Sea faces prospect of depleting fuel for Shopee dream

Singapore

INTERNET company Sea's full-year results on Tuesday (Mar 1) might have confirmed some investors' worst fears about the growth potential of the business, leading to an US$11 billion fall in its market value in a single day.

For the first time since its listing, Sea guided that its gaming business could see a year-on-year decline. This raises some concerns about the continued viability of Sea's ambitious e-commerce plans, which have been key to the stock's rapid ascent.

Sea's management took pains to highlight the group's cashflow generation in Tuesday's earnings call. It also provided a profitability timeline for e-commerce arm Shopee and fintech arm SeaMoney; and, for the first time, shed light on Shopee's rapid rise in Brazil.

"Based on our current plan, we believe that we have the financial resources required to grow (both Shopee and SeaMoney) to the inflection point without having to heavily rely on cash generated from the digital entertainment business," group CEO Forrest Li said.

In spite of that assurance, however, Sea's shares fell 13.1 per cent on Tuesday in New York to close at US$126.50. The stock fell a further 6.9 per cent on Wednesday.

Sea expects bookings for its digital entertainment arm Garena, responsible for hit mobile game Free Fire, to be between US$2.9 billion and US$3.1 billion in 2022. Even at the higher end of expectations, that's still a 32.6 per cent fall from US$4.6 billion in bookings last year.

Most market watchers had predicted a possible dip due to slowing user growth and Free Fire's woes in India. But "the magnitude of the decline still shocked most expectations", Citi analysts wrote in a report.

Citi, Maybank Securities and DBS Group Research were among brokerages that slashed their target prices for Sea on Wednesday.

India was one of the most lucrative markets for Free Fire until authorities decided to ban the battle royale game and 53 Chinese apps from the Google and Apple mobile app platforms. Shares of Sea fell 18 per cent on Feb 14 following the ban.

It reportedly prompted an intervention from the Singapore government, which asked India why Singapore-headquartered Sea was targeted in a crackdown on Chinese apps.

Sea said its guidance for Garena takes into account the headwind from India. Even if the situation is resolved, however, Free Fire is not the hot property it used to be.

Active and paying users for Garena have declined, adding to fears that momentum for the hugely popular Free Fire has peaked.

Quarterly paying users in Q4 2021 fell to 77.2 million, from 93.2 million in Q3, after 4 consecutive quarters of growth. Quarterly active users fell to 654 million in Q4 from 729 million in Q3.

Sea's management was eager to ease those concerns. "We are working on multiple prototype games across different stages through both self-development and publishing pipelines," it said in its earnings report, though tangible details have yet to be given.

The stability of Sea's gaming arm is more critical than ever as its e-commerce business Shopee grows internationally. Loss-making Shopee is exiting France just months after its foray into Europe, which perhaps reflects prudence, but the company is still moving into other markets outside South-east Asia.

Sea expects Shopee to turn profitable by the year's end on an earnings metric that takes into account depreciation and amortisation but excludes share-based compensation and headquarter costs in South-east Asia and Taiwan - a figure the company refers to as adjusted Ebitda (earnings before interest, taxes, depreciation and amortisation).

SeaMoney is expected to record positive cashflow by next year. And by 2025, cash generated by Shopee and SeaMoney is expected to self-fund their long-term growth, Li said.

E-commerce revenue continued to grow significantly in 2021, jumping 156.8 per cent to US$4.6 billion, although Ebitda loss for the segment widened from US$1.3 billion to US$2.6 billion.

Still, investors will be wise to watch the group's cashflow. Li highlighted around US$10 billion of cash, equivalents and short-term investments on Sea's balance sheet. But Sea also has huge ambitions. For FY2021, the company reported US$3.8 billion of net cash spent on investing activities.

As Shopee ventures into competitive new markets, customer and merchant acquisition costs are likely to be high. The e-commerce arm has historically dedicated a huge chunk of expenses to sales and marketing, and this more than doubled to US$2.6 billion last year amid continued cash burning.

Bright spots remain. Unit economics for Shopee's core business in South-east Asia and Taiwan improved year on year, as its adjusted Ebitda loss per order narrowed to 15 cents from 21 cents. In Brazil, the adjusted Ebitda loss per order improved by more than 40 per cent to below US$2.

But uncertainty remains over the company's ability to sustain its long-term growth. In the current risk-averse market environment, it might not be the best time for Sea to raise more capital. Sea's market value has suffered a beating from macroeconomic factors too, nearly halving from the start of the year to US$65.7 billion.

As the company expands, it will have to face the harsh reality that money does not come as easily as before.

READ MORE: Grab crashes 37.3% after Q4 net loss nearly doubles