• Both 4Q23 revenue and PATMI were in line with expectations. FY23 revenue was at 98% of our FY23e forecasts, while PATMI was ~US$0.7bn below. Sea has hit its first profitable year since its IPO in 2017.
• Shopee is gaining market share against its competitors, with both GMV and gross orders growing strong (29%/46% YoY), driven by increased investments in the business since 3Q23. Garena is guided to increase by double digits after two years of decline.
• We raised our FY24 revenue growth rate/PATMI by 2%/0.28bn driven by higher e-commerce and gaming growth. We expect FY24 to be profitable given profitability contribution from Garena and Shopee. We roll over an additional year of valuations and downgraded our recommendation from Buy to Accumulate due to a recent share price change. Our DCF target price is raised to US$70 (prev. US$61), with an unchanged WACC/growth rate of 7.6%/3%.

The Positive

+ Investments in Shopee are paying off; gaining market share. Shopee’s strategic pivot to reinvigorate its topline growth through ramped up investment to competed aggressively for market share since July last year has paid off, helping Shopee gain more market share: there was a renewed surge in its GMV and gross orders (29%/46% YoY). Revenue grew 23% YoY in 4Q23. Shopee focuses on the expansion of last-mile delivery facilities and optimising routing, which cuts costs and improves delivery speed. Both market gain and improved logistics signal long-term growth for Shopee.

+ Shopee expected to see high-teens GMV growth in FY24e. Shopee has guided high-teens GMV growth YoY in FY24e as its investment in gaining market share starts to bear fruit. Its new initiative live-streaming e-commerce business continues to gain traction due to its leadership position and economics of scale. It now accounts for 15% of order volume by the end of FY23. SE claims to be making adjustments in take-rates, especially in ads, which has a sizable room to grow compared to global peers. SE has disclosed their confidence of returning Shopee to positive EBITDA in 2H24 even as competition picks up.

+ Gaming guidance is a pleasant surprise. Despite gaming continuing to show a 52% YoY revenue decline, SE has surprisingly guided a positive outlook for Free Fire. Both user base and bookings of SE’s largest and most profitable game are expected to increase by double digits in FY2024, indicating a rebound in gaming earnings after two years of decline.

The Negatives

- Nil.

• 3Q23 revenue was in line with expectations, while the -US$144mn net loss was a disappointment due to a 50% YoY surge in e-commerce sales and marketing (S&M) spend. 9M23 revenue/PATMI were at 71%/68% of our FY23e forecasts.
• Shopee is gaining market share against its competitors as GMV and gross orders return to strength, driven in part by Shopee Live. Market share gains have come at the cost of profitability. Garena user trends negatively impacted by back-to-school seasonality.
• We cut our FY23e/FY24e EBITDA by 19%/16% to reflect a ramp-up of investments in Shopee. FY23e PATMI is cut by 46% as a result. Even as its near-term outlook is clouded by increasing spend and competition, we still believe SE is well-positioned to capture e-commerce growth in many under-penetrated emerging markets due to its scale and logistics infrastructure. We expect FY24 to be profitable given comments from SE regarding its commitment to not overspend on Shopee, plus profitability contribution from Garena and SeaMoney. We maintain BUY with a reduced DCF target price of US$61 (prev. US$87), and an unchanged WACC/growth rate of 7.6%/3%.

The Positive

+ Investments in Shopee paying off; gains market share. Shopee saw sequential increases in its GMV/gross orders, with both growing 11%/24% QoQ as a result of a reacceleration in investments into the business. In addition, active buyers also increased 11% QoQ as SE made a strong push into e-commerce livestreaming (Shopee Live). Core marketplace revenue (transaction-based fees and advertising) was up 32% YoY to US$1.3bn.

The Negatives

- Disappointing gaming trends impacted by seasonality. Bookings and QAUs for Garena were flat QoQ, impacted by a return to school for many of its users. This was slightly disappointing given expectations of user growth following the release of its new game Undawn in Jun 23. On a YoY basis, QAU decline (-4%) seems to be moderating, although bookings are still down 33% YoY, implying still present near-term headwinds for gaming as its largest and most profitable game, Free Fire, continues to decline in popularity.

- 3Q23 net loss driven by increasing Shopee spend. On a group level, 3Q23 net loss was US$144mn, reversing 3 quarters of profitability. The net loss was mainly due to a 50% YoY (US$286mn) surge in Shopee S&M spend, as SE reaccelerated its investments in Shopee for market share gains. SE said that spending into 4Q23e will continue – as it is seasonally the best time to acquire new users and gain market share, while we further expect spending to persist into FY24e as SE attempts to penetrate deeper into its LATAM markets.

GMV: Gross Merchandise Value, QAU: Quarterly Active User, QPU: Quarterly Paying User              

• 2Q23 revenue missed expectations marginally due to increased shipping subsidies. Earnings were in line. 1H23 revenue/PATMI was at 46%/103% our FY23e forecasts. We expect break-even in 2H23 due to increased incentives and investments.
• Garena looks to have bottomed out, posting an 8% QoQ increase in operating income after 5 quarters, with an 11%/15% sequential uptick in QAU/QPU.
• Increasing shipping subsidies and marketing spend for Shopee GMV growth to impact both top and bottom line, with potential of operating losses in the near-term.
• We cut our FY24e revenue/PATMI by 3%/3% to reflect increasing shipping subsidies and marketing spend, and we raise our outstanding share denominator by 8% due to share dilution. We maintain BUY with a reduced DCF target price of US$87.00 (prev. US$100.00), with an unchanged WACC of 7.6%, and a terminal growth rate of 3.0%. We still believe SE is well-positioned to capture e-commerce growth in many emerging markets due to increased digitalisation.

