Sea Limited FY20, Gaming, Commerce, Digital Banking and now Venture & AI
(Equity Research)
Good morning,
Today we are going to be discussing the Q4 & FY20 earnings report of Sea Limited. The South-East Asian darling, known for its three business units that span across gaming, digital payments, and e-commerce, has branched out into new avenues during Q4. The company now operates a venture arm and has opened an artificial intelligence unit.
Sea Limited Reported Earnings on Tuesday, March 2nd.
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“2020 was a landmark year for Sea. Our team, users and communities all faced unprecedented challenges as a result of the pandemic. This further reinforced the importance of our mission to empower the consumers and small businesses in our communities with technology.
The lockdown and social distancing measures to curb the pandemic have materially accelerated the digitalization of our economies, and we expect the effect to be long-lasting. During this time, our team has demonstrated their resilience, adaptability and strong execution. We believe these capabilities position us very well to capture and drive the significant growth opportunities ahead as a strong market leader.” - Forrest Li, CEO
Recent Coverage:
1.0 Sea Limited: Q4 & FY20 Key Highlights
The following information will be as of Q4 FY20 unless stated otherwise. Any percentage comparisons will be on a YoY basis unless otherwise stated.
• Revenues: $1.6 billion +102%
• Digital Entertainment Revenues: $693 million +71.6%
• E-Commerce Revenues: $842 million +178%
• Digital Financial Services Revenues: $24.4 million +662%
• Gross Profit: $533.7 million +102%
• Adjusted EBITDA: $48.7 million, up from a loss of $104.9 million
• Operating Loss: $357 million, up from $230 million loss
• Net Loss: $524 million, up from $281 million loss
The following information will be as of FY20 unless stated otherwise. Any percentage comparisons will be on a YoY basis unless otherwise stated.
• Revenues: $4.4 billion +101%
• Digital Entertainment Revenues: $2 billion +77.5%
• E-Commerce Revenues: $2.16 billion +158%
• Digital Financial Services Revenues: $60.8 million +560%
• Gross Profit: $1.35 billion +123%
• Adjusted EBITDA: $107 million, up from a loss of $178 million
• Operating Loss: $1.3 billion, up from a $891 million loss
• Net Loss: $1.6 billion, up from a $1.45 billion loss
1.1 Digital Entertainment
Sea Limited’s digital entertainment arm, Garena, is the company’s cash cow. Garena currently pulls in ~46% of the consolidated revenue for the company and is the only unit to report profitable operations on a GAAP basis, with $1.3 billion produced in FY20, at a 65% operating margin.
Shopee, Sea’s commerce unit, overtook the cash cow this year with respect to revenues ($2.16 billion vs $2.01 billion) but remains unprofitable as costs remain rampant during expansion.
For the Garena unit, bookings expanded to $1.0 billion for the quarter, up 111.1% on the year, with full-year bookings totalling $3.2 billion, up 80% from FY19 which exceeds the upgraded FY20 guidance of $3.1 billion that Sea put out in Q3. Average bookings per user now stand at $1.70, up from $1.40 one year ago.
Revenues stood at $693.4 million for the quarter, up 71.6%, with annual revenues totalling $2.01 billion, up 77%.
As stated, the digital entertainment unit is the only operationally profitable part of Sea’s operations, earning $485 million and $1.3 billion in operating incomes across Q4 and FY20 respectively.
Quarterly active users (QAUs) grew 72% during FY20, reaching 610 million, with quarterly paying users now representing 12% of total users, at 73.1 million, up 120% on the year.
The key driver for Garena’s growth is undoubtedly their battle royale sensation, Free Fire. The game was the most downloaded game, globally, for a second consecutive year in 2020, as well as taking the position of the highest-grossing mobile game across Latin America, Southeast Asia, and India, for 2020.
The Free Fire frenzy has been powering Garena’s impressive QUA and QPU growth after its launch in late 2017. At first, there was some noticeable divergence between the growth of users against paying users, highlighted by the rapid decline in paying users as a percentage of total users. This soon reversed in 2018 after monetisation efforts were widely adopted by users, and total user growth began to decelerate into 2019.
At present 12% of Garena’s total quarterly users are monetised, up from 9.4% in 2019, and 5.5% in 2018. As noted, paying user growth has accelerated, and outpaced the growth of total users from 2019 until 2020.
The success of Free Fire comes with questions. Hot on the lips of most observers, is how long can Free Fire support the Garena division without a new blockbuster title?
Back in the Q2 earnings call, when asked to detail the weighting of Free Fire on overall revenues, management declined to comment but did state it was the largest game in their portfolio.
Now more than three years old, is there a threat that the cash cow (Free Fire) within the cash cow (Garena) begins to decline and severely impede Sea Limited’s ability to finance their expansion efforts in other areas of the business?
