Massive Opportunity for Sea but Path to Profitability Remains Difficult to Navigate

Business Strategy & Outlook

The Shopee e-commerce platform to be Sea’s main growth driver for the long term; the company’s valuation will be predicated on this business. Per Euromonitor, Shopee has 30% share of its main market, Indonesia, and it estimated about 30%-35% share in the rest of Southeast Asia. It has built leading market share quickly using subsidies, free shipping, and incentives that attracted consumers to its platform, but in the process, it incurred heavy cash burn and has not yet seen positive EBITDA. While positive macro signs exist and Shopee enjoys a market-leading position currently, that it is too early to tell who the ultimate long-term winners will be. E-commerce is still in the early stages in Southeast Asia, and outside of a slight lead in market share, one cannot see obvious distinct advantages for Shopee. As user growth has been highly contingent on subsidies that heavily increased sales and marketing expenses, the growth could decelerate sharply once these incentives stop and when Sea becomes more focused on profitability.

The massive potential for Sea is evident as e-commerce is 7%-8% of overall retail sales in Southeast Asia, compared with 22% for China. It forecasted a 23% five-year compound annual growth rate for the digital economy in the region. China’s e-commerce is expected to grow 11% in the same period. Given the robust macro backdrop, this should provide a conducive landscape for Shopee to succeed. Despite a massive opportunity, Shopee remains vulnerable to increased sales and marketing expenses and low switching costs. Other platforms can offer the same products with subsidies to consumers who are cost-conscious. This also implies the possibility of new competitors in e-commerce in the region that can replicate the same strategy. Given the lack of differentiation for Shopee, one can see further heavy subsidies in order to ward off threats and maintain market share, which could be impossible to continue in the long term in the pursuit of profitability. The company has indicated a goal for Shopee to be cash flow positive by 2025, but this could be a challenge without clear key advantages.

Financial Strengths

One cannot believe that Sea has any financial issues outside of the concerns about heavy cash burn. It has cash and short-term investments of USD 11.7 billion against only USD 3.3 billion total debt as of the end of 2021. Short-term liquidity is not an issue as the firm has USD 286 million of short-term debt and its current ratio is 2 times. The main concern is that the cash balance could erode quickly if sales and marketing and research and development expenses continue at this rate. In 2021, cash (excluding stock-based compensation and depreciation) operating expenses were USD 5.0 billion, which implies that Sea should be able to withstand cash burn for at least two years in a worst-case scenario where it generates zero revenue. It would not surprise us if Sea raises additional capital in order to have more of a cash buffer, but one cannot believe this poses any risk for now should the company become profitable. Outside of cash burn concerns, there are no red flags concerning leverage nor interest expenses.

Bulls Say

Sea could maintain its leading market share as Southeast Asia e-commerce expands without having to sacrifice profitability through increased sales and marketing spending.

Garena could find another hit game that increases bookings in addition to Free Fire. Also, India could rescind its sanctions on Free Fire

SeaMoney could increase its market share above its current 3% and become the one of the preferred payment options in Southeast Asia.

Company Description

Sea operates Southeast Asia’s largest e-commerce company, Shopee, in terms of gross merchandise value and number of transactions. Sea started as a gaming business, Garena, but in 2015 expanded into e-commerce, which is now the main growth driver. Shopee is a hybrid C2C and B2C marketplace platform operating in eight core markets. Indonesia accounts for 35% of GMV, 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.

(Source: Morningstar)

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