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Sea (NYSE:SE) Q3: Beats On Revenue But Stock Drops 11.4%


Full Report / November 14, 2023

E-commerce and gaming company Sea (NYSE:SE) reported Q3 FY2023 results topping analysts' expectations, with revenue up 4.9% year on year to $3.31 billion. Turning to EPS, Sea made a GAAP loss of $0.26 per share, improving from its loss of $1.02 per share in the same quarter last year.

Sea (SE) Q3 FY2023 Highlights:

  • Revenue: $3.31 billion vs analyst estimates of $3.21 billion (3.1% beat)
  • Adj. EBITDA: $35.3 million vs. analyst estimates of $179.8 million (large miss, as the company said it is currently prioritizing growth and market share over profits)
  • EPS: -$0.26 vs analyst estimates of $0 (-$0.26 miss)
  • Free Cash Flow of $599.8 million, similar to the previous quarter
  • Gross Margin (GAAP): 43.5%, up from 38.9% in the same quarter last year
  • Quarterly paying users: 40.5 million, down 11 million year on year (miss vs, expectations of 44 million)

Founded in 2009 and a publicly-traded company since 2017, Sea (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 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 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.

Online Marketplace

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 that 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's revenue growth over the last three years has been incredible, averaging 63.9% annually. This quarter, Sea beat analysts' estimates but reported lacklustre 4.9% year-on-year revenue growth.

Sea Total Revenue

Ahead of the earnings results, analysts were projecting sales to grow 5.8% over the next 12 months.

Usage Growth

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

Sea has been struggling to grow its users, a key performance metric for the company. Over the last two years, its users have declined 28.5% annually to 40.5 million. This is one of the lowest rates of growth in the consumer internet sector.

Sea Quarterly paying users

In Q3, Sea's users decreased by 11 million, a 21.4% drop since last year.

Revenue Per User

Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like Sea 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's take rate, or "cut", on each order.Sea ARPU

Sea's ARPU growth has been exceptional over the last two years, averaging 83%. 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 33.4% year on year to $81.73 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'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 43.5% this quarter, up 4.6 percentage points year on year.

For online marketplaces like Sea, 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 had $0.44 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.

Sea Gross Margin (GAAP)

Sea's gross margins have been trending up over the last 12 months, averaging 46.5%. This is a welcome development, as Sea'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 grow from a combination of product virality, paid advertisement, and incentives (unlike enterprise software products, which are often sold by dedicated sales teams).

Sea is efficient at acquiring new users, spending 38.5% of its gross profit on sales and marketing expenses over the last year. This level of efficiency indicates relatively solid competitive positioning, giving Sea 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's EBITDA was $35.28 million this quarter, translating into a 1.1% margin. The company has also shown above-average profitability for a consumer internet business over the last four quarters, with average EBITDA margins of 10.4%.

Sea 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's free cash flow came in at $599.8 million in Q3, turning positive year on year.

Sea Free Cash Flow

Sea has generated $2.12 billion in free cash flow over the last 12 months, an impressive 16.6% of revenue. This high FCF margin stems from its asset-lite business model and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a cash cushion.

Key Takeaways from Sea's Q3 Results

With a market capitalization of $26.09 billion, a $7.50 billion cash balance, and positive free cash flow over the last 12 months, we're confident that Sea has the resources needed to pursue a high-growth business strategy.

It was great to see Sea beat analysts' revenue expectations this quarter. That stood out as a positive in these results. On the other hand, its user base fell, missing expectations. The company also stated that they will "prioritize investing in the business to increase our market share and further strengthen our market leadership", which is having a negative impact on profits. As a result, adjusted EBITDA missed by a large amount. Overall, the results could have been better. The company is down 11.4% on the results and currently trades at $40.8 per share.

Is Now The Time?

Sea may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We think Sea is a solid business. Its revenue growth has been exceptional over the last three years, and analysts believe that's sustainable for now. 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. On top of that, its strong free cash flow generation allows it to invest in growth initiatives while maintaining an ample cash cushion.

Sea's price/gross profit ratio based on the next 12 months is 4.3x. There are definitely things to like about Sea 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 $63 per share right before these results, implying that they saw upside in buying Sea even in the short term.

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