Or rather, can a game that is three years old continue to bring in cash flow?
My best guess would be yes. Observe the data for the December 2020 worldwide highest-grossing apps.
Below I have plotted their release dates onto the IOS app store.
Honor of Kings: 2015
PUBG Mobile: 2018
Genshin Impact: 2020
Pokemon GO: 2016
Roblox: 2012
Coin Master: 2015
Fate/Grand Order: 2015
Rise of Kingdoms: 2018
Free Fire: 2017
Homescapes: 2017
Many are older than Free Fire. These games are able to continue producing attractive returns as a result of their loyal userbase, as well as continuous updates to the game that keep it fresh and enticing for gamers.
Grand Theft Auto V sold 20 million units in 2020.
The last time it did sales that large in a calendar year?
2013.
The year the game first launched.
The dramatic shift in longevity for the GTA franchise came with the prominence of online gaming.
Previously a game that would mostly be single-player, GTA 4 was the first of the series to show signs that an online, free world, version of the game would keep players coming back. The next instalment, GTA V, came with an improved adaptation of the online GTA world, which has players who have been religiously logging on for over seven years now.
Free Fire’s longevity follows a similar path on account of the consistent updates to the game, the e-sport community built around the game, and the continuous influx of new players as the game is launched in new countries each year.
Free Fire’s e-sports tournaments held over Q3 attracted more than 150 million online views, which included a national Brazilian tournament that spanned 2 months and attracted 47 million views. In Q4, they were named the Esports Mobile Game of the Year at the Esports Awards 2020.
During Q4, Free Fire partnered with Cristiano Ronaldo to offer new in-game items and characters, as well as two new game modes.
Despite the challenge of holding live events as a result of the global lockdowns, Sea claims that 3 of the 5 top esports tournaments by peak concurrent viewers in 2020 were Free Fire tournaments. Moreover, Free Fire was the most-viewed mobile-only game on YouTube in 2020 with over 72 billion views for Free Fire related content.
All of this digital activity helps ensure Free Fire remains in the centrefold of the gaming community. In a previous earnings call, Forrest Li indicated that he feels Free Fire still has another 3 to 5 years before it peaks.
That is grand, and as an investor, I hope that remains to be true. Despite Forrest’s admission, in 2019, that Shopee could turn a profit in the next ‘couple of years, Garena is still the only unit bringing in an operational return. With the height of Sea’s expenditures that are geared towards growing out their other divisions, the company can not only rely on equity dilution and debt offerings for eternity. As such, Garena is pivotal to their success.
The question pertaining to Garena’s future cash cows still remains, however. When asked about whether the guidance for FY21 gaming bookings contained estimated new game revenues, management downplayed the question and suggested they only guide for that they currently have in the works.
When quizzed about a product pipeline Sea’s CCO, Wang Yanjun, stated the following:
“We don't specifically discuss pipelines, but as we all know, we've always been testing prototypes, ideas and even more advanced games at any time -- at any point of time, and we continue to also diversify our pipelines, genres and capabilities across different types of games. So the revenue guidance or booking guidance is based on our reasonable estimates for 2021 based on whatever is currently visible to us.” - Wang Yanjun, CCO
What is interesting on the gaming front, is that Phoenix Labs, Garena’s AAA gaming studio based in Vancouver announced new offices in Montreal and Los Angeles, alongside its existing bases in Vancouver and Seattle. Phoenix is expected to be kitting these new offices out with new teams that will be focussing on new game development. A small consolidation there.
So, no news on that front, but there is evidence that Sea Limited is investing in the production of potential new blockbusters.
1.2 Shopee Commerce
As mentioned, Sea’s commerce arm, Shopee, overtook Garena for revenue generation in FY20, reporting $2.16 billion in sales for the year, up 158% from last year. Marketplace revenues, from transaction-based fees, advertising income and revenue generated from other value-added services, accounted for ~73% of annual revenues.
Sales for the quarter stood at $842.2 million, up 178%, with ~75% of sales stemming from marketplace revenues.
Gross orders for the quarter grew 135%, reaching $1.03 billion, totalling $2.8 billion for the year, up 132% from FY19.
Gross merchandise value (GMV) climbed 113% on the year with $11.9 billion generated in Q4, totalling $35.4 billion for the full year. up 132%. Engagement is improving, with purchase frequency growing sequentially, at 5.7 times per month.
Impressive growth once more. Shopee is still unprofitable, but management has vocalised in the past that this unit may break even in 2021. I don’t see that happening personally. The focus for Shopee at the current moment in time is scale, which is something that eats cash flow like a moth in a cashmere enthusiast’s cupboard. There was discussion pertaining to the 41% reduction in adjusted EBITDA losses, but I don’t personally care for these non-GAAP metrics, so disregard them during my study.
