Sea Limited (NYSE:SE) Misses Q2 Sales Targets, Stock Drops 10.2%

Full Report / August 15, 2023

E-commerce and gaming company Sea Limited (NYSE:SE) fell short of analysts' expectations in Q2 FY2023, with revenue up 5.2% year on year to $3.1 billion. Sea Limited made a GAAP profit of $331 million, improving from its loss of $931.2 million in the same quarter last year.

Sea Limited (SE) Q2 FY2023 Highlights:

  • Revenue: $3.1 billion vs analyst estimates of $3.25 billion (4.68% miss)
  • EPS: $0.54 vs analyst estimates of $0.46 (16.8% beat)
  • Free Cash Flow of $595.5 million, similar to the previous quarter
  • Gross Margin (GAAP): 46.9%, up from 37% in the same quarter last year
  • Quarterly paying users: 43.1 million, down 13 million year on year

Founded in 2009 and a publicly-traded company since 2017, Sea Limited (NYSE:SE) started as a gaming platform and has since expanded to offer a variety of services such as e-commerce, digital payments, and financial services across Southeast Asia.

Garena, the initial product offering, is not just a single game but an ecosystem that allows users to play and socialize with other gamers from around the world. Whether players prefer action-packed shooters or strategy games, Garena seemingly has something for everyone, with additional features such as real-time chat to enhance engagement.

After gaming, Sea Limited expanded into e-commerce with its Shopee platform, which is one of the largest digital marketplaces in Southeast Asia. Shopee allows users to buy and sell a wide variety of products, from electronics to groceries. Sea’s approach to e-commerce is a hybrid one–it acts as a marketplace but also holds inventory for some product categories. The company also offers financial services such as money transfers, bill payments, and pre-paid mobile phone top-ups through its SeaMoney platform.

In e-commerce, Sea Limited generates revenue by taking a cut of the sale price when it acts as a marketplace and makes money on the actual sale price when it holds inventory. Gaming revenue primarily makes money through in-game purchases, where players can buy virtual goods such as skins, weapons, and other enhancements to improve the gaming experience.

Marketplaces have existed for centuries. Where once it was a main street in a small town or a mall in the suburbs, sellers benefitted from proximity to one another because they could draw customers by offering convenience and selection. Today, a myriad of online marketplaces fulfill that same role, aggregating large customer bases, which attracts commission paying sellers, generating flywheel scale effects which feed back into further customer acquisition.

Competitors offering e-commerce platforms include Amazon.com (NASDAQ:AMZN) and Alibaba (NYSE:BABA), and competitors offering digital gaming include Sony (TSE:6758) and Nintendo (TSE:7974).

Sales Growth

Sea Limited's revenue growth over the last three years has been incredible, averaging 71.7% annually. This quarter, Sea Limited reported mediocre 5.2% year-on-year revenue growth, missing Wall Street's expectations.

Sea Limited Total Revenue

Ahead of the earnings results, analysts covering the company were projecting sales to grow 12.8% over the next 12 months.

Usage Growth

As an online marketplace, Sea Limited generates revenue growth by increasing both the number of users on its platform and the average order size in dollars.

Sea Limited has been struggling to grow its users, a key performance metric for the company. Over the last two years, its users have declined 20.5% annually to 43.1 million. This is one of the lowest rates of growth in the consumer internet sector.

Sea Limited Quarterly paying users

In Q2, Sea Limited's users decreased by 13 million, a 23.2% drop since last year.

Revenue Per User

Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like Sea Limited because it measures how much the company earns in transaction fees from each user. Furthermore, ARPU gives us unique insights as it's a function of a user's average order size and Sea Limited's take rate, or "cut", on each order.Sea Limited ARPU

Sea Limited's ARPU growth has been exceptional over the last two years, averaging 85.8%. Although its users have shrunk during this time, the company's ability to successfully increase prices demonstrates its platform's enduring value for existing users. This quarter, ARPU grew 36.9% year on year to $71.83 per user.

Pricing Power

A company's gross profit margin has a major impact on its ability to extert pricing power, develop new products, and invest in marketing. These factors may ultimately determine the winner in a competitive market, making it a critical metric to track for the long-term investor. Sea Limited's gross profit margin, which tells us how much money the company gets to keep after covering the base cost of its products and services, came in at 46.9% this quarter, up 9.8 percentage points year on year.

For online marketplaces like Sea Limited, these aforementioned costs typically include payment processing, hosting, and bandwidth fees in addition to the costs necessary to onboard buyers and sellers, such as identity verification. After paying for these expenses, Sea Limited had $0.47 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.

Sea Limited Gross Margin (GAAP)

Sea Limited's gross margins have been trending up over the last 12 months, averaging 45.4%. This is a welcome development, as Sea Limited's margins are below the industry average, and rising margins could suggest improved demand and pricing power.

User Acquisition Efficiency

Consumer internet businesses like Sea Limited grow from a combination of product virality, paid advertisement, and incentives (unlike enterprise software products, which are often sold by dedicated sales teams).

Sea Limited is efficient at acquiring new users, spending 39.2% of its gross profit on sales and marketing expenses over the last year. This level of efficiency indicates relatively solid competitive positioning, giving Sea Limited the freedom to invest its resources into new growth initiatives.

Profitability & Free Cash Flow

Investors frequently analyze operating income to understand a business's core profitability. Similar to operating income, adjusted EBITDA is the most common profitability metric for consumer internet companies because it removes various one-time or non-cash expenses, offering a more normalized view of a company's profit potential.

Sea Limited reported EBITDA of $510 million this quarter, resulting in a 16.5% margin. The company has also shown above-average profitability for a consumer internet business over the last four quarters, with average EBITDA margins of 12.5%.

Sea Limited Adjusted EBITDA Margin

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Sea Limited's free cash flow came in at $595.5 million in Q2, turning positive year on year.

Sea Limited Free Cash Flow

Sea Limited has generated $1.35 billion in free cash flow over the last 12 months, a solid 10.8% of revenue. This strong FCF margin stems from its asset-lite business model, giving it optionality and plenty of cash to reinvest in its business.

Key Takeaways from Sea Limited's Q2 Results

With a market capitalization of $32.2 billion, a $5.7 billion cash balance, and positive free cash flow over the last 12 months, we're confident that Sea Limited has the resources needed to pursue a high-growth business strategy.

Sea Limited's user base fell and its revenue missed Wall Street's estimates. In the press release, management also signaled that the company would be stepping up investments. This shows some optimism around the market opportunity but could depress profits in the near to medium term. On the positive side, adjusted EBITDA beat and was much improved some a year ago. Overall, this was a mixed quarter for Sea Limited, with the revenue miss weighing on shares. The company is down 10.2% on the results and currently trades at $50.95 per share.

Is Now The Time?

Sea Limited may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity. We think Sea Limited is a solid business. Its revenue growth has been exceptional, and that growth rate is expected to increase in the short term. And while its growth in users has been lackluster, the good news is its top-tier ARPU growth shows the increasing value of its platform to its users and its strong free cash flow generation allows it to invest in growth initiatives while maintaining an ample cash cushion.

At the moment Sea Limited trades at 33.8x next 12 months EV/EBITDA. There are definitely things to like about Sea Limited and looking at the consumer internet landscape right now, it seems that the company trades at a pretty interesting price point.

Wall Street analysts covering the company had a one year price target of $95 per share right before these results, implying that they saw upside in buying Sea Limited even in the short term.

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