The Positive

+ Garena likely to have bottomed out. After several quarters of weakness following its Free Fire ban in India last year, Garena finally posted a sequential increase in its segment operating income. 2Q23 operating income grew 8% QoQ to US$296mn (-41% YoY), driven by an increase in higher margin Free Fire bookings. User metrics QAU and QPU also ticked up 11% QoQ and 14% QoQ, respectively, indicating some improvements in user retention and monetization. Garena operating margins have remained relatively high compared to its peers at 56%. And with the release of its new game, Undawn, we should be able to see sustained improvements in most gaming-related metrics moving forward.

The Negatives

- Shopee a slight disappointment due to increased shipping subsidies. Even with orders increasing >10% QoQ, Shopee revenue grew by only 2% QoQ (21% YoY) from ramping up shipping subsidies recorded in its GAAP revenue line. In addition, a sequential US$100mn rise in marketing spend resulted in a -43% QoQ decline in e-commerce operating income. Shopee’s 2Q23 operating margin was 3% (1Q23: 6%).

- Spending more for growth. Throughout its 2Q23 earnings call, management reiterated its stance to ramp-up investments to boost e-commerce growth, citing a stronger base and improved cost efficiencies as reasons for the resumption of investments. SE also said that the ramp-up in investments will negatively impact its bottom line and could see the company move back into the red in the near term. Some of its key areas of focus include live streaming, short-form video, and affiliate partner programs.

GMV: Gross Merchandise Value, QAU: Quarterly Active User, QPU: Quarterly Paying User

• 1Q23 revenue missed expectations marginally due to decline in gaming revenue. Earnings were above our expectations, but negatively impacted by a 121% YoY increase in loan provisions. 1Q23 revenue was at 21% our FY22e forecasts, with PATMI ~US$670mn better than our FY23e forecasts due to better monetization and lower marketing spend.
• Shopee growth is re-accelerating on better monetization and resilient GMV trends in Southeast Asia. Expenses continued to decline, increasing operating profitability across all business segments.
• We cut our FY23e/FY24e revenue by 9%/12% respectively to reflect slower growth as Garena continues to drag, while increasing FY23e PATMI/EBITDA by US$940mn/US$838mn on profitability across all segments. We maintain BUY with a reduced DCF target price of US$100.00 (prev. US$120.00), using a WACC of 7.6%, and a terminal growth rate of 3.0%.

The Positives

+ Shopee growth re-accelerating on better monetisation. Revenue growth accelerated sequentially from 32% YoY in 4Q22 to 36% YoY. 54% YoY growth in core marketplace revenues (transaction-based fees and advertising revenue) were the main driver as monetisation improved. Indonesia, Malaysia, and Thailand were the best performing regions, with Shopee Brazil breakeven in sight. Operating margin increased sequentially by 40bps to 5.6%, with operating income improving by ~US$915mn YoY due to a -52% reduction in marketing spend.

+ Expenses continued to decline, contributing to sustained profitability. Operating expenses were down -23% YoY, led by a drop in marketing spend of -60% YoY (US$605mn), offset with a ~US$100mn YoY increase in loan provisions. SE had its 2^nd straight quarter of net profit (US$87mn). Operating expenses are expected to continue declining given the company’s focus on cost optimization and profitability.

The Negative

- Topline growth declining sequentially, dragged by Garena. YoY revenue growth for 1Q23 was 4.9%, down sequentially from 7.1% in 4Q22. Overall growth was hurt by a -53% decline in gaming revenue, with bookings down -44% YoY. The quarterly paying user (QPU) ratio was also down 2.3% to 7.7% (1Q22: 10.0%) as Garena continued to see weakening user trends. Garena revenue represented 31% of total revenue in FY22, but only 16% in 1Q23.

Gross Merchandise Value (GMV): total value of merchandise sold over a given period on Shopee.

Quarterly Paying User (QPU) Ratio: ratio of the average number of QPU in a quarter vs the average quarterly active users (QAU).     

• 4Q22 revenue missed expectations slightly due to continued weakness in gaming revenue and FX headwinds; net income beat by ~US$1bn on significant reduction in overhead costs and sales & marketing expenses. FY22 revenue was at 96% our FY22e forecasts, with Net Loss ~US$1.2bn better than our FY22e forecasts.
• Positive net income for the first time, led by 7% topline growth, improved logistical efficiencies, and sharp reduction in sales & marketing expenses.
• Shopee was driving overall revenue growth, and was finally profitable due to higher take rates, reduction in expenses.
• We cut our FY23e revenue by 20% to reflect a continued decline in gaming revenue and slower e-commerce growth, while increasing FY23e PATMI/EBITDA by US$1.2bn/US$0.7bn respectively to reflect improving profitability trends. We forecast positive net income by FY24e. We maintain a BUY with a raised target price of US$120.00, using a WACC of 7.6%, and a terminal growth rate of 3.0%.