As the Shopee brand continues to penetrate new markets, the economies of scale and learnings will eventually facilitate profitability. The importance, for now, lies in scaling the business with the support of marketing and consumer adoption.
After just one year of operating in Brazil, the Shopee store now sits atop the number one spot in terms of app downloads.
“In terms of our comparison between LatAm and Southeast Asia, I think these are very different markets. And we wouldn't presume that we know those markets very well at this point. Again, given the early stage of the development there, we will let the team explore a bit more and see how that goes.” - Wang Yanjun, CCO
In Indonesia, also ranked one for downloads and, Shopee’s second-largest market, they recorded over 430 million sales during the fourth quarter, for an average of 4.7 million orders per day, up 128% on the year. Shopee also ranks number one across the rest of Southeast Asia and Taiwan, with market share exploding across each geography.
1.3 Sea Money
Sea Limited’s digital bank licence, granted late last year, as well as their recent acquisition of Bank BKE, an Indonesian bank, demonstrates the gradual motion that looks to be taking place in their smaller digital financial services division, SeaMoney. These are yet more steps towards Sea’s goal of building digital infrastructure across the Asian region.
“We'll continue to focus on the technology front of our business as part of our core DNA. But at the same time, our focus is to use the technology that we have in our Internet DNA to see how best to further strengthen the digital economy infrastructure in our region, which were products. And at the same time, we believe there are significant opportunities in the long run that could even exceed the size of our current opportunities we're looking at -- in that segment. So we're very -- we're going to adopt a very long-run view towards that and look at DFS as a highly comprehensive segment, and each part as an integral part of our long-term venture into DFS.” - Wang Yanjun, CCO
Singapore, Sea’s domestic nation, has been signing exclusive digital trade agreements, the first of their kind, with the likes of Chile, the UK, Australia, and New Zealand over the past few quarters, marking uncharted territory but one that highlights the country’s willingness to embrace the digital age.
Sea Money generated $24.4 million in revenues for Q4, up 662.5% from the same period last year, and recorded $60.8 million in sales for the full year, up 560%, which accounts for just 1.3% of the total revenue base.
Ignoring the relative size of the SeaMoney unit, it had an impressive year. As internal investment ramps up, this should soon become a larger portion of the consolidated pie. Back in Q1 FY20, the digital financial services segment reported just over $1 billion in mobile wallet payment volume. During Q4 FY20, the volume ballooned to almost three times the size, at $2.9 billion for the quarter, marking $7.8 billion in wallet payment volume for the full year.
Back in the first quarter of FY20 SeaMoney registered ~10 million quarterly paying users for their mobile wallet services. SeaMoney is now attracting ~10 million paying user per month, with 23.2 million paying users now utilising the wallet on a quarterly basis.
Within the DFS segment, the ShopeePay wallet has reportedly assisted the strong growth in revenues this year, with the increasing adoption of the Shopee-based payments wallet on the marketplace across users and merchants. This stands to remove the friction for Shopee customers.
“Both platform online and offline use cases and the partnerships also grew in 2020 as we continued our initiatives to expand use cases and as we saw more natural adoption by users who appreciate assessability and the convenience of our mobile wallet services.
For example, we recently expanded our partnership with Google to offer our mobile wallet as a payment option for the Google Play Store in Indonesia, in addition to our existing partnership in Thailand. As we onboard more online and offline use cases, we are seeing that our users increasingly appreciate the ease and the convenience of using our mobile wallet services.” - Forrest Li, CEO
1.4 Sea Capital
Last December, the Monetary Authority of Singapore awarded Sea Limited, along with one other company, Grab Holding & Singtel, with full digital banking licenses. There were supposedly 14 applicants waiting for the chance to earn a license.
This license looked set to enable Sea Limited to support and develop the digital economy within their home market of Singapore, with emphasis on servicing the needs of young Singaporeans and SMEs.
Sea later announced their acquisition of Composite Capital, led by David Ma. David founded the investment management firm in 2016 after serving for seven years at Hillhouse Capital Group, a China-focussed investment firm that managed ~$20 billion at the time.
“I have known David for several years. In the past, he has been a long-term shareholder of Sea and shared our vision for the business and our passion to serve our communities through technology. David and his team have a demonstrated track record of thoughtful long-term investing with a deep understanding of industry trends and the businesses globally. I'm very excited to welcome David and the team at Composite Capital to the Sea family.” - Forrest Li, CEO
Coinciding with this announcement, Sea formed Sea Capital, which will act as a unit within Sea Limited that manages Sea’s investment efforts and will see David Ma take up the Chief Investment Officer role, reporting directly to Forrest Li.
The new venture arm will be funded with an initial $1 billion, set to cover the next few years of operations. The primary aim of Sea Capital will be to discover and partner with technology companies that share Sea Limited’s vision of betterment across the Asian region, mostly across financial and technology firms.
