June 10, 2024

Still Easy To Sea


Over the last nine months, I've conveyed the Sea Ltd. thesis to you in a number of ways; however, in August of 2023, as the stock fell to $35/share, I specifically articulated the thesis via ten definitive points.

Today, I'd like to start by revisiting those ten points, after which we will review Sea's most recent quarterly report and discuss the thesis through a few different lenses.

Let's begin!

In August of 2023, following a report after which Sea stock sold off in dramatic fashion, I rebutted the market's perspective via the ten point, distilled thesis articulated below:

Easy To Sea (Originally Written August 18th, 2023)
  1. Shopee remains the #1 ecommerce platform in SE Asia. It is the only profitable one. Lazada is the #2, and this is a Rocket Internet Startup that existed before Shopee but has since been surpassed by Shopee by a very long shot. Shopee is indisputably the best ecommerce platform in the region, and it's the only profitable platform.
  2. WMT, AMZN, TGT, LOW, HD, DG, grocery stores, and department stores have all co-existed and created trillions in equity value over the last 75 years.
  3. MELI has co-existed with a host of rivals, including Amazon quite formidably in Latin America, and it has still done very well profitably. I believe SE will experience the same.
  4. SE has $7.7B in cash & equivalents; $3.3B in convertible debt. This is a massive amount of resources with which it can further dominate the aforementioned unprofitable and historically stagnant/inferior competition. SE also generates robust free cash flow quarterly now alongside its giant liquidity position on its balance sheet.
  5. SE owns Garena, which is now returning to growth. This is like SE's AWS (AMZN) in a sense, giving it an advantage over rivals. Garena could also experience sales growth in the future. Garena produces about $1B in annualized cash flows for the conglomerate.
  6. SE has a FinTech business (Sea Money) with about 60M users on the platform. This alone could be worth $20B to $30B, and SE currently trades at ~$18B in enterprise value (preposterous in my opinion). This is a rapidly growing, free cash flow generative business that provides core economic infrastructure to SE Asia.
  7. SE Asia has a very, very long runway for growth demographically. The region is still in the very early innings of economic growth and development.
  8. SE has demonstrated an ability to successfully and organically (meaning without acquiring) build new products and scale them rapidly. While it's built three incredibly successful franchises over the last decade or so, i.e., Garena (500M+ users and highly profitable), Shopee (#1 ecom platform in SE Asia and only profitable one), and Sea Money (~60M users and profitable), it's highly likely that it creates new and compelling products in the future as well, adding to the 20-30% annualized growth I believe the conglomerate will achieve in the decade ahead, once we emerge from the current rate hiking cycle and Asian economic woes broadly.
  9. Lastly, SE Asia's demographics are very favorable for sustained, elevated growth for Sea in the decades ahead (depicted below).
  10. SE is so preposterously easy at these levels it's not even funny. I believe a 10 bagger over the next 10 years will be seen as base case for the business.

I updated each point below:

  1. Sea Ltd. remains the #1 ecommerce platform in SE Asia, having not just maintained market share over the last nine months, but also gained market share against its vastly weaker competitors, e.g., Lazada and Tokopedia, the latter of whom sold itself to TikTok for just ~$1B. I would say it's natural to expect Sea to continue to maintain, if not gain, market share considering the DNA of its competitors is simply inferior to the DNA of Sea.
  2. In recent podcasts devoted to Sea, I noted that Amazon has had vastly fiercer competition in America, hence Amazon has lower market share in U.S. ecommerce than Sea has in SE Asian ecommerce; notwithstanding, Amazon continues to produce fantastic unit economics within its ecommerce division. Sea has vastly less competition, and the competition it does have is from competitors that do not have the DNA of a juggernaut like Walmart, Home Depot, or Target.
  3. MercadoLibre continues to perform well, despite competing against Sea, Amazon, Shein, and others within its home markets. Similarly, while Sea does have competition, weak though it may be, there's no reason it cannot do well over time while operating alongside these competitors, just as has been the case for Meli and Amazon in their respective regions.
  4. Today, Sea holds $8.6B in cash against $2.8B in convertible debt. Over the last few quarters, it has been gradually reducing its debt burden by repurchasing its convertible debt itself. Notably, Sea issued its convertible notes, thereby raising cash, during ZIRP in 2021 at a ~0% coupon. As interest rates rose, those convertible notes had to begin trading at a discount to par value so as to offer a yield that was more competitive with the rising risk free rate. This created a scenario, on which Sea is now capitalizing, where Sea could use its cash balance to repurchase its own debt at a discount to fair value. So, for instance, in 2021, Sea issued $1B of debt and received $1B of cash. At the time, interest rates, as measured by the risk free rate, which is a reflection of the U.S. Fed's prime rate, were zero percent, or very, very nearly zero percent. As the Fed raised rates, those interest rates rose, forcing all interest rates in the U.S. economy to rise so as to be more competitive with the newly higher risk free rate. In order for existing bonds' interest rates to become more competitive with the newly higher risk free rate, these bonds had to decline in value. In recent months, Sea has been using its aforementioned $1B in cash to repurchase its debt that is now worth eighty five cents on the dollar. The spread here represents free money for Sea. Awesome. In short, Sea's balance sheet health has been improving immensely.
  5. Garena has, indeed, once again, returned to sales growth, and it should grow double digits in 2024, without an India relaunch. India has become one of the fastest growing and most important markets on earth, so relaunching Free Fire in India would be a huge upside catalyst for both the growth of Free Fire and Garena as a whole. This will be something to monitor for future updates to the thesis. At any rate, it's exciting that Garena has now returned to double digit growth. Its free cash flow generation will continue to act as an important subsidy for the growth and dominance of the overall Sea conglomerate; namely, Shopee.
  6. SeaMoney continues to grow at exceptional rates; now at giant scale of ~$2B in annual sales. This line of business is robustly profitable. That said, unlike when these ten points were originally written, Sea now trades at ~$40B in enterprise value, instead of ~$18B.
  7. SE Asia, indeed, still has an incredibly long runway for growth, data underpinning which I recently shared in my note on Grab.
  8. While Sea was only growing at 5% when these points were originally written, today, it's, indeed, as expected, growing between 20-30% due to the healthy growth and status of its three lines of business: SeaMoney, Shopee, and Garena.
  9. In hindsight, points seven and nine were quite similar, though it really does bear repeating that Sea's runway for growth, through the lens of the demographic composition in SE Asia, is massive, and the data underpinning this assertion was delineated in my recent Grab note. I also shared a helpful chart in this regard later in this note.
  10. I maintain that Sea stock was and continues to be preposterously easy for the reasons cited above.

Let's now review data from Sea's most recent quarter together, then we will conclude with a brief valuation exercise.

Sea's Q1 2024 In Charts

Below, we can see an overview of the growth of Sea's three primary lines of business, i.e., Shopee, SeaMoney, and Garena.

Sea Ltd. Q1'24 Investor Presentation

As we can see, Shopee grew at a blistering 33%, and it grew at 6% sequentially, which is about 25% annualized.

SeaMoney grew its loans outstanding at ~29%, though its revenue decelerated to just 21% year over year. I am not disappointed in this deceleration because:

  1. I know that we're still in the very, very (did I mention very?) early innings of digital financial product adoption in SE Asia, as the chart just below depicts.
  2. 21% growth at $2B in sales scale is phenomenal growth, and there's a solid chance this growth rate accelerates in the years or decades ahead in light of point 1.
  3. Sequentially, SeaMoney grew at a rate of 25% annualized (6% sequentially).

Data From Google & Bain Illustrating Sea's Incredibly Long Runway For Growth

Lastly, at long last, as we've anticipated, Garena lapped its brutally difficult comps and returned to growth. Notably, my expectations were essentially non-existent for Garena heading into the Q1'24 print. I just knew we'd not experience -40% growth every year in perpetuity. However, we received very positive news, with Garena growing at 10%+ in Q1 2024, and Sea guided for double digit growth throughout 2024, even without a relaunch of Free Fire India. With a relaunch, I mean it's plausible that we see 20% growth from Garena in H2 2024, as India represents a massive market for Garena. To wit:

"The battle royale game had over 40 million of its 75 million globally monthly active users in India in January of 2022, according to analytics firm App Annie. In fact, 'Garena’s Free Fire: Illuminate' was the most popular app to be banned in India in February 2022."