The Positives

+ Positive net income for the first time, driven by focus on improving efficiencies.  SE announced a major milestone of US$423mn net income for the first time in a quarter, a ~US$1bn improvement from a year ago. This improvement was supported by several factors: 1) revenue growth of 7% YoY led by Shopee; 2) 8% YoY decrease in cost of revenue driven by improvements in logistics costs; 3) 61% YoY cut in sales & marketing expenses as the company looks to further optimize its expenses.

+ Shopee profitable for first time even as GMV and gross orders declined.  SE’s e-commerce business, Shopee, announced 4Q22 operating income/adj. EBITDA (excl. share-based compensation) of US$109mn, and US$196mn, respectively, marking its first profitable quarter. Operating income was driven by 32% YoY growth in revenue due to higher take rates (>10%), a 55% YoY reduction in sales & marketing expenses, and more efficient logistics. This comes even as growth in GMV and gross orders moderated due to continued weakness in online consumption across most markets.

The Negative

- Garena continues to weaken due to moderating trends in gaming. Once regarded as SE’s most stable and profitable business, moderating trends in gaming and a download ban of its most popular game, Free Fire, in India have continued to hurt Garena. Both Quarterly Active Users (QAU), and Quarterly Paying Users (QPU) were down 26%/44% YoY as a result. Garena’s revenue decline also continued to accelerate, down 33% in 4Q22 to US$949mn. Operating income for the quarter was also down 53% YoY to US$400mn – 42% operating margin.

• 3Q22 revenue beat expectations by 7%; net loss was a beat by 35% on employee expense cuts and more prudent spending on sales & marketing. 9M22 revenue was at 69% our FY22e forecasts. Net loss was at 73% of our FY22e forecasts.
• Improving monetization is driving Shopee growth, with a 1.5% YoY increase in take rate. Operating losses in SeaMoney were cut by half due to 33% YoY reduction in sales & marketing expenses.
• Weakness in gaming continues to weigh on Garena; revenue was down 19% YoY due to reduced user engagement and monetization.
• We maintain a BUY recommendation with an unchanged DCF target price of US$110.00, with a WACC of 7.6%, and a terminal growth rate of 3.0%.

The Positive

+ 3Q22 revenue and earnings beat expectations on robust Shopee growth and cost cutting initiatives.  SE’s 3Q22 revenue of US$3.2bn beat estimates by about 7%, driven by a 32% YoY growth in Shopee due to increasing monetization, and a 147% YoY growth in SeaMoney led by an expansion in its credit business. Adj. EPS (excluding share-based compensation) of -US$0.66 beat estimates by about 35%, due to: 1) 3Q22 revenue beat; and 2) sequential decline in expense growth as a result of more prudent as it prioritises self-sufficiency and profitability as soon as possible.

+ Improving monetization driving Shopee revenue growth.  Shopee continued to drive overall revenue growth, posting US$1.9bn for 3Q22, a 32% YoY increase (39% YoY in constant currency). This was led by a 14%/19% YoY growth in GMV and gross orders – showing resilience through an uncertain macroeconomic period, and about a 1.5% YoY improvement in take rate. The operating loss for Shopee also improved 21% YoY to -US$0.6bn, driven by improving operating efficiencies and a 16% YoY reduction in sales and marketing spend.

+ SeaMoney reducing losses, expanding loan book.  SE’s digital financial services business, SeaMoney, continued to show improvements in cost efficiency as a result of more focused spending – sales & marketing expense down 33% YoY. Operating losses for the segment was cut by about 50% YoY, posting a US$82mn loss for 3Q22. Revenue growth of 147% YoY was driven by a healthy credit business of US$2.2bn on its loan book.

The Negative

- Weakness in gaming continuing to weigh on Garena. A weak macroeconomic environment, coupled with reopening trends, continue to be headwinds for SE’s digital entertainment business. Garena’s 3Q22 revenue was down 19% YoY as a result of declining user engagement and monetization. SE also revised its FY22e bookings guidance to a range of US$2.6bn-US$2.8bn, representing an almost 40% expected QoQ drop in bookings for 4Q22.

• 1H22 revenue was at 42% our FY22e forecasts. Net loss was worse than expected at 79% of our FY22e forecasts due to higher operating expenses and tax rate.
• 29% YoY revenue growth, with 51%/214% YoY growth in Shopee and SeaMoney. Shopee generated more international (ex-China) revenue than competitor, Alibaba, and was close to achieving positive adjusted EBITDA per order in APAC for the quarter.
• Net loss grew 115% YoY due to increasing expenses in G&A and R&D, and US$177mn goodwill impairment loss. Shopee revenue guidance for FY22e suspended due to uncertain macroeconomic environment, and shift in focus towards profitability metrics.
• We lower our FY22e revenue slightly to reflect weaker e-commerce growth, and we increase our net loss forecasts by 43% to reflect higher expenses. We maintain a BUY recommendation with a lowered DCF target price of US$110.00 (prev US$150.00), with an increased WACC of 7.6%, lower EBITDA and a terminal growth rate of 3.0%.
• 1H22 revenue was at 42% our FY22e forecasts. Net loss was worse than expected at 79% of our FY22e forecasts due to higher operating expenses and tax rate.
• 29% YoY revenue growth, with 51%/214% YoY growth in Shopee and SeaMoney. Shopee generated more international (ex-China) revenue than competitor, Alibaba, and was close to achieving positive adjusted EBITDA per order in APAC for the quarter.
• Net loss grew 115% YoY due to increasing expenses in G&A and R&D, and US$177mn goodwill impairment loss. Shopee revenue guidance for FY22e suspended due to uncertain macroeconomic environment, and shift in focus towards profitability metrics.
• We lower our FY22e revenue slightly to reflect weaker e-commerce growth, and we increase our net loss forecasts by 43% to reflect higher expenses. We maintain a BUY recommendation with a lowered DCF target price of US$110.00 (prev US$150.00), with an increased WACC of 7.6%, lower EBITDA and a terminal growth rate of 3.0%.