This represents an interesting move for Sea Limited, but one that is not foreign. Other large players in Asia, such as Softbank, Bytdance, Alibaba, and Tencent (who own a portion of Sea Limited) also have venture arms that operate in a similar way.
This could prove to be an attractive source of reinvestment return for Sea Limited, given that the areas they seek to invest in, are within the scope of their existing competencies. Sea Capital may present itself as a resourceful tool for identifying acquisitions in the future too.
There has been no specific announcement of desired returns, but we are in the early stages here, more time is needed before passing judgement.
“We don't have a specific ETA in terms of return rate, in particular, for asset-based fund. I think our overall way -- view towards that is still it is an integral part of Sea's growth story. And whatever we do on the investment side is to further strengthen our growth capabilities in the long run and to further strengthen our ecosystem as well as to further our mission and vision to go -- to use technology to serve our users, our communities as well as ecosystem participants in our core regions” - Wang Yanjun, CCO
1.5 Sea AI Labs
In addition to the announcement of the venture arm, Sea also disclosed another new business unit, this time with a focus on artificial intelligence.
The new AI arm, named Sea AI Labs, will be led by Dr Yan Shuicheng, who will act as the Group Chief Scientist.
“Yan is a leading expert in the field of artificial intelligence with a particular focus on computer vision, machine learning and multimedia analysis. He is an ACM fellow and Fellow of Academy of Engineering Singapore.
I believe that Dr. Yan and Sea AI Labs will strengthen our capabilities in innovation and research, in line with our commitment to advancing technology to drive the development of the digital economy across our region.” - Forrest Li, CEO
The initial goal of Sea AI Labs is to attract and partner with quality talent across the AI space, with the intention of harnessing insights that can put to use within the company’s existing and future operations.
It appears that Sea Limited is steadfastly recruiting for their new Sea AI Labs department. Current job postings include:
1 X Research Engineer
1 X Senior Research Scientist
1 X Research Scientist
1 X Research Intern
Little else was said during the earnings call about AI Labs, but the focus makes sense. With Sea Limited being involved in various sectors that rely on technology such as commerce, gaming, and digital banking, investment in AI would, if fruitful, provide some crucial learnings that can be shared across Sea’s other business segments.
2.0 Performance
Perhaps the most divisive statement in Sea Limited’s filings is the income statement. The top half presents a wealth of growth, and potential for the future. The bottom half presents the painful realities of growing at scale.
Sales for the quarter totalled $1.56 billion, up 101% on the year, and sales for the full year stood at $4.37 billion, up 101%. This continues Sea’s three year stretch of triple-digit revenue growth, having grown revenues by 101%, 163%, and 100% over the last three years. Assuming the company continue to grow close to this level over FY21 and FY22, we could see close to $9 billion in sales for FY21, and $17 billion in FY22.
The consensus is that Sea Limited may see $20 billion in sales by FY2023, and be profitable on a net income basis by that period. You can now splash salt all over yours now.
In 2017, 2018 and 2019, Sea’s digital entertainment business contributed 88.2%, 55.9% and 52.2% of their total revenue. In 2020, digital entertainment contributed just 46% of revenues, with the e-commerce segment now being the largest component of annual sales. This will suppress operating margins (what operating margins?) for the time being, seeing as digital entertainment is the only profitable business.
For the full year, digital entertainment revenues grew 75% reaching $2.01 billion, e-commerce & other services totalled $1.77 billion, growing 115%, and sale of goods totalled $582 million, up 170% on the year. Bear in mind, this is how revenues are recognised on the income statement, which is slightly different from how Sea Limited present them in their marketing materials, as per below, where they break out digital financial services as a separate category.
Within the income statement, digital financial services are partly assigned to e-commerce sales, and the goods that Shopee purchases from third-party suppliers for resale on the marketplace are recognised as “sales of goods”.
After accounting for the cost of each revenue segment, we can identify that digital entertainment supports a healthy gross margin of 65%, producing ~$1.3 billion in gross profit. The commerce division reports a razor-thin $33 million in gross profit, for a margin of 1.8%. This is a marked improvement on the negative gross margin reported in 2019 for the commerce segment.
Sale of goods reports an equally thin margin of $1.7 million for less than 0.5% gross.
Therefore, digital entertainment, which accounts for ~46% of revenues, generates over 97% of the gross profit for the business. This is why we refer to it as the proverbial cash cow. All in all, Sea Limited reported $1.34 billion in gross profit for the year, up 123%, and marking a consolidated gross margin of 30.8% for the business, up ~300 basis points from last year.
The bull case rests in Shopee’s ability to eventually demand a higher gross margin, which will supply the business with a greater infusion of gross profit with which they can fund their operations.