Times Of India

Turning to our next slide...

Below, we can see that Sea grew its sales and gross profits at healthy rates.

Sea Ltd. Q1'24 Investor Presentation

And while Sea did not generate net income in the period, it did generate free cash flow, as evidenced by its $400M in adjusted EBITDA (roughly a proxy for free cash flow), which we can see below.

Sea Ltd. Q1'24 Investor Presentation

On the subject of profitability, the chart below illustrates that Sea's SeaMoney and Garena businesses were robustly profitable in the quarter, while Shopee operated at about breakeven.

Sea Ltd. Q1'24 Investor Presentation

That said, Shopee's SE Asia division did generate positive adjusted EBITDA, which was well ahead of schedule based on Sea's previously stated guidance.

With this overview as our foundation, let's now walk through each line of business individually together.

Shopee In Charts

As the graphic below communicates, Shopee reported a stellar quarter in which it sustained hypergrowth for its gross orders, GMV, and revenue.

Sea Ltd. Q1'24 Investor Presentation

Notably, following its Q3'23 and Q4'23 reports, it was evident that Shopee had returned to hypergrowth, and I was adamant about this while the stock traded down violently following those reports.

It was very fascinating to witness: The data very clearly communicated that Shopee returned to hypergrowth, rebuffing the bearish narratives; nevertheless, the stock sold off.

We received no new news in the Q1'24 report; yet, the stock has rallied nearly 100% in just the last few months. It's worth noting for future reference when our companies report brilliant results, then subsequently sell off for no apparent reason. Sometimes, there genuinely is no real, justifiable basis for a sell off such as that which Sea experienced in late 2023 and early 2024.

"Starting with e-commerce, we are pleased to report that Shopee delivered strong growth this quarter, achieving its highest ever quarterly orders, GMV, and revenue. In the first quarter, on a year-on-year basis, gross orders was up 57%, GMV was up 36%, and revenue was up 33%. Unit economics has also improved. Our overall adjusted EBITDA loss narrowed to $22 million, and our Asian markets achieved a positive adjusted EBITDA of $11 million this quarter."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

So Shopee grew at breakneck speeds while burning very little cash in the quarter. Fantastic and precisely as we've anticipated.

Shopee's Allegedly Non-Existent Logistics Business

Sea Ltd. Q1'24 Investor Presentation

As the graphic above conveys, Shopee has been evolving its vertically integrated logistics network, the same one the bears have said does not exist.

"We have put a lot of hard work into SPX Express, and today it is one of the fastest and the most intensive logistics operators in our market greatly enhancing our customer experience. In the first quarter, about 70% of SPX Express orders in Asia would deliver within three days of order placement. And because of the scale we have achieved in our market, we have managed to steadily reduce its cost. SPX Express's cost for order decreased by 15% for Asia and 23% for Brazil year-on-year in the first quarter.

Having SPX Express in the Shopee ecosystem also allows us to efficiently roll out new features that benefit our buyers, such as the on-time guarantee program that we launched in Southeast Asia. This program provides a guaranteed delivery time for orders, and this certainty is well appreciated by our buyers."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

Importantly, this represents one of the elements within the vertically integrated ecommerce platform template, which I've asserted in the past is painfully difficult to execute well; hence, Meli, Amazon, and Coupang are so dominant in their respective markets; hence, Sea is so dominant in its region.

Sea's further vertical integration of its logistics will allow it to have better control of delivery times, speeds, and costs, and this will further develop its already strong competitive advantages against rivals, evidence for which can be found in its "earth-leading" market share in SE Asia as measured by its % market share of total GMV in the region.

"So taken together, this effort increased operational efficiency, improved customer experience, and reinforced Shopee's reputation as a reliable shopping destination. We will continue to push more on these operational priorities in the coming quarter and year. We expect this effort to further differentiate Shopee from its competition and bring greater value to both our buyers and sellers."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

Turning to Shopee's GMV and gross orders, as noted already, they re-entered hypergrowth in Q1'24 as anticipated.

