Google recently published a report on the digital economy in South East Asia with the region ready to reach ~$100B in revenues in 2023 primarily driven by digital financial services ($30B) and other sectors contributing the remaining $70B. With the region having grown at a CAGR of 27% since 2021 and strong growth expected in coming years, it is no doubt that investor’s expectations are high and companies in the region continue to represent a big opportunity to deliver strong shareholder returns. At the heart of this opportunity lies Sea Group which is driving ~10-15% of the regions overall revenue, with the latest quarter’s revenue coming in at $3.3B (~$13B annualized). Sea operates in 3 of the fastest growing digital sub-sectors: gaming, eCommerce and fintech and has had its fair share of successes – building a profitable gaming cashcow in Free Fire, tasting success outside SEA in Brazil & Mexico with its eCommerce platform Shopee and seeding a hypergrowth digital financial arm Seamoney which continues to present a really big opportunity in tapping the underserved demand of financial services in the region.
As with any company – Sea has had its fair share of failures too. For starters, Free Fire has been experiencing degrowth since 2022 and Garena has not been able to launch a new game which can even remotely match the success of Free Fire. Secondly, the company became too aggressive at the height of the quantitative easing era by charting growth plans for Shopee in India, Europe and beyond which they were forced to stop to preserve cash. And finally, it has also come under threat from many eCommerce competitors (especially from China) who have tried to replicate their model and have been showing varying degrees of success in doing so.
Let’s first start with analysing how Q3 fared for $SE.
Q3 Earnings, Analysis
Sea’s Q3 revenue came in at $3.3B, up ~5% YoY and ~6% QoQ. The growth is definitely not as high as anyone would have liked, but if we segment this into Garena vs Shopee & Seamoney we would know why. Shopee actually grew 16% YoY and Seamoney grew by 36% YoY but the group performance got dragged down by Garena which was down 35% YoY.
Shopee
Coming to Shopee, core marketplace revenue was up 32% YoY and 8% QoQ at $1.3B with the higher take rates and growth in ad sales continuing to drive positive growth. VAS logistics segment dragged the overall Shopee growth a little, with revenue coming in at $593M which was 4% down YoY making the overall Shopee revenues stand at $2.2B (+16% YoY, +5% QoQ). The concerning part here was the profitability – the Asia segment swung into an adjusted EBITDA loss of (-$306M) compared to (-$217M) in Q3’22 and a positive (+$204M) in Q2’23. The biggest reason which drove this loss was the re-investment into sales & marketing with expenses up by ~$420M QoQ and ~$100M YoY. Despite the $420M QoQ expenses growth, core marketplace revenue only grew by $100M – definitely disappointing. Where could these S&M $$ have gone? Well, Shopee capitalized on the TikTok Shop ban in Indonesia by expanding livestreaming subsidies, new user vouchers & new seller incentives/programs (such as lower short term take rates).
The proof is that management mentioned during the Q3 earnings call that livestreaming accounted for 10% of total order volume in October – a huge contribution given Shopee processes 2.2B orders per quarter (!) and the number of orders grew by 24% QoQ. GMV was at $20B, up 11% QoQ. We know that livestreaming purchases are generally of a lower average order value (AOV) given they are in fast moving categories such as fashion, beauty & home. Therefore, if we see the efficiency of the sales & marketing expenses from a GMV & order growth perspective, it actually makes much more sense:
1. From an order growth perspective, based on the 2.2B orders representing a 24% QoQ growth, it means Q2’23 orders were ~1.77B. Therefore, the additional $420M S&M spend contributed 430M orders, implying a ~$1 spend to get each additional order.
2. From a GMV perspective, based on the $20.1B GMV representing a 11% QoQ growth, it means Q2’23 GMV as $18.1B. Therefore, the additional $420M S&M spend contributed $2B in GMV, implying each $1 S&M spend contributing ~$5 in incremental GMV. At a ~10% take rate on $2B incremental GMV, the revenue should have grown by $200M, but the shortfall can be most likely attributed to lower short term take rate offered to livestream sellers to capture market share from TikTok Shop ban + competing with TikTok in markets where they are still present (like Malaysia, Thailand).
Quite honestly, when the headline numbers of the massive S&M spend came out they were a bit scary but putting things into perspective at a per order and incremental GMV basis makes things much more easier to rationalise. These clearly show that the company is prioritising long term moat creation over short term profitability as the users & sellers it acquires now will continue to stick as long as the logistics & product experience is strong which Shopee already has proven with its regular eCommerce operations. Therefore, there is a clear path for Shopee to be the next leader in livestream shopping after cementing its position as the market leader in regular eCommerce and management is ensuring it is executing strongly on that path.
Outside of SEA, unit economics in LATAM continued to improve for Shopee, recording a massive improvement to (-$40M) in adjusted EBITDA vs (-$279M) for Q3’22, i.e. on the verge of profitability with Brazil contribution margin loss per order reducing by 90% YoY. This is also a really positive sign as LATAM is a very high growth digital economy with existing players like MercadoLibre continuing to grow profitably. Sea looks to be on the verge of hitting profitability in LATAM and proving that its platform is capable of success not only in SEA, but also in underserved markets globally.