Sauntering over to the operating expenses, we can see why this potential turn of events is so pivotal to the success of the company. Sea Limited burn cash like a fireman attempting to extinguish a fire… with fresh dollar bills.
Ronaldo doesn’t come cheap. Sea Limited’s marketing expenses are monstrous.
S&M, composed of online and offline advertising expenses, promotion expenses, and staff compensation and welfare expenses, which include share-based compensation for our employees engaged in sales and marketing functions, has been Sea Limited’s largest expenditure for a number of years. This should come as no surprise to those who follow the company closely. The company are open about their desire to outspend their growth in monetisation, in order the acquire customers, encourage engagement for Shopee and their games, and build brand awareness.
“We have made a strategic decision to invest in the growth of our Shopee marketplace by incurring sales and marketing expenses in advance of our monetization efforts. We believe that taking a thoughtful approach to monetization by building our user base and increasing engagement first will allow us to maximize our monetization in the future” - 20-K Filing, 2019
When asked how she intends to distribute the marketing expenses (across revenue categories) going forward during the Q4 earnings call, Yanjun stated the following:
“So for e-commerce, sales and marketing expense, as you can see, we continue to improve on our efficiency. And our allocation on sales and marketing is a -- again, a dynamic process based on the time of the year. And what we think is the development pace and pace of growth for the market, and efficiency of investment in that market as well as any opportunistic media events, for example.
So these are a combination of factors we look at in allocating sales and marketing. But the gist of it is we continue to focus on efficient growth to make sure that every dollar we spend there is driving effective user growth and strong user retention and also increasing user frequency.
For example, we -- during Q4, during the peak sales period, this is a very strong shopping period, and we have a lot of shopping activities as well as media activities across different markets. And these have shown very strong results, as you can see. And more importantly, we're driving up not just user time spent but also user frequency on our app. We now see more than 5.7x purchase frequency -- order frequency per month. That's another step-up from the last quarter's Q3 number. So that is a very good testament to the strength of our platform and the efficiency of our investment into sales and marketing.” - Wang Yanjun, CCO
After operating expenses that amount to double that of gross profit, the company reports a loss of $1.3 billion, widening from their $891 million loss in 2019. After other expenses, the company reports $1.6 billion in net losses.
Zooming out, what you will see here are rapidly compounding sales and gross profits, but equally rapidly compounding losses, as the company continue to plough back their gross profit, and the mountain of financing they raise each year, into the business. Interest expense from borrowings amounted to $148 million during 2020, up over 2 times the amount expensed in 2019. At this stage, I would usually ascertain how much their interest expense eats into the operating margin. However, Sea Limited have no margin.
We are going to move onto debt & equity shortly, but one must understand that what Sea Limited is doing is bold.
You have to spend money to make money, but when that money is someone else’s, it raises some significant risks pertaining to their ability to remain a going concern.
Should the flows of external funding suddenly halt, due to some unknown circumstance, then Sea Limited would struggle to afford their expensive growth strategy, which could result in substantial cutbacks and even the divestment of assets.
It is clear, that whilst aggressive S&M expenditure artificially suppresses their operating margin (or lack thereof), even a sufficient reduction in S&M expense would not bring profitability. Sea is blowing 135% of their gross margin on marketing, alone.
We are banking on Sea Limited compounding sales and growing their business units here, not much else. With the idea that, over time, the economies of scale, and subsequent margin expansion, will act as a catalyst to shore up the company’s losses. The early signs are apparent but until then they appear to reliant on debt & equity for future financing.
2.1 Liquidity
Sea Limited’s liquidity, although propped up by debt and equity offerings, has remained fairly solid throughout their affair with the public markets.
At present, the company holds $6.16 billion on the books in cash as of December 2020, which is enough to cover their entire $4.6 billion in current obligations, and almost enough to cover their $7.03 billion in total liabilities, of which $1.84 billion is derived from long-term borrowings via convertible notes.
In addition to liquid cash, the company have a further $859 million held in restricted cash, which comprises deposits pledged with banks as security in relation to the utilization of certain bank services, cash received and held in escrow in connection to the e-commerce business and advances received from customers in connection with digital financial services business. Fairly liquid, but restricted in some sense, hence the name. All in all, the Sea’s $8.9 billion in current assets are sufficient to keep the train moving.
Will they be raising additional debt and/or equity in the future? My guess is yes they will be.
Being a loss-making operation, they should seek to bolster their liquidity with additional financing, until the point where they can fund growth via their operations and potentially pay down some debt.
On the liability side, after an additional $1 billion raised in notes, circa May 2020, the company now hold $1.84 billion in term debt on the books, after a slight offset from the paydown of the 2023 notes from the proceeds of the 2025 note offering in May 2020.
Deferred revenue stands at $2 billion, expected to be realised over 2021, with an additional $2.03 billion in payables, essentially netting out.
