity to add more color on its progress and strategy in Brazil. Group Chief Corporate Officer Yanjun Wang articulated (edited):

And another growth area that we focus on is Brazil. We also shared that when we enter into the market, we focus first on user growth and then order growth and then market leadership and positive unit economics over time with scale. Now when you look at Southeast Asia and Taiwan, we're probably the first large e-commerce player to show profitability in this region. But in Lat Am, all the existing major players are quite profitable. So the profitability model for the LatAm market is highly proven. (Sea Limited)

Is SE Stock A Buy, Sell, Or Hold?

There's no doubt that SE Stock could still be in the penalty box as investors could wait for a quarter or two to observe its execution towards profitability. It's a significant change in its execution, coupled with the moderation in Garena's growth. Therefore, there's still an element of execution risk that some investors could be concerned with.

However, we see it differently. With the stock trading at less than 5x NTM revenue and moving closer towards profitability, the outlook is looking more favorable for long-term investors. If you can tolerate near-term volatility, we encourage you to capitalize on the market's overreaction and add SE stock.

Therefore, we reiterate our Buy rating on SE stock.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SE, MELI either through stock ownership, options, or other derivatives. 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.