🌏 Sea: To profitability and beyond
A look into the Southeast Asia giant behind Shopee and Garena
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Sea Limited (SE) is a tech conglomerate based in Singapore, often dubbed the “Tencent of Southeast Asia.”
The company delivered a big earnings surprise earlier this week. So let’s zoom in on this complex international business.
Today, we’ll cover the following:
Sea Q4 FY22 .
Recent business highlights.
Key quotes from the earnings call.
What to watch looking forward.
Sea Limited is a three-legged business.
The company is involved in gaming (Garena), e-commerce (Shopee), and digital payments (SeaMoney). While Sea initially focused on Southeast Asia, it has global aspirations and has found some success in South America.
Tencent—the largest gaming company in the world—has used Garena as a publisher in Southeast Asia and owns 19% of Sea.
Garena has been highly profitable and cash flow accretive. As a result, it served as a flywheel, fueling innovation in new cash-hungry segments like e-commerce.
However, this narrative is changing. After a pandemic catalyst, Garena has collapsed back to its pre-COVID run rate. So the company has been on shaky ground, with cash flow turning deep in the red. Management had to adapt, and the first signs of a turnaround appeared in the last quarter (more on that in a minute).
Let’s review the three core businesses and key metrics you should know:
🛍️ Shopee (E-commerce Platform): Mobile-centric, social-focused marketplace with integrated payment, logistics infrastructure, and comprehensive services to sellers.
GMV: Gross merchandise value (the value of orders on Shopee).
Orders: Confirmed order from a transaction between a buyer and a seller.
🎮 Garena (Digital Entertainment): Mobile and PC online games. While the company relies on 3rd party publishing and licensing, it developed in-house a free-to-play battle royale game called Free Fire launched in 2017. It became one of the most popular mobile games globally.
Bookings: Cash spent by users on games (similar to Roblox).
Game QAUs: Active users during the quarter.
Game QPUs: Paying users during the quarter.
💳 SeaMoney (Digital Financial Services): Mobile wallet services, payment processing, and other offerings (credit, insurtech, and digital bank services).
Mobile wallet total payment volume.
SeaMoney QAUs: Active users with at least one financial transaction with SeaMoney products and services.
Let’s turn to the financials:
Revenue: Shopee has steadily become a more significant part of the top line. Of note, SeaMoney barely made any revenue before FY21.
🛍️ Shopee: 61% of overall revenue.
🎮 Garena: 27% of overall revenue.
💳 SeaMoney: 11% of overall revenue.
Costs and expenses include:
Cost of revenue: Direct expenses in generating revenue. Channel distribution cost, logistics and other value-added services, bank transaction fees, server and hosting costs, and cost of goods sold.
Sales & marketing: Advertising expenses, promotion expenses, staff compensation.
General & administrative: Costs associated with running corporate operations (legal, accounting, marketing, etc.), depreciation, and amortization.
Research & development: Product development functions.
The gross margin has improved since 2018. While Garena has a gross margin profile north of 60%, Shopee has had a low gross margin for a while, driven by an aggressive loss leader strategy.
The operating margin has been deep in the red since the company went public in 2017. Garena’s operating income was more than offset by the Shopee and SeaMoney losses.
The bull case for Sea is around future operating leverage and scalability. Investments in the cost structure of its ecosystem put the company in a great position to serve a large and fast-growing region of the world that is complex to maneuver for new entrants. In addition, Sea’s founder Forest Li is celebrated for his way of thinking about the business in 10-15 years cycles, reminiscent of Pony Ma (Tencent) or Jeff Bezos (Amazon).
The bear case has been focused on the cash burn in the past few quarters. There are many near-term challenges, and management had to show they could get self-sufficient quickly.
Let’s look at the most recent quarter.
1. Sea Q4 FY22
Key business metrics:
Bookings declined -50% Y/Y and -18% Q/Q to $544 million.
Quarterly active users dropped -26% Y/Y and -15% Q/Q to 486M.
Quarterly paying users ratio was 9.0% of users (-0.1pp Q/Q).
Gross orders declined -12% Y/Y to 1.7 billion.
GMV fell -1% Y/Y to $18 billion (but grew +8% Y/Y fx neutral).
Here is the bird’s-eye view of the income statement.
Revenue grew +7% Y/Y to $3.5 billion ($0.4 billion beat).
🛍️ Shopee grew +32% Y/Y to $2.1 billion.