Whilst liquidity may be strong, one must note that liquidity has been built from the issuance of equity and debt, and not the success of the company’s operations. Pinches of salt to be applied, please.
2.2 Cash Flows
As discussed in previous newsletters, the limited depth in Sea Limited’s cash flow statements is concerning to me as an analyst. Still awaiting the 20-F filing (annual report), so I don’t have a great deal of detail to work with.
What we can see is that operational cash flow is improving. Sea Limited reported operational outflows across 2017 ($259 million), 2018 ($495 million), and in 2019 reported $69.8 million inflows from operations, with a negative free cash flow of ~$177 million. During 2020, cash flow from operations improved almost 7-fold to reach $555 million. At present, I have no access to a granular cash flow statement, therefore can not ascertain free cash flow for the recent year. Based on the previous year’s Capex, with some margin of safety applied, I would assume that Sea managed to generate a small amount of free cash flow in 2020.
With a lack of discussion pertaining to cash flows in the Q4 earnings call, we are truly in the dark. My best guess is that the increased revenue streams from the entertainment segment, which are operationally profitable, is the primary reason for the improved operating cash flow.
Investing activities witnessed outflows of $886 million on the year, far outstripping their operational inflows. Sea Limited are financing their internal investment via liquidity on the balance sheet, and additional financing.
There comes a time in every great company’s history when the cash flows that stem from the operations of the business supersedes the inflows from equity and debt financing. For Sea Limited, that day is nowhere in sight.
For the entire duration of their life as a public entity, the primary source of inflows has come from their continuous common stock offerings, and note issuance. More recently, the company raised $1 billion in May 2020 via the offering of convertible notes, set to mature in December 2025 at a coupon rate of 2.375%. A portion of the proceeds was used to pay down their 2023 notes. During the offering of the 2025 notes, Sea also converted ~$150 million of the principal of their 2023 notes into 6.9 million additional ADSs (American Depositaries).
In December of 2020, Sea then announced an additional 13.2 million ADSs that would be offered to the public, an amount which was upsized from the original 11 million offering. Sea suggested they expect to use the net proceeds from this offering for business expansion and other general corporate purposes, including potential strategic investments and acquisitions.
As we can see, the outstanding share count has continued to soar from 2017 (IPO) onwards. Often a necessary form of financing in the early years of a company’s growth, but not a sustainable one.
One of the largest detractors for me is Sea’s reliance on external financing. Should the debt markets suddenly dry up, the company would struggle to finance their operations. Granted, the company hold ~$6.2 billion in liquid cash, they also make zero operational profit, and burned through ~$2.7 billion in operational expenses last year.
This is where the expanding gross margin should eventually come to assist, offering up a fatter purse from which to spend from. Moreover, should the commerce segment become profitable, we can expect some flywheel dynamics to occur around that area of the P/L statement. Until then, the company is overly reliant on debt and equity financing, which bears significant risks.
For now, I am sure the admiration of the company, from investors, will ensure they remain an attractive vehicle to offer debt to.
3.0 A Few Notes from the Call
Here I wanted to share a few interesting quotes from management during the earnings call. These can typically be somewhat lengthy.
Thus, I have cherry-picked some of the responses I found most interesting and useful for you.
1) Shopee Growth Geographics & Digital Finance
Question:
“On Shopee, I would like to ask about our triple-digit revenue growth. Can management comment about the business trend across different regions, Indonesia, Singapore, Taiwan, Malaysia, et cetera. I just want to get a sense about which countries are we seeing faster growth for this year?
And my second question is on the digital finance side. Can management comment about our strategies for this year? In particular, whether we will step up our efforts in the food delivery or other O2O initiative?”
Wang Yanjun, CCO:
“Thank you. In terms of the business trends and revenue growth for Shopee, first of all, we are seeing very strong growth across the regions and, in particular, our largest market in Indonesia, which we disclosed continued accelerate growth. So on GMV, orders as well as take rate side, we see even accelerated year-on-year growth rate, which speaks to volume, again, to the strength of our market leadership and our platform growth, even as most of the countries have opened up the -- in more of a contained manner as the COVID situation increasingly being under management.
And I think in terms of the growth rates across different markets, we don't specifically give the breakdown. But usually, we see very strong growth in larger markets where we already established very strong market leader position as well as highly accelerated growth in some of the markets that -- where we see very strong adoption during the COVID period. For example, in the Philippines, Malaysia, Singapore, we see very strong growth as people embraced online solutions during the COVID period, and Shopee becoming increasingly the go-to platform for people's consumption needs across various segments.
And that trend we're seeing going into 2021, as shown in our guidance for e-commerce again. And we're continuing to focus on driving efficient growth across our region and especially focused on serving the new users as well as the sellers being onboarded during this period of time and catering to the shift in lifestyle choices now accelerated by the COVID and lockdown measures taken so far, which will be -- as we said before, we believe it's going to have a long-lasting effect on digitalization of our economy in the region.