Shopee GMV and Gross Orders Re-Enter Hypergrowth Year Over Year

Sea Ltd. Q1'24 Investor Presentation

"We are pleased to report that Shopee delivered strong growth this quarter, achieving its highest ever quarterly orders, GMV, and revenue. In the first quarter, on a year-on-year basis, gross orders was up 57%, GMV was up 36%, and revenue was up 33%. Unit economics has also improved. Our overall adjusted EBITDA loss narrowed to $22 million, and our Asian markets achieved a positive adjusted EBITDA of $11 million this quarter."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

And this resulted in healthy revenue growth, as can be seen below.

Sea Ltd. Q1'24 Investor Presentation

And, as noted already, this was achieved with negligible cash burn, as the chart below illustrates.

Sea Ltd. Q1'24 Investor Presentation

Turning to SeaMoney...

SeaMoney In Charts

As we can see below, SeaMoney grew its revenue at a very healthy rate. On a year over year basis, it grew 21%.

Sea Ltd. Q1'24 Investor Presentation

However, if we annualized its Q4'23 to Q1'24 sequential growth rate, we'd find that it grew ~25% on an annualized basis. Fantastic.

"Credit business is currently the primary driver of SeaMoney's revenue and the profit growth. Our credit business benefits from Shopee's transaction volume and user base. In addition, we are also seeing strong growth in off-Shopee loans, which include cash loans and off-Shopee as pay later consumption loan. By the end of the first quarter, off-Shopee loans accounted for over 40% of our total Consumer and SME loans outstanding. Going forward, we see further updates to improve our off-Shopee penetration across different markets as we continue to grow."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

There's not really much more to say. This line of business continues to be a gem within the conglomerate, and, as we know based on the Google & Bain study, there's still a truly giant runway for growth still ahead.

Turning to Garena...

Garena & Free Fire

Sea Ltd. Q1'24 Investor Presentation

As we read in the graphic, Free Fires users grew 24% year over year, which was fantastic, and it was the most downloaded mobile game globally(!) in Q1 2024.

"Finally, turning to our digital entertainment business. We are pleased to share that Garena is back to positive growth with bookings up 11% year-on-year.

This was led by Free Fire’s strong performance across markets. In the first quarter, Free Fire’s average MAU increased 24% year-on-year.

Our operational priorities for Free Fire will remain consistent in 2024, improving user acquisition, engagement, and retention. We continue to introduce play modes, redesign features, and launch new content all at a high frequency, allowing Free Fire to sustain high player engagement with this huge user base."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

This likely drove the strong overall performance for Garena, which we can see in the chart below.

Garena Grew Its Quarterly Active Users By A Lot In Q1'24

Sea Ltd. Q1'24 Investor Presentation

Notably, over the last few years, bears have endlessly cited a decline in quarterly active and quarterly paying users as bear theses. In Q1'24, this metric improved dramatically, supporting the aforementioned double digit growth in Garena bookings, which you can see below.

Garena Bookings (Sales Booked Ahead Of Revenue Recognition) Grew At 10%+ For The First Time Since Pre-Pandemic

Sea Ltd. Q1'24 Investor Presentation

"In its seventh year, Free Fire’s are still one of the largest mobile games in the world by user scale, and remains highly effective in attracting new users. According to Sensor Tower Free Fire was the most downloaded mobile game globally in the first quarter. Giving this track record of being able to sustain and the growth requires massive global user base, we are confident of building Free Fire into an ever growing franchise."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

I found the following commentary heartening in terms of looking froward atop this fantastic performance:

"On the gaming side, we are very happy to see what we have achieved in the Q1. So it's a pretty strong result and a strong trend. And we see this trend continued in Q2 so far. And in general, we are pretty optimistic about the rest of the year.

I think, as we shared in the last quarter, and we expected we're going to achieve specific for Free Fire the double digit growth, for the whole year.