🎮 Garena declined -33% Y/Y to $0.9 billion.
💳 SeaMoney grew +93% Y/Y to $0.4 billion.
Gross margin was 49% (+8pp Y/Y).
Operating income was $0.3 billion (10% margin, +24pp Y/Y):
🛍️ Shopee $0.1 billion (5% margin, +64pp Y/Y).
🎮 Garena $0.4 billion (42% margin, -19pp Y/Y).
💳 SeaMoney $0.1 billion (16% margin, +96pp Y/Y).
Unallocated: ($0.2) billion.
EPS (earnings per share) $0.72 ($1.27 beat).
Operating cash flow: $0.3 billion (9% margin, +19pp Y/Y).
Cash and short-term investments: $7 billion.
Long-term debt: $4 billion.
So what to make of all this?
The overall revenue exceeded expectations ($0.4 billion beat). But we need to dig deeper. Garena delivered $2.8 billion in bookings in FY22, just in line with the dramatically reduced expectations last quarter.
Gross margin improved dramatically: The improvement was driven by cost efficiencies for Shopee and Sea Money. In FY22, the growth in core marketplace revenue (high margin profile) has contributed to the positive trend.
Spending efficiencies: The significant operating margin gains were driven by cuts in sales & marketing expenses (-61% Y/Y). The cuts affected all segments (see chart).
Operating income: One of the critical soundbites of the quarter was that all three segments were profitable. But it comes with a giant asterisk. The segment breakdown sets apart $200 million of unallocated expenses (stock-based compensation). If we allocate these expenses to each segment based on their revenue contribution, the conclusion would be that Garena still drives all the operating profit while the rest of the business is essentially breakeven.
Cash flow rebound: Sea used $1.4 billion in cash from operations in the first nine months of 2022. So seeing operating cash flow turn positive again in Q4 was an impressive turnaround.
A necessary turnaround, but not sufficient: Given that Garena’s user metrics, bookings, revenue, and margins remain in free fall, Shopee and Sea Money must maintain operating leverage and growth momentum to keep the overall business on track. While the margin improvements are undeniable, the progress from here might be more challenging with limited room for cost-cutting.
Can we trust management when performance metrics they volunteered disappear one by one? One of my pet peeves is when companies suddenly change the data they share with investors when it no longer fits their narrative. Case in point this quarter: GMV and gross orders. Management will share these metrics only once a year moving forward (instead of every quarter). This is because they believe our focus should be on profitability. With the sales and marketing expenses cuts, it’s reasonable to expect a lumpy road ahead for GMV and orders. But why hide it? Investors should be able to see the whole picture in good and bad times. Similarly, management used to share Quarterly Active Users and payment volume of digital financial services. But they abruptly stopped in Q3 FY22. Likewise, this quarter they removed Garena’s Quarterly Active Payers from the company presentation (we have to calculate it ourselves). Do you see a pattern?
Is the business sustainable?
Sea has a robust balance sheet with a ~$3 billion net cash position.
The company used $1.1 billion in cash from operations in FY22. As a result, the cash pile could dwindle quickly at this rate. But, of course, Q4 FY22 showed an encouraging trend, with the business turning cash flow positive again.
The primary driver of operating cash flow is the Garena segment. So a continued decline of this segment could still be a problem over time and is something to watch.
In short, Sea must make Shopee and Sea Money cash flow accretive to compensate for the decline of Garena, and the clock is ticking.
2. Recent business highlights.
The collapse of Garena:
Forest Li explained during the call:
“In 2022, online games as a market was broadly impacted by ongoing moderation in user engagement and monetization. Our games experienced similar trends.”
That’s not entirely true. For context:
Roblox grew bookings by +17% Y/Y in Q4 FY22 (or +21% Y/Y fx neutral).
Activision Blizzard increased net bookings by +2% Y/Y in FY22.
Electronic Arts saw net bookings decline -1% Y/Y in the past 12 months.
So while the market has been more challenging, Garena dramatically underperformed the rest of the industry, with bookings collapsing -50% Y/Y. So I have to call shenanigans again here.
Note: Free Fire was banned in India in February 2022, but bookings were already on a sharp downtrend when it happened.
After seeing massive demand during the pandemic, many companies have seen their growth normalize since the end of 2021—Roblox, Etsy, DocuSign, Zoom Video, and so on. But the normalization materialized with a revenue flattening or simply growing slower from a new elevated base. Garena’s problems are on an entirely different level.