In terms of digital financial services, we see, again, very strong growth, even though we started integrating our ShopeePay and SeaMoney wallet platform with Shopee just at the beginning of last year. We already saw a very strong adoption as demonstrated by our pay user ratio, our pay user number as well as TPV growth, and will continue to drive efficient growth for us through Shopee user base and also continue to expand it to third-party merchants. As we mentioned, we are expanding our partnership with Google to Indonesia.
We have also partnered with other off-line malls and SME chains to continue to make our payment and wallet offerings available to a broader user base. Again, this is further accelerated by the fact that now people are increasingly look for -- looking for alternative contactless payment method and shifting their consumption online that requires a convenient infrastructure for online payments in a region where credit card penetration remains very low.
And in terms of food and other initiatives, we see these as category on Shopee that can offer additional value-adding to our consumers. We'll continue to observe what is based on the consumers' natural consumption behavior in terms of expansion into new categories over time with efficiency.”
2) Free Fire Longevity, Entertainment Margin Enhancement & The Future of Garena
Question:
“May I just ask about the guidance that you provided on the gaming side. And looking back at the growth that you've seen in the user number in 2020, could you extrapolate from that and give us just a feel for what sort of user growth we can foresee in 2021 that's underpinning the growth in gaming revenues for 2021? And related to that, if you could expand on the driver of the improvement in margins that we're observing on the gaming side, that would be great.”
Wang Yanjun, CCO:
“In terms of the user growth, we don't separate forecast for 2021. But if you look at our past performance, so far, our revenue growth -- or bookings growth for the digital entertainment segment has been driven by both user base growth as well as pay user penetration deepening, with a relatively stable average revenue per paying user. And that speaks to the strength of our game, especially our self-development game, Free Fire, which has been a top grossing game in Southeast Asia and LatAm for multiple quarters and has also become a top grossing game in India for 2020 as well as the fourth quarter of 2020.
I think that is a very positive trend we are observing. We'll continue to grow our user base globally for this game. And we are also seeing very positive diversification of our revenue with Latin America now contributing the largest share of revenue. But at the same time, we see other parts of the world, including India, increasingly contribute significant portion of bookings to the digital entertainment segment. With this diversification, we're seeing Garena to become increasingly a global player with revenue coming from all over the world and user base expanding to the rest of the world rapidly.
When we reached last quarter -- third quarter, we reached more than 570 million quality active users. We thought that was a very good number. And then you see in fourth quarter, our active user base has increased to 600 -- more than 600 million users. We are still continuing to see very positive user growth across all our regions, and that to us is a very positive sign for the longevity and longer term commercialization of this game as well as a return to our effort to build this game into a long-lasting IP, a strong platform and increasing the ecosystem of itself.
In terms of the improvement of digital entertainment adjusted EBITDA margin, we're seeing -- as we mentioned, this is mainly attributable to Free Fire being our self-development game, which doesn't require any revenue share with any IP owner or developer. And therefore, we will continue to see margin improvement. Of course, in the longer run, we will also see more diversification of revenue both from self-developed as well as the publishing side. And we are also focusing on investing into our ecosystem in recruiting top talent, in building our technology capabilities and introducing more IT collaborations with partners across different sides, whether it's on the gaming side as well as on the social and the entertainment front, to further improve our content offering to our user base so that -- but in the longer run, we do expect to maintain a very healthy adjusted EBITDA margin for our game business, and we'll continue to run it in a very efficient manner.”
3) Sea Capital Plans & Outlook
Question:
“First, can you elaborate a little bit on Sea Capital? What are the objectives on that business? Is it you're looking more like a SoftBank kind of an investment wherein you will turn up new kind of a thing? And what kind of returns time horizon? Any more colour will be helpful given there are so many investments that you're looking into, into business also. That's one.
And number two, there have been, during the last few months, report about you acquiring a bank in Indonesia. If you can provide more colour on that, that will be helpful.”
Wang Yanjun, CCO:
“In terms of Sea Capital, as we shared earlier that we are very happy to have the Composite team led by David Ma to join us to further strengthen our investment and capital allocation capability. We think it's very important for a global Internet company to have that capabilities in the longer run. And we will continue to build on our talent pool as well as our pipeline to further strengthen that.
We don't have a specific ETA in terms of return rate, in particular, for asset-based fund. I think our overall way -- view towards that is still it is an integral part of Sea's growth story. And whatever we do on the investment side is to further strengthen our growth capabilities in the long run and to further strengthen our ecosystem as well as to further our mission and vision to go -- to use technology to serve our users, our communities as well as ecosystem participants in our core regions. So I think this is not a -- any departure from our existing course of trying to grow the business in the long run and maximizing return to our shareholders for the long run.
