Sea Ltd. (SE, Financial) operates Southeast Asia's largest e-commerce company, Shopee. Started as a gaming business called Garena, the company has expanded into e-commerce, which is now its main growth driver.
Shopee is a hybrid consumer-to-consumer and business-to-consumer marketplace platform operating in eight core markets. Indonesia accounts for 35% of gross merchandise value, with the rest split mainly among Taiwan, Vietnam, Thailand, Malaysia and the Philippines. For Garena, Free Fire was the most downloaded game in January 2022 and accounted for 74% of gaming revenue in 2021. Sea's third business, SeaMoney, facilitates e-wallet payments on Shopee and offline and provides other digital financial services such as credit lending.
The company its shares decline nearly 29%, closing at $40.58 on Aug. 15, after reported its second-quarter 2023 financial results. The sell-off was sparked by a business decision to invest in the e-commerce business and a warning about further losses.
Now the stock is near its 52-week low of $40.11, but is it time to go and catch this discount? No. The main problem Sea has to solve is choosing between growth and profitability.
Profitability versus growth
In previous quarters, Sea announced it had decided to focus on profitability over the pursuit of growth. Now it seems it has switched back to growth as CEO Forrest Li said the company intends to expand the online shopping arm, Shopee, and that “such investments will have an impact on our bottom line and may result in losses.”
The company has been growing rapidly in recent years, but has also been struggling to be profitable. In 2022, Sea reported a net loss of $1.65 billion. This was an improvement from the net loss of $2.8 billion in 2021, but it was still a significant loss. Sea's profitability has been hurt by its high spending on marketing and sales, as well as its investments in new businesses.
Strategies for balancing profitability and growth
In the short term, Sea may need to focus on profitability in order to reduce its debt and improve its financial position. However, the company also needs to continue to invest in growth in order to maintain its competitive edge. Sea is operating in a rapidly growing market, so it needs to be able to grow its business in order to stay ahead of the competition.
The right balance between profitability and growth for will depend on several factors, including the company's financial situation, its industry, its goals and its competitive landscape. However, it will need to find a way to achieve both profitability and growth in order to be successful in the long term.
Some possible strategies that Sea could adopt to achieve a balance between profitability and growth include a focus on increasing sales in existing markets, reducing costs, investing in new businesses and partnering with other companies.
Profitability at risk
The Singapore-based company earned a profit of 54 cents per share for the quarter that ended in June on $3.1 billion in revenue. However, it should be noted that analysts polled by FactSet were expecting sales of $3.26 billion and earnings per share of 65 cents.
A miss on the top and bottom line was a catalyst that caused the sell-off, which now has losses of around 22% in 2023 and losses of about 44% for the past year. Some of the second-quarter highlights were that total GAAP revenue was $3.1 billion, up 5.2% year over year, total gross profit was $1.5 billion, up 33.1%, and total net income was $331.0 million, as compared to a total net loss of $931.2 million for the second quarter of 2022.
Business segments and cost-cutting measures
In terms of the business segments, E-commerce GAAP revenue was $2.1 billion, up 20.6% year over year, while Digital Entertainment GAAP revenue of $529.4 million was lower than $539.7 million for the previous quarter and Digital Financial Services GAAP revenue was $427.9 million, up 53.4% year over year.
Cost-cutting on expenses seemed to be the effective way for Sea to report a net profit as total operating expenses were reduced to $1.16 billion, a decline of 39.4% year over year.
Concerns over financial performance
The main problem I see is that Sea has been losing money over the past five years, with a net loss of $1.65 billion in 2022. Turning to the quarterly net income trend, the company seems to have found an edge as, for the quarter ending on Dec. 31, 2022, it reported a net income of $430.66 million. Further, for the first quarter of 2023, net income was $88.27 million.
The revenue growth seems to be another main concern as, after the strong surges of 163.18% in 2019, 101.35% in 2020 and 127.11% in 2021, the revenue growth fell substantially to 25.06% in 2022.
What makes me nervous now is that the GF Value of $364.47 suggests the shares are significantly undervalued, which is in contrast with the annual free cash flow trend, which is mostly negative for the period between 2018 and 2022.
Although Sea has a high growth rank at 8 out of 10, the profitability rank is low at 3 out of 10 and the financial strength rank is moderate at 5 out of 10.
Final thoughts
I am skeptical and think that the profitability of Sea seems very fragile now. The company has mentioned increasing spending to boost its e-commerce business and warned of future losses. While net profits have been achieved over last three consecutive quarters, a return to potential net losses over the next several quarters will likely not support a higher stock price. I consider the decision to support an e-commerce business a risky one, with uncertain results. Therefore, I do not find the shares attractive now due to this high risk.
