Sea Limited: Adding Here May Burn – Let The Rally Fade (SE)

Investment Thesis

While Sea Limited (NYSE:SE) lowered its FY2022 game bookings guidance to between $2.6B and $2.8B, we were not overly concerned yet, since it only implied a -10% decline at the midpoint from the original guidance of between $2.9B and $3.1B. In addition, most of the decline was attributed to the projected downtrend in Q4, as the company had reported a stellar $2.2B of bookings YTD.

It is important to highlight that reduced discretionary spending is natural during a time of uncertain macroeconomic outlook and rising inflationary pressures. The pessimism similarly impacts many other companies, especially ones in the e-commerce and gaming segments.

For now, we were encouraged by the SE management’s prudent choice to reduce its headcount by -10% in H2’22, while similarly tightening its capex moving forward. These suggested the much-needed pivot from a growth-at-all-cost strategy to prioritizing profitability and business sustainability moving forward. Forrest Li, CEO of SE, said:

Our number one objective for the next 12-18 months is achieving self-sufficiency. This means achieving positive cashflow as soon as we can. (theinformation.com)

While it remains to be seen when SE expects to achieve break-even, market analysts are already expecting an optimistic adj. profitability from FY2024 onwards, with adj. EPS of $0.34 and FCF generation of $639.52M. In addition, its projected top-line growth remains more than decent at a CAGR of 18.2% at the same time.

We expect SE’s e-commerce segment to continue being an excellent top-line driver moving forward, as Shopee proved to be the largest and most popular online marketplace in Southeast Asia by January 2023, with 342.8M monthly visits compared to Tokopedia, in second place at 137.3M.

While these numbers might not appear impressive against Amazon’s (AMZN) 2.7B monthly visits in December 2022, we must also highlight that the Southeast Asia region only comprised a population of 685.6M, compared to the global population of 8.01B. Therefore, with a market-leading penetration in eleven countries, SE appeared to be better entrenched in the region it focuses on, against AMZN’s presence in over 100 countries at the same time. Notably, the Southeast Asian region boasted an excellent e-commerce penetration at 20%, against the US at 14.8% and China at 47%.

Therefore, it was no wonder that SE recorded a stellar e-commerce GMV of $55.5B YTD (+25.2% YoY), while similarly expanding its e-commerce revenue to $5.1B YTD (+45.7% YoY). Notably, its marketplace revenue has proven to be the backbone of the company with $4.4B (+57.1% YoY) in revenue contribution YTD, comprising 48.8% of its total sales thus far.

On the other hand, SE’s gaming segment proved to be a bottom-line driver, with $1.05B of adj. EBITDA contribution YTD, supporting the cash-burning e-commerce segment. While the reduced booking guidance might be a concern, the company continued to boast a war chest of cash/investments of $7.29B in the latest quarter.

Despite the worsening macroeconomic, SE investors likely need not worry about its immediate liquidity since only $31.3M of its 2023 Notes and $152M of its 2024 Notes remained outstanding as of April 2022, with no further updates offered in quarterly reports. As a result, the company has plenty of time to achieve its positive cash flow over the next two years, with the remaining long-term debts of $3.97B staggered through 2026.

All of these point to a robust case for SE to moderately recover moving forward, especially once it achieves break-even by hopefully sometime in 2023 and profitability from 2024 onwards. Naturally, this recovery is also assuming that management delivers decent forward guidance.

So, Is SE Stock A Buy, Sell, or Hold?

SE 1Y Stock Price

Based on the stock action thus far, SE has rallied tremendously by 77.1% from the November bottom, breaking the previous December and January resistance levels in the $60s. Given Powell’s dovish commentary in the recent Fed meeting, there is a good chance that the stock may further recover to test the June and August resistance levels of ~$85 in our view.

These mirror the consensus price target of $88 as well, suggesting a 17.2% upside potential from current levels. Depending on individual investors’ risk tolerance, one may consider nibbling here if it consequently lowers their dollar cost average.

Based on its peer’s NTM EV/ Revenues of 2.18x for AMZN (3.5x normalized) and 5.33x for MercadoLibre (MELI) (12x normalized), we may see SE moderately recover from the current NTM EV/ Revenues of 3x to its normalized levels of 5x by 2024, significantly aided by its leading market share in Southeast Asia. For this reason, we think it is not overly bullish to assume a target in the $100s for the SE stock price then.

On the other hand, we must highlight that the SE stock is trading above its 50-day moving averages, while recording a notable short interest of 7.25% at the time of writing. As a result, portfolios should also be sized appropriately in the event of volatility, since the Fed’s optimism may soon be digested differently, as witnessed after the previous meeting in December 2022.

As a result, we prefer to rate the SE stock as a Hold for now. Investors would be well advised to wait for a $50s entry point for an improved margin of safety and better long-term prospects for portfolio growth. Do not chase this rally.