Sea Limited: The Long-Term Bull Case Is Stronger Than Ever
Sea Limited (SE) reported spectacularly strong numbers for the second quarter of 2020. Not only was revenue above expectations, but the company's different segments are also firing on all cylinders and profitability is moving in the right direction. The stock price is a bit too hot in the short term, but any pullbacks in Sea Limited stock should be considered buying opportunities for long-term investors.
Firing On All Cylinders
Sea Limited reported $1.29 billion in revenue during the second quarter, up 93.4% year-on-year versus $665.4 in the same quarter last year. The figure exceeded Wall Street expectations by $230 million. Gross profit grew 106.1% to $200.8 million, and the total adjusted EBITDA was $7.7 million compared to $-11 million in the same quarter last year.
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Source: Sea Limited
Accelerating revenue growth in combination with improving profit margins is clearly good news for investors, and the business is firing on all cylinders across its multiple growth engines.
In the digital entertainment business, adjusted revenue reached $716.2 million, up 61.6% year-on-year, while adjusted EBITDA grew 65.4% to $436.2 million. Quarterly active users reached 499.8 million, an increase of 61%. Paying users grew by 91.2% year-on-year to 49.9 million.
According to App Annie, Free Fire continued to be the top-grossing game in both Latin America and Southeast Asia across both iOS and Android in the second quarter. The game recently hit a new record high in terms of peak daily active users of more than 100 million. Management said that momentum remained strong into the third quarter, even as many markets eased their restrictions on movement.
A major driver in the investment thesis for Sea Limited is the company's ability to successfully expand into e-commerce over the long term. This is obviously a huge opportunity going forward, and the numbers for the second quarter are validating this thesis.
Shopee registered accelerating growth during the second quarter, gross orders increased by 150% year over year to reach 615.9 million. The number represents an acceleration versus a 111% increase in the first quarter of the year. Gross orders for Shopee Mall increased at an even faster rate of 210% year-on-year, as a growing number of global brands are relying on Sea Limited in order to adapt to an evolving industry landscape.
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Source: Sea Limited
Monetization levels increased during the quarter, adjusted revenue grew by 188% year-on-year to reach $510.6 million, with monetization reaching pre-pandemic levels.
Management attributed this strong performance in e-commerce to two major drivers: Fist, e-commerce penetration is deepening across different markets and demographics, with momentum remaining strong into the third quarter. In addition to this, Shopee is capturing an outsized proportion of the growth opportunity in the industry.
The first factor is a major tailwind for the business, and Sea Limited is not only a beneficiary from it but also a big driving force for the e-commerce industry in South East Asia. From a long-term perspective, however, outperforming the competition can be even more important, the market is still in its initial growth stage, and consolidating a leading position in such a huge opportunity can be a game-changer for investors in Sea Limited over the years ahead.
The fintech business is much smaller than online games and eCommerce, but it is also growing at full speed. Mobile wallet total payment volume increased to more than $1.6 billion in the second quarter versus nearly $1 billion in the first quarter. Quarterly paying users grew by about 50% quarter-on-quarter to more than 15 million.
The company is basically firing on all cylinders across the board, and the e-commerce segment is particularly important. Sea Limited is reporting accelerating growth in this business while also increasing monetization and outperforming the competition, and this is a key bullish driver for the stock going forward.
The Long-Term Picture
From a fundamental perspective, the online games industry is always changing and dynamic, and it will not be easy for Sea Limited to replicate the massive success of Free Fire in the future.
The company will also face growing competition in its different segments going forward, and Lazada - owned by Alibaba (BABA) - is a particularly relevant competitor to watch in e-commerce. Sea Limited is performing brilliantly in terms of competitive dynamics, but this is always an important risk factor to monitor in the future.
Shares of Sea Limited are trading at a forward price to sales ratio around 10.3 times revenue estimates for 2021. After such a strong report, there is a good chance that revenue estimates will be increased in the near term, which could push down the price to sales ratio to some degree. Leaving that aside, the valuation is admittedly reflecting strong growth expectations.
This does not mean that the stock is overvalued, though. Valuation is demanding but not excessive if the company keeps executing well across its different businesses in the years ahead.
Sea Limited has a market capitalization value of around $63.5 billion, which is still quite reasonable when considering the size of the long-term opportunity in the South East Asia Internet economy and the fact that the business is delivering accelerating growth.
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Source: Google, Temasek, and Bain & Company. e-Conomy SEA 2019
In the short term, let's say over the next year or so, returns for investors will depend on how revenue, earnings, and valuation evolve. Expectations are quite high for Sea Limited, and the stock has gained more than 230% in the past year, so the current stock price leaves little room for disappointment.
If the numbers miss expectations or if growth decelerates more than expected, shares of Sea Limited would be vulnerable to the downside from current levels. However, this is mostly a matter of volatility and uncertainty in the short term. Missing expectations in a particular quarter do not affect the value of the business by much, and it can provide a buying opportunity if the stock pulls back substantially in that context.
In the long term, returns for investors will depend on the company's ability to continue successfully expanding into games, e-commerce, and fintech in a region with enormous potential for growth. From this perspective, the recent numbers from Sea Limited validate the long-term thesis when considering revenue growth, operational performance, and competitive dynamics.
For investors who are willing to tolerate the short-term volatility that can come with a position in Sea Limited, the long-term bullish thesis in the company is looking stronger than ever after the recent earnings report.
Disclosure: I am/we are long SE.
Disclaimer: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any ...
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