Sea Limited

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 3/5

Sea Limited is a global consumer internet company operating across e-commerce, digital entertainment, and digital financial services, primarily in Southeast Asia and Latin America.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

The company operates in three core segments: E-commerce (Shopee), Digital Entertainment (Garena), and Digital Financial Services (SeaMoney).

Business Overview

Sea Limited, headquartered in Singapore, is a multifaceted global technology company with a significant presence in Southeast Asia and Latin America. Its business is best understood through the three main segments:

  • E-Commerce (Shopee): Shopee is a leading e-commerce marketplace in Southeast Asia and Latin America, providing a platform for consumers to buy and sell a wide variety of products. It is known for its mobile-first approach, social features, and localized marketing strategies.
  • Digital Entertainment (Garena): Garena is a digital entertainment platform offering online games, particularly mobile games. Its flagship title, Free Fire, is a highly popular battle royale game that has a strong following globally, especially in developing markets. It also offers game development and distribution services.
  • Digital Financial Services (SeaMoney): SeaMoney provides financial services, such as digital payments, mobile wallets, and credit products, integrated into the Shopee and Garena ecosystem. It aims to provide basic financial services to its users, primarily in Southeast Asia and Latin America.

Notably, Sea Limited derives a majority of its revenue from its e-commerce business, Shopee, while a sizable portion is from Digital Entertainment (Garena). Digital financial services, though growing, still contribute less than the other divisions.

Recent Trends in the Industry

The e-commerce and digital entertainment industries are both experiencing rapid changes. E-commerce is becoming increasingly competitive, with more players entering the market, and is affected by supply chain disruptions, increasing online payment options, and the integration of offline and online shopping models. Mobile gaming continues to grow, but is also marked by intense competition, changing consumer preferences, and the need for constant innovation to keep users engaged. The digital financial services sector is driven by the increasing demand for online payments and micro-loans, which are very highly regulated by local governments. Furthermore, Fintech firms must comply with data security and privacy laws that can change frequently.

Financial Performance

Let’s look into SE’s finances using the information from the latest reports, starting with 2023:

  • Revenue: Sea has seen significant revenue growth across all its business segments, although primarily driven by e-commerce. The Company’s total revenue increased from $10 billion in 2021 to $12.4 billion in 2022. Its operating revenues, driven by e-commerce, digital entertainment, and digital financial services, increased to $13.1 billion in 2023
  • Profitability: The profitability of the company is heavily tied to the e-commerce segment. The cost of sales, while still a big chunk of revenue, has declined greatly, while operating profits (excluding those for Digital entertainment) have improved in 2023. The company’s Q4 2023 adjusted EBITDA loss was of just $10.7 million ( a big improvement over the past quarters). Despite a solid increase in revenues and increased financial discipline, the company still posts a loss. In 2023 the full year loss was $(1.63) billion, in line with the prior year results of $(1.64) billion. On the Q4 call, the company guided to profitability on a ‘sustainable’ and ‘full-year basis’, even though it did not reveal their target time frame.

It is important to note that most of the revenue is coming from its e-commerce business unit, however, most of the losses are associated with the digital entertainment division, Garena. The company is also improving profitability of digital financial services.

  • ROIC (Return on Invested Capital): It is difficult to precisely calculate ROIC without significant assumptions (no historical tangible ROIC can be calculated, given the massive amounts of intangible investment). However, the company is now actively focusing on maximizing its profitability, suggesting positive improvements in ROIC in coming years.

A positive development is that management is targeting profitability as a goal, and reducing costs, including headcount. This will improve its return on capital.

  • Capital Expenditures: CapEx is still significant and important in order to continue to improve and expand into new markets, and improve its logistics. However, there is an increasing focus on optimization, implying the company is willing to spend money wisely. In the FY2022 report, Property, plant and equipment (PP&E) expenditures was a total of $1.2 Billion with no mention on any intangible assets, that was completely different than previous years.

A notable part is that most of the expenses are concentrated on improving the e-commerce division, rather than the digital entertainment division.

  • Cash Flows: Despite ongoing losses, the company is generating positive cash flow from operating activities, but still has a substantial negative free cash flow after Capital Expenditure.
  • Debt: While the balance sheet has a decent amount of long-term liabilities, it also has significant amounts of liquid assets.
  • Shareholder Equity: The equity has been substantially reduced since 2021 but has been steadily growing since.

Competitive Landscape

  • E-Commerce: Shopee faces intense competition in Southeast Asia and Latin America from players like Lazada, Tokopedia, MercadoLibre, and numerous other smaller local and international e-commerce platforms. The competition in the e-commerce industry is especially heavy on price, and as a result, customer loyalty tends to be fickle.
  • Digital Entertainment: Garena faces competition from various global game publishers, including Tencent, Activision Blizzard, and Epic Games. Success in the game business hinges on creating and sustaining player engagement, as well as developing new hit games.
  • Digital Financial Services: SeaMoney is competing against existing payment providers, fintech companies, and traditional banks. Competition is heavy on providing favorable rates, low fees, and also good risk management of the loans.

What Makes the Company Different

Sea Limited has a number of strategies that sets it apart from its competitors.

