Singapore has announced four winning bidders for the digital banking license which are expected to start their digital banking operation by early 2022.

One of the digital full bank licenses went to Sea Limited (NYSE: SE), a home-grown internet technology company listed on the New York Stock Exchange.

Many investors are familiar with Shopee, the e-commerce platform operated by Sea Ltd (Sea), but may not have heard much about its mobile gaming and digital financial services. In this article, we shall delve into Sea’s business segments, financials, strengths, and threats to better understand the company. 

Overview

Sea started as a gaming company in 2009 and diversified into digital financial services in 2014 and e-commerce in 2015. As the digital financial services business grew larger, it was rebranded into SeaMoney in 2019.

According to its annual report, the company has the largest revenue share of online gaming in South East Asia and Taiwan. It also claims the top spot in terms of Gross Merchandise Value (GMV) and total orders in the region’s e-commerce market according to Frost & Sullivan. 

Sea Ltd: Earnings Preview – Asia Market Edge

Source: Sea Ltd website

In 2019, Sea raked in US$2.17 billion of revenue, with Digital Entertainment (gaming) and E-Commerce contributing 52% and 37% of the revenue respectively. 

Digital Entertainment

Sea’s Digital Entertainment business is housed under Garena, a major mobile and PC online games developer and publisher.

It licenses popular games from third-party developers globally, customisesthe  them to suit the preferences and demands of different markets, and publish the games locally. Garena also develops mobile games in-house and has achieved great success with its Free Fire, a battle royale game that was the most downloaded mobile game globally in 2019. 

Garena generates revenue from its games by selling functional and decorative in-game items to players as well as season passes. Hence, a large player pool correlates directly to the number of paying players and higher revenue. 

As seen below, quarterly active users (QAUs) and quarterly paying users (QPUs) have been growing in past two years. The figure got a boost from Covid-19 and saw more rapid growth in 2020 so far.  

Source: Annual Report 2019

Source: Sea 3Q 2020 Results Presentation 

E-Commerce

Sea’s e-commerce platform Shopee is a mobile-centric marketplace that provides efficient and reliable selling processes for individuals, small businesses, and large retailers. 

Shopee is heavy on user engagement and social activity as it enhances user acquisition and customer retention. For example, shoppers can win Shopee Coins to offset the cost of purchase by inviting friends, and interact with other shoppers via Shopee Games. 

As a result, Shopee has enjoyed strong GMV and orders growth since its founding in 2015, with a more pronounced growth rate in 2020 partly due to Covid-19 driving more buying activities online. 

Source: Annual Report 2019

Source: Sea 3Q 2020 Results Presentation 

With increasing orders and GMV, Sea will intensify monetisation efforts of its marketplace via paid advertising services, transaction-based fees, and charging sellers for value-added services to further grow its e-commerce revenue.  

Digital Financial Services

SeaMoney offers e-wallet services, payment processing, and other financial products under Airpay and ShopeePay. Leveraging Shopee’s pool of user data, SeaMoney piloted a consumer credit programme under ShopeePayLater. Revenue is earned through commission to third-party merchants using Sea’s e-wallet services and interest payment from borrowers. 

2019 was a year of integrating the SeaMoney e-wallet with Shopee platform across different markets and expanding the adoption of e-wallet services among third-party online and offline merchants. The company is seeing some fruits of its efforts as the total payment volume increased to US$2.1 billion in 3Q 2020 and more than 30% of Shopee’s gross orders were paid using SeaMoney. 

Source: Sea 3Q 2020 Results Presentation 

Financials 

As seen from the table below, Sea had enjoyed explosive revenue and gross profit growth in past five years, demonstrating its successful business expansion. However, typical of most aggressively expanding companies, its operation is still loss-making. Earnings taking into account non-cash and non-operational items was negative US$867 million. 

Source: Annual Report 2019

In the recent 3Q 2020 earnings, Sea’s revenue increased strongly but it is still operating at a net loss:

  • Revenue: US$1.21 billion (+99% year-on-year)
  • Gross profit: US$407.6 million (+101% YoY)
  • Net loss excluding share-based compensation and convertible notes fair value: US$346 million (3Q 2019: US$175.2 million)

The Positives

Sea’s business model leverages its user-friendly internet platforms to capture a large share of internet users’ online gaming and shopping. The company further retains and monetise users through innovative e-commerce services, engaging game content, and convenient digital financial services. Collectively, the business segments generate a network effect with better monetisation efficiency as the user base grows. 

The Negatives

The size and engagement of the user base are critical to Sea’s success. While its user base had expanded significantly thus far, fierce competition, failure to adapt to changing user preferences, or even regulatory factors may adversely impact the growth rate. A lower user growth rate would result in Sea incurring larger expenditure acquiring users, affecting its earnings. 

Another aspect of slowing growth may occur in the form of failure in monetising business. Game players may spend less on in-game purchases due to lower disposable income. Paid advertising services revenue and transaction-based fees from Shopee platform may fall due to economic slowdown or a decrease in transactions. 

In a nutshell, the key risk about Sea is whether current operational and financial growth can continue into the foreseeable future. 

Conclusion

I believe that the digital bank license will boost the growth of Sea’s nascent Digital Financial Services, allowing it to expand into the lucrative financial sector. Singapore government’s stamp of approval further polishes its brand as a trustworthy technology company.

However, Sea is not earning any profit yet despite its stellar growth. Hence the traditional price-earnings valuation is not applicable here. Herein lies the greatest risk of investing in Sea: expected future growth fail to materialise. 

Hence this is a growth stock that is suitable for high-risk investors who are prepared for share price volatility. Not for the faint-hearted. 

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