Bookings are a leading indicator of growth (as explained in this article). Revenue will continue to decline in the coming quarters based on bookings, so we should expect less operating income contribution from the digital entertainment segment.
Q4 is a seasonally strong quarter for gaming, so the $544 million bookings were particularly disappointing (matching the very low expectations). The user metrics are also concerning, no matter how you look at them. Quarterly active users are below their Q2 FY20 level (500 million).
Let’s look again at Garena in FY22:
Revenue declined -10% Y/Y to $3.9 billion.
Adjusted EBITDA $1.3 billion (34% margin).
The booking run rate at the end of FY22 implies an annual revenue of ~$2.2 billion. And with significant cuts in sales and marketing expenses, it’s hard to anticipate any improvement in bookings and user trends in the near term.
Garena’s financial contribution could be cut by 40% or more in the coming quarters (once revenue catches up to bookings). That’s why Garena is unlikely to keep its role as a cash cow for the business. So again, the new focus on efficiency for Shopee and Sea Money is a matter of survival.
Shopee’s path to profitability
Shopee’s $2.1 billion revenue includes:
Sales of goods: This category declined -16% Y/Y to $0.3 billion. They are products owned and sold by Shopee. It’s a low-margin business (18% gross margin in Q4).
Marketplace: Shopee Marketplace grew +44% Y/Y to $1.8 billion. It has two revenue segments (see chart):
Core marketplace: Generated from the commission fees charged to merchants for selling on Shopee, including advertising revenue.
Value-added services: Additional services like inventory management, online store operations, and fulfillment services.
Transaction-based fees and advertising were behind the rapid +54% Y/Y growth in core marketplace revenue.
The positive adjusted EBITDA for Shopee is misguiding since it includes $80 million of accruals reversal (artificially boosting profitability in Q4) and excludes SBC.
In Asia markets, Shopee reached a positive adjusted EBITDA of $320 million (compared to a $217 million loss in Q3 FY22).
In other markets, the adjusted EBITDA loss decreased more than 50% Q/Q to $124 million.
The path to profitability in Asia is encouraging. Sea cut its losses early in several European countries, applying discipline to its international expansion. Now, the company is well-positioned to succeed in the countries where it remains operational.
The sales and marketing expenses for Shopee dropped more than 50% Y/Y. While sales of goods declined, the marketplace revenue continued to grow at a fast pace.
For context, MercadoLibre—an e-commerce giant in South America—spent only 13% of its overall revenue on sales & marketing in Q4 FY22 and grew its e-commerce segment +36% Y/Y fx neutral. Sea spent 14% of revenue (see income statement chart). So Sea essentially aligned its level of spending with its peers.
Can the existing network effects (more buyers bringing more sellers and vice versa) remain in place in the coming quarters? As long as sellers continue to use Shopee as the best place to grow their business, the ebb and flow of GMV and gross orders won’t be as much of a concern.
Since January 2023, Shopee has increased its commission fees from 2% to 2.5% to 4%. So Shopee Marketplace revenue could get a big boost from this take rate hike. The main question is whether sellers will blink or not. Etsy successfully implemented comparable take rate hikes. This will be a test of Shopee’s competitive moat.
3. Key quotes from the earnings call
Chairman and CEO Forrest Li touched on efficiency:
“We have adopted the approach of doing less but doing it better.
First, we sharpened our focus on the areas with the greatest potential across our businesses. We exited or downsized operations in non-core markets, streamlined our game pipeline with divestments and project closures, and deprioritized non-core initiatives. These measures brought immediate cost improvements. More importantly, they allowed us to focus our managerial, operational and financial resources on doing the core things better.”
These adjustments caused a $178 million goodwill impairment in Q4 FY22 (non-recurring).
On the macro environment:
“Given the macro uncertainty and our recent strong pivot, we continue to closely monitor the market environment, and adjust our pace and fine-tune our operations accordingly. As a result, there may be nearterm fluctuations in our results and performance. However, we remain highly confident in the long-term growth potential of our markets and highly focused on capturing this opportunity.”
Logistic costs are an important area of focus for further margin improvements:
“Our focus this year will be to continue to solidify the efficiency gains and optimize the cost structure across our markets. […] GMV will largely remain an output for us in the near term.”