The Positive

+ Growth drivers still performing well, with Shopee close to positive adjusted EBITDA per order.  SE recorded revenues of US$2.9bn for 2Q22, up 29% YoY. Shopee grew 51% YoY, with gross orders up 42% YoY, and gross margins improving sequentially QoQ as a result of faster growth in higher profit margin items like transaction-based fees and ad revenue. Shopee also generated more international (ex-China) revenue than e-commerce giant Alibaba for the first time. Adjusted EBITDA loss per order before HQ costs was >US$0.01, improving 95% YoY, with expectations that this would turn positive by year end. SeaMoney grew 214% YoY as a result of increasing synergies with Shopee, with Total Payment Volume (TPV) up 36% YoY. Quarterly Active Users (QAU) grew 53% YoY, with around 40% of buyers on Shopee using SeaMoney products.

The Negatives

- Wider-than-expected net loss, due to higher expenses and goodwill impairment loss. SE’s net loss for 2Q22 grew 115% YoY, largely due to a doubling of R&D and G&A expenses YoY, and a US$177mn goodwill impairment loss due lower valuations of prior acquisitions. G&A expense jumped 96% YoY, mainly due to higher allowances for credit losses from SeaMoney which was driven by loans growth. R&D expense increased 115% YoY as a result of increasing headcount growth due to expansion of tech capabilities. Net loss for 1H22 was at 79% of our FY22e forecasts.

-  Shopee revenue guidance suspended for FY22e. SE suspended its Shopee revenue guidance for FY22e, with its original guidance in the range of US$8.5bn to US$9.1bn, stating increasing volatility, continuing macro uncertainties, and a strategic shift towards focusing on efficiency and optimization for the long-term as reasons for the suspension of guidance.

• 1Q22 revenue was in line, at 21% our FY22e forecasts. Net loss slightly underperformed, at 30% of our FY22e forecasts due to higher operating expenses and tax rate. EPS of -US$0.80 beat consensus estimates of -US$1.15 by 31%.
• Revenue growth led by 64%/360% YoY growth in Shopee and SeaMoney.
• FY22e revenue guidance for e-commerce widened on the bottom-end by US$0.4bn
• We maintain a BUY recommendation with a lowered DCF target price of US$150.00 (previous US$196.00), with a WACC of 6.9%, and a lowered terminal growth rate of 3.0%.

The Positives

+ 1Q22 revenue in line with our forecasts, EPS of -US$0.80 in line with our estimates. SE recorded 1Q22 revenue of US$2.9bn, beating consensus estimates for its top line by 5%, and was in line with our estimates. Revenue grew 38% YoY, driven by a 64% growth in Shopee, and a 360% growth in SeaMoney, as these segments continued riding digitalization tailwinds in Southeast Asia. SE also posted EPS of -US$0.80 for 1Q22, comfortably beating estimates of -US$1.15 by 31%.

+ Shopee closer to profitability in mature markets. SE’s e-commerce business, Shopee, saw YoY improvement in its gross profit margin, led by strong growth of higher margin services like advertising and transaction-based fees. Shopee is also on track for a positive adjusted EBITDA before HQ costs in Southeast Asia and Taiwan, with this number at -US$0.04 for 1Q22, compared to -US$0.12 in 1Q21. Globally, Shopee continues its top rank in its Shopping category on the Google Play Store for most downloads and total time spent in app, and ranked 2^nd for average monthly active users.

+ Rapid growth of SeaMoney due to increased adoption of digital payments in Southeast Asia. SE’s digital financial services business, SeaMoney, posted 1Q22 revenue of US$236mn, a YoY increase of 360%, led by increasing consumer adoption of digital payments in Southeast Asia – particularly in Indonesia, as well as the company’s expansion of credit products into more markets. Quarterly active users (QPU) grew 78% YoY, while total payment volume (TPV) was up 49% YoY.

The Negative

- Reduced its bottom-end range for Shopee FY22e revenue guidance. SE adjusted its FY22e revenue guidance for its e-commerce business, Shopee, from US$8.9-9.1bn, to US$8.5-9.1bn. A more uncertain macroeconomic environment was the main reason with this change. Taking the midpoint of US$8.7bn would represent a 72% YoY increase, compared to 76% previously.