In terms of the Indonesia bank, we have gotten a bank license in Indonesia as well, and we see this as an integral part of our SeaMoney segment where we continue to build out the infrastructure for digital payments as well as digital financial services. We'll continue to focus on the technology front of our business as part of our core DNA. But at the same time, our focus is to use the technology that we have in our Internet DNA to see how best to further strengthen the digital economy infrastructure in our region, which were products. And at the same time, we believe there are significant opportunities in the long run that could even exceed the size of our current opportunities we're looking at -- in that segment. So we're very -- we're going to adopt a very long run view towards that and look at DFS as a highly comprehensive segment, and each part as integral part of our long-term venture into DFS.”
4.0 Forward Guidance
Management did provide some guidance, but only in terms of digital entertainment bookings and e-commerce revenue, which I find odd personally. Every time and there were numerous occasions, that Sea’s CCO, Wang Yanjun, was asked about particular areas of guidance, she rejected the pleas and stated they don’t issue guidance on those areas in question.
The official guidance for FY21 is as follows:
Digital Entertainment Bookings to be between $4.3 billion and $4.5 billion, reflecting a median 38% growth rate on the year.
Revenues for E-Commerce to be between $4.5 billion and $4.7 billion, reflecting a median 112% annual growth rate.
That’s all folks.
In response to a question which asked if the entertainment guidance included new games, Yanjun responded indicating that the guidance is only inclusive of what is currently visible to them. This suggests to me that, despite their admittance of prototype testing, the guidance is the spawn of the existing assets, as opposed to baking-in any new games.
Yanjun was also probed to share some insight into EBITDA guidance, requesting he provide some flavour on whether losses would expand in FY21, to which he responded: “we don't provide guidance or forecast on EBITDA”.
In my mind, this warrants a yellow flag. Not a severe as a red flag, which would make me question the investment, a yellow flag represents odd behaviour. The lack of guidance, as well as the shooting-down of any analyst requesting additional insight, was not pleasing.
However, the company do have a history of smashing their own guidance, so I will let it pass.
Overall, a fairly tight-lipped affair.
5.0 Concluding Remarks
The narrative for Sea Limited aligns with the one that I have weaved throughout the body of this piece. It’s a growth story. Eventually, investors are hoping that the fundamentals catch up with the top-line narratives.
The market valuation appears to be pricing-in the full extent of this hopium. Valued at ~$120 billion, this company reported less than $5 billion in sales and is bleeding cash. The only significant inflows it receives are from the entertainment business, which is smoked through S&M expense, and the debt financing and equity offerings they raise each year.
However, if estimates are near enough correct, and this company is generating upwards of $20 billion in sales by FY23, and perhaps upwards of $40 billion by FY25, then investors may be rewarded, should their cost basis be attractive enough. The glaring problem with buying companies that have the potential to grow at such a pace is that everyone thinks they are going to grow at such a pace.
As a consequence, it can be difficult to acquire a piece of the business at a fair price. The greater the price soars, the weaker your risk/reward relationship becomes.
Despite what you may read on Twitter, this company is by no means destined to reach the heights many think it will. There exists a graveyard of companies that collapsed on some hurdle in their journey, often forgotten due to the curse of survivorship bias.
This is partly why I disagree with the “buy at any price” mentality. At a certain point, you may be rewarded for your capital, but the downside risk is great. If your bet pays off, you may think “great” and move on, never considering the actual underlying risk that was apparent in your bet. Should it not work out… then the lesson would be learned by most accounts.
Should Sea Limited move on to become a $1 trillion company, then whether you bought at $120, or $200 would not make so much of an issue.
“But look, my shares are now worth X more, Imagine if I had sold, or not bought? I would have missed out on this momentous run.”
This is certainly true, and people often cite that you could have bought Amazon at the peak of the dot-com boom and gained a handsome return.
Not every company is Amazon, and be aware of your survivorship biases.
That being said, I like the potential, as well as the optionality that Sea Limited offer, for the cost basis that I acquired my share for, which was closer to $55 billion, which I still considered expensive.
The thesis is less based on any solid fundamental strength, but more so on the potential dominance that this company can exhibit across their three primary business units. Commerce, Payments, and Gaming once the economies of scale fully present themself. I will remain long to find out if that holds true but am not ignorant to the realities.
“I'm very proud of the outstanding results our team achieved in 2020, and believe we are moving into 2021 primed for the exciting growth opportunities ahead of us. Across the business, we are focused on driving sustenance and efficient growth as we scale towards becoming a top global Internet company. We believe our single-minded goal of delivering value to our users will continue to drive our success.” - Forrest Li, CEO
Conor,
Lead Analyst at Occasio Capital Ltd
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