Sea: Recovery In Gaming And Increased Loan Profitability (Rating Upgrade) (NYSE:SE)

In a mostly pessimistic earnings season, it’s been rare to see tech companies soar on good news. Sea (NYSE:SE), the Singapore-based e-commerce conglomerate often considered the Amazon (AMZN) of Southeast Asia, is one of the exceptions. The company saw tremendous results across all three of its major businesses (gaming, e-commerce, and financial services) which helped prop up its stock by nearly 15%.

Year to date, Sea shares have now risen nearly 2x:

I last wrote a neutral opinion on Sea in April, cautioning investors on the slowdowns we’ve seen over multiple quarters in the gaming business. Now, after parsing through the company’s latest Q1 results and seeing a resurgence in paid users, plus tailwinds in the nascent financials services business, I’m re-upgrading my viewpoint on Sea to bullish, as my fears of a Garena meltdown were assuaged.

Here is my updated long-term bull case on Sea:

• Sea operates in the attractive “tiger economies” with secular multi-year growth tailwinds. Serving the fast-growing economies of Southeast Asia (Singapore, Indonesia, Philippines, Malaysia, etc.). Outside of its home country of Singapore, Sea benefits from rapidly modernizing infrastructure and a burgeoning middle class. It’s not ludicrous to compare an investment in Sea to an early bet on Alibaba (BABA) and JD.com (JD) in China.
• Synergies between businesses. Unlike many other e-commerce companies, Sea also has its own payments and financial services arm, which prevents it from needing to pay fees to a third party. The company’s loan-origination arm is also seeing better profitability and lower portfolio losses.
• Continued innovation. The company not only has the know-how to make new games, but it’s also constantly updating its games as well as its marketplace with new features (such as social shopping).
• Trimmed headcount and cost discipline. Sea has proven its commitment to profitability and expense discipline by laying off ~10% of its headcount in 2023 amid slower gaming bookings. Bookings have since rebounded, but the savings will help the company become more profitable with scale.
• Incredibly well capitalized. Sea has more than $9 billion of cash and investments on its balance sheet (for sizing, that is approximately a year’s worth of opex for the company) to continue investing in growth and potentially acquire new platforms.

There are risks present in this stock, of course. The volatility in the gaming business is the biggest one: the company relies on in-game bookings for a good chunk of its revenue (as well as profit, as the gaming division is the most profitable segment), and this has tended to fluctuate quarter-over-quarter (constant releases and in-game events are helping to stimulate activity and purchasing behavior, but a steady stream of gaming activity is not guaranteed). Competition is another, especially in the battleground market of Indonesia, Southeast Asia’s largest economy by far, where Chinese company ByteDance (the parent of TikTok) has taken a large stake in local company Tokopedia.

All in all, however, I’d say there are enough secular tailwinds in Sea to justify a long-term investment here. With the more favorable trends we’ve seen in the gaming division, I’m comfortable going long here again.

Q1 download

Let’s now discuss Sea’s latest results and trends in each of its businesses in greater detail.

The biggest headline here: paying users for Garena, which is the name of Sea’s gaming division, are improving dramatically.

After several quarters of decline, as seen in the chart above, the company added 66 million net-new paid users in Q1. The paid user ratio of total users reached a multi-quarter high of 8.2%, up 70bps sequentially and up 50bps year over year (we note that during the pandemic, paid user ratios were closer to ~10%).

Meanwhile, gaming bookings returned to growth at 11% y/y. And though revenue declined (recall that Garena recognizes revenue as users consume in-game items / as time for memberships passes), adjusted EBITDA grew 27% y/y to $292.2 million, representing a 57% margin on bookings (versus 50% in the year-ago Q1).

New features and higher engagement are a primary cause behind the resurgence in gaming. The company notes that Free Fire, its flagship game, remained the #1 downloaded gaming app globally in Q1 (per independent ratings firm Sensor Tower). It recently added a new feature where players can vote on in-game events, which the company has said boosts engagement. Average MAUs (monthly average users) increased 24% y/y.

On the e-commerce side, revenue grew 33% y/y to $2.7 billion, with underlying core marketplace revenue growing 47% y/y to $1.7 billion (representing sharp acceleration from 23% y/y growth in Q4).

On the profitability side, after seeing sharply negative adjusted EBITDA over the past two quarters, the company reached near-breakeven in Q1, with the Asia region achieving a slight profit:

Improvements in logistics and order fulfillment continue to be both a driver and a sustained priority for the company. Per CEO Forrest Li’s remarks on the Q1 earnings call:

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 briefly 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.

Another initiative we implemented is having Shopee directly manage the return and refund process. This has resulted in a 30% year-on-year increase in resolution time. In the first quarter, about 45% of cases were resolved within one day. So taken together, this effort increased operational efficiency, improved customer experience, and reinforced Shopee’s reputation as a reliable shopping destination.”

Finally, in the financial services arm, the company’s loan book reached an all-time record of $3.3 billion in outstanding loans.

Profitability and performance of its loan book are also improving, with the “NPL90+” ratio, a measure of non-performing loans that are in longer than 90 days of default status, declined by 30bps y/y to 1.4%. Revenue in digital financial services grew 21% y/y, while adjusted EBITDA soared 50% y/y to $148.7 million.

Key takeaways

There is strong momentum in each of Sea’s businesses: recovering user trends in gaming, huge order growth in e-commerce, and improving loan performance and overall profitability in financial services. Given these trends, it’s a good time to get back on the Sea train.