• Shopee to drive revenue growth with CAGR of 62% expected over the next two years. Foothold in Southeast Asia to strengthen together with penetration into Brazilian market.
• Rapid expansion of SeaMoney as an additional growth driver, drawing on synergies with Shopee for frictionless transactions; segment revenue expected to grow 5x by FY23e.
• Profitability of SE’s digital entertainment business concentrated on a single product, heavy reliance on equity markets for funding through convertible notes.
• Initiate coverage with a BUY recommendation and DCF-based target price (WACC 6.9%, g 4.0%) of US$196.00.

Company Background

Sea Ltd. operates as a holding company with subsidiaries operating in digital entertainment (Garena, 43% revenue), e-commerce (Shopee, 52%), digital financial services (SeaMoney).

Investment Highlights

1. Shopee’s high growth rate supported by uptick in both Gross Merchandise Value (GMV) and Gross Orders. E-commerce revenue from Shopee grew 130% YoY in FY21, supported by 118%/77% YoY increases in Gross Orders/GMV respectively – outpacing its main competitor Lazada (40% YoY). Shopee, which contributes almost 52% of SE’s total revenue, has consistently been top of its shopping category in Southeast Asia and Taiwan – monthly active users, and total time spent on the platform. We expect revenue from Shopee to more than double by the end of FY23e, as it expands its global footprint, and continues riding on a fast growing Southeast Asian e-commerce industry.
2. Shopee’s expansion into Brazil showing great potential. Shopee’s strategic expansion into the world’s 6^th most populated market has seen tremendous uptick, with 400% YoY revenue growth in 4Q21. Shopee Brazil also continues to be ranked at or near the top of its shopping category. With a profitability model that is well proven in the LATAM region – take rates of existing profitable players at ~18% vs ~8% in Southeast Asia, we think this expansion should contribute significantly to the overall profitability of SE’s e-commerce segment sooner rather than later.
3. Rapid expansion of SE’s Digital Financial Services (SeaMoney). SeaMoney saw rapid YoY revenue growth of 673% in FY21, supported by expanding product offerings, and increasing user base and payment volumes. It contributed almost 5% of SE’s total revenue in FY21, compared with only 1% in FY20, with this number expected to increase. We view SeaMoney as a natural extension of SE’s e-commerce business and expect synergies between both business segments as they grow in tandem, and forecast revenue to grow 5x by the end of FY23e.

Risks

1. Profitability concentrated in Free Fire. The majority of SE’s digital entertainment revenue comes from its most popular in-house developed game, “Free Fire”, which we view to be somewhat concerning as Garena’s revenue could be significantly impacted if the growth and popularity of Free Fire were to decline moving forward. We expect Garena’s revenue to contract by about 12% YoY in FY22e due to a recent ban on Free Fire downloads in India and a moderation in online activity globally.
2. Reliance on equity markets for funding. SEA has been very reliant on raising funds via convertible notes and common stock, with almost US$10bn raised so far. Poor conditions in equity markets may result in difficulty raising more funds through these methods in the future, which could affect SE’s growth plans moving forward.

We Initiate coverage with a BUY rating and a target price of US$196.00 based on DCF valuation, with a WACC of 6.9% and terminal growth of 4%.

REVENUE

SE posted US$10bn in revenue for FY21 – increasing 128% YoY, with 51.5% of its total revenue coming from its e-commerce business (Shopee); 43.4% from its Digital Entertainment segment (Garena); 4.7% from its Digital Financial Services segment (SeaMoney), and the remaining 0.4% from other services (Figure 5).

E-commerce (Shopee): Shopee is a mobile-centric, highly scalable, social-focused marketplace platform that connects both buyers, as well as sellers. The platform also provides its own integrated payment and logistics infrastructure, as well as comprehensive services aimed at empowering sellers with the appropriate tools to better engage with buyers. Shopee generates revenue by: 1) selling paid advertising services; 2) charging transaction-based fees; 3) charging sellers for certain value-added services; and 4) direct sales of certain products to consumers. It is also the largest e-commerce platform in the Southeast Asian region by Gross Merchandise Value (GMV), and total orders.

According to data.ai, in 4Q21 and FY21, Shopee continued to top its shopping category in Southeast Asia and Taiwan by average monthly active users and total time spent in the app. Shopee also topped its shopping category in Brazil for most downloads and total time spent in the app, while ranking second for average monthly active users. Globally, Shopee was the top ranked app in the shopping category by downloads.

The main metrics used to track performance in this segment are GMV, Gross Orders, Take Rate, and Average Basket Size (Figures 7 and 8). Revenue from this segment was US$5.1bn for FY21, increasing 130% YoY. GMV increased 77% YoY to US$63bn, with gross orders increasing 118% YoY, and an average take rate of about 8% for FY21. We are quite positive on Shopee’s expansion into other highly populated markets like Brazil, where gross orders are growing around 400% YoY. Gross orders in Indonesia – where it’s the largest e-commerce platform, grew 88% YoY in 4Q21. However, we expect overall growth to slow down slightly in FY22e to about 75%, or US$9bn. This is mainly due to increased competition from other big players in the region like Lazada, a maturation of Shopee in several markets, and a reduction in platform incentives for users.