  • Regional Focus: Unlike many players who often focus on just one region, it operates mainly in the Southeast Asia and Latin American markets, giving it a more defined target audience that is underserved by competitors.
  • Mobile-First Strategy: It has made a conscious effort to focus on mobile platforms for the e-commerce segment, where mobile usage is significantly high in the developing markets.
  • Integration: It is actively trying to integrate financial and payments services with its other segments to increase user adoption and retention.
  • Low-Cost Model: It is operating with a low-cost model where is has fewer retail stores, with focus on smaller cities and rural customers, creating more avenues for cheaper goods.

Moat Rating: 3/5

Sea Limited has a narrow moat (3 out of 5) rating.

  • Brand Recognition (Narrow Moat): While the brand is recognizable and has a huge userbase (particularly for Shopee and Free Fire), these brands are still vulnerable to market competition, because they are not a premium brand in a mature economy.
  • Network Effects (Medium Moat): Shopee benefits from the network effects from its marketplace by creating a virtuous cycle between sellers and consumers. But these benefits are not as strong as those seen in other platforms. While Garena’s network is very valuable, it can be quickly substituted if new and better free or paid games come into the market, which is also common in other forms of media. SeaMoney’s network effects depend greatly on building trust among the clients, so that they chose a newer payment and credit provider over well-established players.
  • Switching Costs (Weak Moat): For Shopee, customer switching costs are relatively low since consumers can move from one e-commerce seller to another without incurring any costs. Moreover, e-commerce is usually a highly price-sensitive market. For Garena, the switching costs are also extremely low as the users can play other games quite easily. SeaMoney has a slight switching cost because of integrations, but the users can switch services rather easily. In summary, switching costs are not an important aspect of its competitive advantages.
  • Proprietary Technology (None to Weak Moat): The company has many proprietary algorithms and technological processes, but the same is available to all other companies and their value tends to be very small in the long run.
  • Economies of Scale (Narrow Moat): It has started creating a scaled distribution network in order to make its products available in remote areas, but it isn’t too difficult for a competitor to replicate.

Given these factors, the company’s wide-moat status is questionable because of a number of factors. It is not a clear dominant leader in the e-commerce or gaming industry and most of the assets have low switching costs.

Risks

  • Macroeconomic Factors: While the company has strong revenue growth in emerging markets, the same markets are more vulnerable to local and global economic downturns, geopolitical uncertainty, and currency fluctuation. These factors can cause serious risks for Sea Limited’s revenues and profitability.
  • Competitive Risks: The e-commerce and mobile gaming sectors are intensely competitive, with low barriers to entry and many new competitors all the time, in all its markets. SeaMoney faces an evolving financial services industry with established and newer competitors. Intense competition from both local and international players may further affect revenue and profits of the company.
  • Regulation: As a financial company, it is subjected to rules and regulations of the financial markets that change constantly and are different in many locations. Changes in regulation can impact its ability to operate effectively and may require higher operating expenses, and may even impose restrictions on business activities, thus negatively affecting revenues.
  • Reliance on a few key products: The company’s revenue is highly dependent on Shopee and Free Fire, which are vulnerable to changing consumer preferences.
  • Execution Risk: Given the complexity of its core industries and a wide range of operations, its ability to execute and continue innovation is paramount for the company’s growth.
  • High Spending: Despite the company focusing more on profitability, they still need to invest a lot of money into research and development and marketing in order to grow. The company still has a negative free cash flow, and an inability to achieve profitability may force the company to dilute shareholder value through stock offerings.
  • Supply Chain issues: These companies are vulnerable to supply chain disruptions that may impact revenues.
  • Growth Slowdowns: The company may not be able to sustain its previously high growth rates, resulting in an unfavorable rating in the market.

Business Resilience

The company has proven that it has a resilience against adverse market events due to strong brand awareness among consumers, and the willingness of consumers to try out its diverse products. However, it may struggle when new technological changes completely disrupt its business models. The company is trying to shift from a growth-at-all-costs approach to a sustainable-profit-based approach, thus improving its financial strength and overall long term viability.

Understandability: 4/5

Sea Limited has a moderately easy business to understand (4 out of 5).

  • The core business segments of e-commerce, digital entertainment, and digital financial services are fairly straightforward in isolation.
  • The way each segment works is fairly transparent and easy to understand.
  • The biggest difficulty arises from figuring out how the company is integrating the three segments into a single platform.
  • The financials, though somewhat complex, are reasonably transparent and provide sufficient details about the business.
  • The future is heavily dependent on its ability to continue to grow market share and improve operational efficiency.

Balance Sheet Health: 3/5

Sea Limited has a moderate balance sheet health (3 out of 5).

  • It has a good amount of liquid assets and cash reserves.
  • There is a notable debt that can be easily repaid through asset sales.
  • The total equity of the company has been reduced significantly over the last couple of years.
  • Cash burn is still present for the business.
  • The level of debt has risen slightly in the past years.

Final thoughts

While Sea has a huge global presence, and is showing impressive growth and scale, it is still at a fairly early stage with a lot of profitability challenges in the digital entertainment and e-commerce segments. The company has a narrow and somewhat questionable moat, but its wide-spread operational presence may make it into a good bet for long term investors. However, if they cannot achieve a predictable profitability, or increase the growth in the digital entertainment division, the company will be forced to sell some of its assets or raise additional funding to stay afloat.