On the long-term e-commerce opportunity:
“In our view, ecommerce penetration in our markets remains low as compared to its full potential relative to offline retail. Our markets also enjoy highly favorable demographical trends in terms of their large and growing digital populations. This is further supported by the long-term economic growth potential across our markets. The key question presented to us at this stage is how much of these underserved needs for online 3 consumption we can sustainably address. This determines the size of the profitable TAM we will be able to capture. We believe a large part of the answer lies in our ability to continue to improve the cost structure of our ecosystem through creativity, technology, operational excellence and most importantly, an unwavering commitment to serve our users.”
Management sees many bullish tailwinds:
A relatively young population in Sea’s markets.
Deepened digital penetration vis-à-vis offline retail.
The economic growth potential across South East Asia and Latam.
On SeaMoney and its long-term contribution:
“Our SeaMoney business is a highly synergistic part of our digital ecosystem. For example, our mobile wallet has resulted in lower transaction costs and a more seamless transaction experience on Shopee. Shopee in turn has allowed the mobile wallet to grow its user base and build user habits more efficiently. With Shopee, our credit business is able to leverage a large captive user base, a highly relevant use case with significant scale, and a wealth of user insights for more effective underwriting. At the same time, Shopee benefits as consumers enjoy more flexible payment options, access to credit, and greater affordability. We expect our digital insurance, wealth management and bank businesses to enjoy similar synergies with our e-commerce platform to serve the large, underserved communities in our markets. We see SeaMoney as an important long-term growth engine for us.”
Chief Corporate Officer Yanjun Wang added on the near-term outlook:
“We continue to see macro uncertainty, headwinds to consumption, so we will be adjusting and fine-tuning our pace and operations carefully in a highly dynamic manner, observe our markets from period to period and adjust accordingly.”
On Garena’s headwinds and when they might stop:
“We won't be able to give guidance on any short-term trends at this point yet.”
4. What to watch looking forward
How much worse can it get for Garena?
Management cannot predict with confidence what the future holds for Garena. As an executive in the gaming industry for over a decade, I’ve learned firsthand that a gaming business can be unpredictable. Given the user trend sequentially, there is no reason to be optimistic about the state of Free Fire and the rest of the portfolio until we see evidence of stabilization in the numbers.
You understand how bookings work if you regularly read How They Make Money. Because of deferred revenue, the current decline in bookings will take several quarters to be reflected in the revenue and operating income. So the existing margin profile of the company on a GAAP basis is artificially inflated by the booking surge during COVID. So looking at trailing financials is misguiding.
Garena’s near-term fate will also have direct implications on the cash flow margins.
Shopee’s network effects
Sea demonstrated an exceptional turnaround in Q4 FY22 from a margin perspective. But we have to see how it will translate into revenue trends in the coming quarters.
The company can control the input but not the output. It’s reasonable to expect more GMV attrition in FY23, given the sales & marketing cuts. But management came short of providing guidance and insisted the near term would look lumpy.
The take rate hike in January could provide a significant revenue boost in FY23. It will tell us more about the strength of Shopee and its importance to sellers compared to Alibaba’s Lazada, for example. But keep in mind it will be short-lived. A rising take rate is not a lever you can pull every year.
I suspect Shopee’s moat is solid in South East Asia once we look past the near-term lumpiness, but the competitive landscape could change fast.
I’m wary of the repeated lack of transparency by this management team. They have been adept of chart crimes and hiding key metrics when they don’t fit the narrative.
If revenue is down significantly, they only highlight the movements Q/Q.
If paying users are in free fall, they remove the chart from their presentation.
GMV and gross orders will decline. As a result, they won’t share it anymore.
The guidance would look bad, so they don’t provide any outlook.
It begs the question: What else are they not sharing?
Sea may be on a fantastic multi-year trajectory that could make it a behemoth in South East Asia and Latam. But the path to get there will be more challenging than the Q4 FY22 numbers suggest due to Garena’s continued collapse.
As a shareholder (I have a small position), I hope the long-term vision around e-commerce and digital payments will come to fruition. But there are many moving pieces, and we might need a few more quarters before taking a victory lap on self-sufficiency.
That’s it for today!
Stay healthy and invest on!
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Disclosure: I am long SE in the App Economy Portfolio. I share my SE rating (BUY, SELL or HOLD) with App Economy Portfolio members here.
One of the largest holdings in my portfolio (I have quite a strong risk appetite 😅), really good analysis and an interesting take on the company.
Great visuals as always 😉