Digital Entertainment (Garena): Garena is a global developer and publisher of video games, mainly focusing on Mobile, as well as PC games. Besides developing its own games, Garena also exclusively licenses and publishes games developed by third parties, focusing on several game genres: battle royale, multiplayer online battle arenas (MOBA), action role-playing games (RPG) and massively multiplayer online role-playing games (MMORPG). Garena also provides access to other entertainment content, such as live streaming online gameplay, and social features such as user chat and online forums.

The majority of revenue generated from this segment can be attributed to its most popular in-house developed mobile game “Free Fire”, which has consistently been ranked amongst the top few mobile games on Google Play by Monthly Active Users (MAU). For 4Q21 and FY21, “Free Fire” remained the most downloaded mobile game globally, and ranked second globally by MAU for all mobile games on Google Play. It also continued to be the highest grossing mobile game in Southeast Asia and Latin America. SE monetizes this by adopting a “freemium” model, allowing users to download and play the game for free, while generating revenue from the sale of in-game virtual items.

Revenue from this segment came in at US$4.3bn for FY21 (Figure 9), representing a 114% YoY growth, and a 5-Yr CAGR of 67%. Quarterly Active Users (QAU) and Quarterly Paying Users (QPU) are the main metrics used in this segment, with both metrics seeing considerable QoQ growth since 4Q18, but this has started to plateau and decrease moderately over the last 3 quarters as a result of headwinds from reopening trends globally (Figures 10 and 11). Garena has also seen its Quarterly Paying Ratio creep up from 5.5% in 4Q18 to 11.8% in 3Q21 (Figure 12).

Revenue growth for this segment is expected to be negative for FY22e, as restrictions on downloads of Free Fire in India present significant headwinds in one of SE’s most heavily populated markets. We forecast revenue to decrease by 12% YoY to about US$3.8bn because of this, coupled with a moderation in online activity as reopening trends continue globally.

Digital Financial Services (SeaMoney): This segment contributes the smallest portion to total revenue, at only 4.7%, and can be broken up into two key areas – payments, and financing. The payments portion includes SeaMoney’s mobile wallet services, which are branded as ShopeePay and AirPay in different countries, as well as other payment processing services.  The other portion – financing, includes SeaMoney’s consumer financing products, as well as their “Buy-now-pay-later” (BNPL) products.

SeaMoney generates revenues primarily from commissions earned from third-party merchants via mobile wallet services, as well as interest earned from borrowers in SeaMoney’s consumer financing business. In FY21, SeaMoney started offering services in digital banking and insurtech in Indonesia, and also obtained a bank license in the Philippines. QPU and total payment volume are metrics used to track the performance of SeaMoney, with both these metrics increasing QoQ since 1Q20 (Figures 13 and 14).

This segment generated revenue of US$470mn in FY21, representing a 673% YoY increase, and is expected to grow about 150% YoY in FY22e to about US$1.2bn due to the rapid expansion of use-cases within this segment, increases in user adoption of digital financial services, and synergies drawn with Shopee to provide frictionless transactions.

RULE OF 40

The “Rule of 40” was first introduced as a benchmark to measure the balance between growth and profitability of SaaS companies, taking into account both revenue growth, as well as profitability (Revenue Growth + EBITDA Margins), with the addition of both metrics needing to exceed the 40% threshold. We have modified this slightly by averaging revenue growth over a 3-year period compared with just a single period growth rate. Adding together SE’s 3-year average revenue growth of 129.2% and its EBITDA margin of -13.4%, the total of 115.8% is more than our required threshold of 40% (Figure 15).

EXPENSES

The cost of sales grew 100% in FY21 to US$6.1bn, slightly below total revenue growth of 128%. Operating expenses include research and development (8% of revenue); sales and marketing (39%), and general and administrative (11%). R&D expense grew 135% YoY, and was primarily due to an increase in staff cost as the company continues to expand its tech capabilities. Sales and marketing expense grew 109% YoY, primarily due to higher online content costs, and marketing incentives as the company continues its expansion across different markets. General and administrative expenses grew only 68% YoY.

Total Operating Expense as a percentage of revenue has been reducing over the last 3 years, from 143% in FY17 to 58% in FY21, and we expect this trend to continue as the company begins tapering its sales and marketing expenditure (Figures 16 and 17).

Capital expenditure for FY21 was US$923mn (9% of revenue), a significant increase from US$336mn the previous year. We expect CAPEX to increase moving forward, in line with the company’s expansion plans into other geographical markets.

MARGINS

Besides FY17 and FY18, SE’s gross margins have generally been on an upward trend over the last few years, with gross margins at 39% for FY21 (Figure 18). The 1.8% gross margins in FY18 were a result of rapid expansion of the company’s e-commerce business, which significantly increased cost of revenue associated with elevated staff compensation and benefits, as well as higher bank transaction fees driven by exponential GMV growth. We expect gross margins to reduce slightly in FY22e, on the back of a expected reduction in revenue of SE’s high margin digital entertainment business.

Net margins remained negative for FY21 at -21%, although we have seen continued improvements in net margins over the years – from -135% in FY17 to what it is currently. We forecast net margins to continue improving to about -3.7% by FY23e, as the company reduces cash burn and improves profitability of its business segments (Figure 19).