And I think like the current, growth and the trend is a pretty much kind of a reflection of what not just what we have done in the past quarter and actually it is reflection what we have done in the past two years."

Forrest Li, CEO, Q1 2024 Sea Ltd. Earnings Call

As a summary chart, we can see below the positive profitability of Garena and SeaMoney and the fact that Shopee is operating at about cash flow breakeven presently.

Sea Ltd. Q1'24 Investor Presentation

Taken together, Sea now grows 20%+ while generating free cash flow alongside $8.6B in cash and $2.8B in convertible debt. Brilliant.

Valuation Exercise

Below, you may review my assumptions for Sea's valuation.

Notably, I assumed an 18.5% free cash flow margin based on Meli's attainment of this margin at various points in the last decade, downstream of an ~45% gross margin. Sea also has an ~45% gross margin, and I believe, Meli aside, that this is sufficient to achieve an 18.5% free cash flow margin long term.

Meli & Sea Gross Profit And Free Cash Flow Margins

And here are the results:

And here are the projected returns:

As we can see, even using relatively conservative assumptions, i.e., 18.5% long run free cash flow margin, downstream of ~45% gross margins, and 20% annualized growth, a reasonable growth rate after Amazon and Meli have demonstrated how long elevated growth can sustain for these multi-faceted ecommerce businesses, we're generating huge, huge returns.

And, notably, these returns are atop $8.6B in cash and just $2.8B in long term debt, i.e., a brilliantly solid balance sheet, and atop sustained free cash flow generation for the overall conglomerate.

Sea operates from an incredible, incredible position of financial strength today.

Concluding Thoughts: Ads & Valuation

To close, I continue to like Sea at these levels quite a bit, and I believe my messaging when the stock traded at $35/share will prove correct in the decade ahead:

At $35/share, the stock offered fairly easy 10x returns over the next 10 years.

We're already 100% through the 900% returns that equate to a ten bagger, and Sea remains, in my eyes, substantially undervalued.

It could appreciate another 50-100% in the next 12 months and still just be fairly valued, in accordance with the valuation exercise I performed just above.

And I think looking at Sea through just its ads business substantiates this rather bold thinking:

As we know, Amazon generates about 5% of its GMV in 55%+ free cash flow margin digital ad sales.

Were Sea to achieve just 2% of its current ~$100B in GMV in 55%+ free cash flow margin digital ads, this would equate to ~$1B in free cash flow coming from just this line of business in 2024.

Presently, Sea trades at ~$38B in total enterprise value, so we're paying just 38x EV/base case ads free cash flow, while this line of business is poised to grow at 20%+ for the next 10-20 years consecutively.

"And for the -- sorry, for the ad take rate, I don't think we disclose the ad take rate actual number. But what we can share is that if you compare with our global peers, for example, in China or in the U.S., we are kind of like still meaningfully lower than where they are. We still have a few percentage to catch up to them. So there is meaningful room for us to increase the ad take rate.

I think there are a few tools that we can deploy to do that. I think one is just having more seller presentation in terms of the -- to enhance the total pool of the skills they're utilizing the ad. In order to do that, we have to develop simpler ad products for the sellers to use. Unlike many of the sellers in multiple markets, we are more familiar with the apps in our market, they have quite some sellers that left some with that. So we have to customize our app tool for those sellers to make sure that it's easier for them to adopt so they can -- so we can have more skills into our app pool. That's number one.

Number two is to increase ad efficiencies through technology. We are spending a lot of effort on making sure that we increase the conversion rates for our ad products, so the conversion ad, so we can actually serve more ads to our users because of increased conversion rate. And number three is to find a way to balance organic and add traffic better. So by having an enhanced product to balance the organic and ad products in a common frame, we can essentially dynamic adjust and load. It depends on the conversion rate and the SKU presentation and scenarios within our app. So by doing all the three things, we see there is a meaningful potential to increase the ad take rate over the next few quarters."

Tony Hou, CFO, Q1 2024 Sea Ltd. Earnings Call

In closing, I continue to find Sea to be a very compelling investment, just like the market saw it for 10+ years prior to its bout of amnesia in the last year or so.

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