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Seamoney
Perhaps the most underrated and almost ignored segment of Sea is Seamoney – investors don’t realize that Seamoney is growing so fast that it has reached almost ~$2B in annualized revenue (Q3’23 revenue was $446M, up 36% YoY, similar levels as Garena) and has reached an adjusted EBITDA of +$165M! This means, Garena is not the only cash cow anymore as Seamoney’s adjusted EBITDA is actually ready to eclipse that of Garena (+$234M in Q3’23) if the growth trajectory continues. Seamoney has proven profitable growth with minimal sales & marketing spend in a region where most users still don’t have a formal credit history. This poses a tremendous opportunity and it is definitely possible for Seamoney to reach a point where it is generating almost $1B in free cash flow annually. What is even more promising is that the growth came at the same time when the company is also underwriting loans more prudently – the non-performing loans % in Q3 declined to 1.6% from 2% in Q2. And all of this growth is not even factoring Seamoney’s upcoming Singapore & Malaysia digital banks scaling up – the Malaysia one is not launched, and Maribank in Singapore is still very new so there is immense opportunity ahead. Management also mentioned that Philippines & Indonesia have seen a strong demand for direct debit services in Q3 – further highlighting new areas of growth that they can tap into.
It is clear that going forward Seamoney will be more important than ever and Shopee should not be the only division being highlighted or analysed by investors. The company has already started to use its Shopee userbase to bring users for Seamoney in different ways and all of these cross-platform synergies will only continue to strengthen and improve the profitability of Sea group as a whole.
Garena
Garena’s slowing growth is a cause of concern and one of the major reasons for the rerating & decline in Sea’s stock price but a positive sign is that Q3’s $592M Garena revenue was up by 12% QoQ. The QoQ improvement signals that the degrowth has stabilised and there is a strong chance Garena gets back to its growth trajectory in upcoming quarters. Management also mentioned that Free Fire was the 3rd most downloaded mobile game globally in Q3 and they have made many investments to enhance user experience and content collaborations to further grow the user base for Free Fire.
What is also important to note is that the proportion of Free Fire paying users is still at just 7.5%. While this is low, this also signals headroom for growth with improved monetization strategies. It will be important for management to signal to the market that they are committed to improving this as Free Fire is still the cash cow of the company and still has a lot of potential in terms of monetization.
Changing Market & Competitive Dynamics
One of the biggest reasons why Sea stock has come under a lot of pressure is due to the rising competition from other eCommerce platforms in South East Asia. These are primarily TikTok Shop, Temu and VIPShop. Historically, Shopee has mainly had to compete with Lazada, who they maintain a formidable lead against but there are some new competing apps mainly from China which are now trying to take a piece of the eCommerce pie.
It is no doubt that Shopee’s most formidable new opponent is TikTok Shop – TikTok is reinvesting all of the profits it makes from their fast growing video reels platform into eCommerce livestreaming as the next frontier of growth. However, what is important to note is – (1) TikTok is doing this very unsustainably with losses mounting into the billions of dollars, (2) TikTok has faced serious regulatory backlash especially in Indonesia where TikTok Shop is already banned; and similar action might happen in Malaysia where the government has already expressed its unhappiness regarding TikTok not complying with local laws.
With regards to Temu, it is still early to see how much of an impact they can create on the SEA eCommerce landscape. If we try to draw a parallel from the US, Temu has been more of a fad rather than a strong competitor with reports highlighting that Temu started out as a top 5 free app in the US in its first couple of months but has now dropped below #40-50, clearly signalling that in entrenched markets it is not so easy to just burn your way to growth. They are also very focused on the US as of now, with 95% of their monthly active users (MAUs) coming from the US and reports showcasing that Temu’s forays into Philippines and Malaysia have been very disappointing (with neither a price differential to Shopee (in fact much higher product prices) nor significant user acquisition). It is likely that will only get aggressive in SEA once their model is proven in the US where it seems to be mainly focused on.
The promising update from Sea also is that the management is not sleeping at the wheel – they have already realized that livestreaming is a rising form of digital commerce and they are aggressively investing and ensuring they capture a strong share of this segment in the coming year. During the Q3 earnings call, management mentioned Sea has already seen a 3X month-on-month growth in both the duration of livestreaming on Shopee and the # of livestream sellers. Livestreaming is already accounting for 10% of their total October orders. At the same time, management mentioned that livestreaming unit economics continue to improve strongly and their upfront investments are showing visible signs of returns in upcoming quarters.
Outlook
The last year or so has been a hard time for Sea investors. The stock price has been under a lot of pressure but what is important to note is that growth is returning to Shopee & Seamoney and Garena is stabilizing all at the same time. What we saw this year were disappointing YoY growth numbers, but with Garena likely having bottomed out and Shopee & Seamoney continuing to grow in high double digits, it is very likely to be expected that Sea group as a whole will again start seeing its YoY revenue growth compounding happen.
The promising part of this is also that Sea has a lot of financial cushion and valuation support at these levels. They had $7.9B of cash & equivalents as of end Q3’23 – up by $274M from Q2’23, showing that despite the net losses, they are cash flow positive. With the market cap at current levels at just $21B, Sea’s enterprise value excluding cash is being pegged at just ~$13B. This is a 1X multiple of annualized revenue, and 13X of approximate annualized free cash flow – clearly showing how much of pessimism has been baked into the stock price.
We continue to be positive on Sea group representing a big long term opportunity. There are definitely many challenges with the slowing global economy, high interest rates and rising competition in the region but the company gives us reason to believe that it has positioned itself strongly to face of all of these challenges with the execution it has done over the past many years and the capabilities they have built for themselves.
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