BALANCE SHEET

Assets: Cash and cash equivalents increased by about US$3bn YoY in FY21 to US$9.2bn, largely due to significant cash flow from financing activities such as issuances of convertible notes and ordinary shares (Figure 20). Prepaid expenses accounted for slightly over US$1.4bn of assets in FY21, and are attributed to receivables due from logistics providers and payment collection channels in SE’s e-commerce business. SE’s current ratio for FY21 was 2.1x (Figure 21).

Liabilities: The majority of SE’s liabilities come from 3 items: Accrued Expenses, Deferred Revenue, and Convertible Notes. Accrued expenses increased about 74% YoY to US$3.5bn in FY21, and was a result of an increase in accrued cost of revenue and sales and marketing expenses, as well as higher escrow payables.  Deferred Revenue increased about 23% YoY to US$2.6bn in FY20, and was mainly due to elevated amounts of cash generated from the sale of in-game virtual items in their digital entertainment business – recognized when users make non-refundable in-game purchases (Figure 22).

US$2.5bn CONVERTIBLE NOTE

SE recorded US$3.5bn in convertible notes on their balance sheet in FY21, increasing about $1.7bn from FY20, and representing around 31% of total liabilities (Figure 23). So far, the issuance of convertible notes have been a very effective and low cost avenue to fund growth plans, with most of these notes converted into common stock on or before their expiration – SE does not have to repay the principal amount to noteholders who converted, and also save on interest payments. The company recently issued a new tranche of 2026 convertible notes with a principal amount of US$2.5bn, at a coupon rate of only 0.25% (Figure 24). However, it’s conversion price (US$477.01 per ADS) is 4 times more than its current stock price of around US$115, which means that SE would be liable to pay back the full US$2.5bn principal amount to noteholders if the share price does not quadruple by its conversion date in 2026, as these notes would not be converted into common stock.

CASH-FLOW

Free Cash Flow (FCF) in FY21 was -US$714mn. We expect this to continue as the company expands its businesses into more markets.

BUSINESS MODEL

E-commerce (Shopee): Shopee is a mobile-centric, highly scalable, social-focused marketplace platform that connects both buyers, as well as sellers. The platform provides users with a  convenient, safe, and trusted marketplace, supported by its own integrated payment and logistics infrastructure, as well as comprehensive services aimed at empowering sellers with the appropriate tools to better engage with buyers. The platform also effectively breaks down barriers to cross-border commerce through its scale and logistics infrastructure. Shopee also periodically introduces new social and gamification elements onto the platform to increase user retention and acquisition.

Shopee’s buyers are predominantly individuals or households who mainly purchase from sellers within the same market. Sellers are primarily small and medium businesses and brands which leverage on the platform’s scale and reach to distribute their merchandise. Shopee currently focuses on long-tailed high-margin product categories such as fashion, health and beauty, home and living and baby products.

The platform has also invested heavily into creating a more secure and reliable shopping environment for buyers, by developing a host of robust consumer protection policies and procedures. For sellers, Shopee has dedicated on-the-ground teams that offer fast and localized operation and technological assistance, as well as a range of value-added services at the sellers’ disposal – inventory management, online store operations and fulfillment services. Transactions on Shopee can be conducted using credit cards, bank transfers, cash payments on delivery, or its own mobile wallet services supported by SeaMoney.

Shopee generates revenue by: 1) selling paid advertising services; 2) charging transaction-based fees; 3) charging sellers for certain value-added services; and 4) direct sales of certain products to consumers. It is also the largest e-commerce platform in the Southeast Asian region by Gross Merchandise Value (GMV), and total orders.

Digital Entertainment (Garena): Garena is focused around two main areas: 1) offering online PC and mobile games; and 2) developing mobile games for global markets. Its digital entertainment services provide users with easy access to a multitude of highly engaging and localized content that are either licensed or developed in-house, while also organizing both online as well as offline gaming activities and events. Garena currently has over 750 developers focusing on building out a pipeline of self-developed games for the future.

Garena’s gaming content library includes some of the most popular and engaging genres of games, including battle royale games, multiplayer online battle arenas (MOBAs), action role-playing games (RPGs), massively multiplayer online role-playing games (MMORPGs), as well as other sports games. In most cases, users play these games online in a virtual environment connected with a large number of other players using existing game servers, allowing users to play simultaneously and interact with one another.

Garena’s most popular in-house developed offering is “Free Fire”, a battle royale mobile game that is ranked 2^nd globally by monthly active users for all mobile games on Google Play, and is also the highest grossing mobile game in Southeast Asia, Latin America, and India.

Garena monetizes its games by adopting a “freemium” model, allowing users to download and play games for free, while selling in-game items to users who are able to purchase these items using various payment platforms and methods, including SeaMoney.

Digital Financial Services (SeaMoney): SeaMoney was introduced in 4Q19, and is a leading digital financial services provider in Southeast Asia. It has obtained licenses and approvals to provide e-financial services and loans in several countries within Southeast Asia, and has also obtained a full digital bank license in Singapore. SeaMoney currently offers mobile wallet services, payment processing, credit-related digital financial offerings and other financial products to various markets in Southeast Asia under several different brand names.

One of the main use cases for SeaMoney is to reduce payment friction for Shopee users, tapping on synergies between both platforms to create transactional volume growth. SeaMoney has also expanded, and will continue to expand the use cases of its mobile wallet services outside of SE’s platforms to include other online and offline merchants.

SeaMoney generates revenues primarily from commissions earned from third-party merchants via mobile wallet services, as well as interest earned from borrowers in SeaMoney’s consumer financing business.

INDUSTRY

E-Commerce (Shopee): SE faces heavy competition for both buyers and sellers in the e-commerce industry from regional, as well as large global players. SE’s key markets of Southeast Asia and Taiwan have a population total of about 680 million people, and an estimated GDP of around US$3.6tn, offering a significant market-size opportunity to support the company’s growth in the e-commerce industry. Continued internet penetration in the region, coupled with a generational transition towards more digital forms of commerce, as a result of the pandemic, have provided significant tailwinds for growth in the overall e-commerce industry.

According to the e-Conomy SEA 2021 report by Google, Temasek, and Bain & Company, 60 million new digital consumers were added since the start of the pandemic, with overall usage frequency and amount spent on e-commerce products increasing 30-40% vs pre-pandemic levels. At the same time, more than 90% of new e-commerce users from FY20 continued using such services in FY21, confirming a strong permanent adoption of e-commerce and other digital services. Overall GMV for e-commerce in Southeast Asia remained resilient, growing 62% YoY in FY21 to US$120bn, and is expected to continue trending upward at a 5-year CAGR of 18% until FY25e (Figure 28), with online groceries still a largely under penetrated vertical within e-commerce.

Digital Entertainment (Garena): According to an industry report by Google and Newzoo, the global gaming market grew 1.4% YoY in FY21 to US$180bn. Of the 3 main segments in gaming, mobile gaming stood out with a 7.3% YoY increase to US$93bn (Figure 29), partly driven by a 6.1% YoY increase in global active smartphone users. This bodes well for SE as it focuses mainly on the mobile gaming market. Around 3 billion game players are expected to drive revenues, with an estimated 20% of this number contributed by new gamers as lockdowns from the pandemic provided more free time for people to spend on gaming.

Global Esports revenue for FY21 grew 14.5% YoY to slightly over US$1bn (Figure 30), with audiences for gaming live streams increasing almost 13% YoY to 747 million people. This is expected to hit 950 million by FY24e. Twitch, which is a leading live streaming platform outside of China, generated slightly over 23 billion hours of live viewerships in FY21 – an all-time high for the platform, with YouTube generating almost 5 billion hours.

We expect the growth in popularity in mobile games, and the ever increasing time spent by people watching and playing games to be substantial growth drivers for SE’s digital entertainment business moving forward.

Digital Financial Services (SeaMoney): SE primarily competes with existing online and offline payment service providers, including other mobile wallet service platforms both regionally and globally, with these services complementing other digital services like e-commerce and gaming. SE operates predominatly in the e-wallet and digital lending verticals.

According to the e-Conomy SEA 2021 report, digital financial services adoption rates are increasing and quickly becoming mainstream services, heavily supported by ongoing e-commerce growth in the region. Cash is still king in the region, with about 59% share of total Gross Transaction Value (GTV), but its dominance is expected to continue eroding away over time due to an increasing demand for seamless digital payment experiences. The GTV of digital payments in the region grew 9% YoY, with consumer e-wallet usage increasing 45% vs pre-pandemic levels, with GTV expected to increase 65% by FY25e (Figure 31).

In FY21, digital lending loan books saw a 48% YoY increase in size to US$39bn, with most of it coming from consumer lending, and the expectation that loan books would continue to see a 31% CAGR until FY25e. The growth in this area is expected to be supported by several tailwinds including a rebound in lending appetite from creditors, an increasing usage of supply chain financing from digital merchants, and the rise in buy-now-pay-later (BNPL) consumer financing products.

RISKS

1. Profitability concentrated in a single product – Free Fire. Currently, Garena is the only profitable segment within SE, with the majority of revenue in this segment coming from its most popular in-house developed game, “Free Fire”. We view this revenue concentration risk to be somewhat concerning, given that Garena’s revenue could be significantly impacted by a multitude of external factors: declining popularity of Free Fire over time, restrictions imposed on mobile game downloads in specific markets.

2. Tough competition in a saturated e-commerce market. The e-commerce landscape in markets where Shopee operates in is very fragmented, with up to 30 e-commerce players in many of the markets. Shopee faces tough competition across its markets by larger well-funded players, which could provide headwinds to Shopee’s growth and monetization plans, especially as the company plans on increasing its take rate and reducing cash burn on marketing and promotional incentives moving forward.

3. Reliance on equity markets for funding through convertible notes. SE has been very reliant on raising funds via the sale of convertible notes and shares, with almost US$10bn worth of funds raised. The company also benefits from the fact that most notes end up being converted on or before its maturity date, resulting in the company freeing up cash flow from not needing to pay back the principal amount, as well as expected future coupon payments of these notes. The downside to this for investors is a dilution in shares as more notes are converted into common stock. Poor conditions in equity markets may result in difficulty raising low-cost funds through these methods in the future, which in turn could affect SE’s growth plans moving forward.

VALUATION

We initiate coverage on SEA Ltd. with a BUY rating and a price target of US$196.00. Our valuation is based on DCF, using a 6.9% WACC and 4.0% terminal growth rate.