When will the bad news on Sea Ltd stop?

TL;DR

• Sea Limited’s share price has taken another hit following media reports that its highly popular Garena Free Fire game has been banned in India.
• This reflects the risk around Sea’s gaming business as it has been highly dependent on a single game.
• Sea also faces increasing competition in its e-commerce and digital bank businesses.
• Despite the share price correction, Sea is still more expensive than other tech companies based on its price-to-sales multiple.

What happened?

Sea Limited’s share price is down sharply in pre-market trading on 14 February, after various media reports have highlighted that its highly popular Garena Free Fire game has disappeared from app stores in India.

This comes after the share price of Sea has plummeted by more than 50% from its peak in October last year, as an endless stream of bad news hit the company. This would include Tencent sale of a stake in the company, rising competition in the e-commerce space, as well as general weakness in tech stocks.

For those who are wondering if it might be time to pick up a bargain, we look are some of the risks relating to Sea and what’s next for the company.

What does this mean?

Before we do so, we think it might be useful for investors that haven’t heard of Sea to understand the company a little bit better. Sea is a Southeast Asian technology company that operates mainly through 3 business segments: (1) Digital Entertainment (2) E-Commerce (3) Digital Financial Services.

Risk 1: Gaming business faces concentration risk

Despite accounting for 47.5% of revenue, Garena is the only profitable segment based on Operating Income (Earnings Before Interest & Taxes). Being the “cash cow” business for Sea, it is essential for Garena to keep up with its current growth to fuel growth in the other business segments.

However, there is single game concentration risk from the dependence on Free Fire. Recent 3Q21 results have shown Free Fire active user base addition has slowed to just 4 million compared to the previous quarter.

In the second week of January 2022, Tencent Holdings (“Tencent”)  sold part of its stake in Sea to “fund other investments and other social initiatives”. This came as a shock because Tencent and Sea have always shared strategic relationships. Since November 2018, Garena has secured a 5 year contract to be the distributor of choice for Tencent’s mobile and PC games like Arena of Valour, Honour of Kings and League of Legends in SE Asia. 

Tencent Holdings sold Sea shares at US$208/share decreasing its stake from 21.3% to 18.7%. Tencent Holdings had participated in five rounds of funding to SEA between 2014 and 2017 and has always acted as a validator for SEA. Hence, the stake sale could have potentially rattled other investors.

Risk 2: Intensifying E-Commerce Battleground

Where there is fish, there will be boats. Given the untapped potential in SE Asia, the rivalry between E-Commerce platforms in the region is set to intensify. In Indonesia, Tokopedia has outpaced Shopee to be the No.1 E-Commerce Platform in Indonesia. Additionally, with the new formation of GoTo, the merged entity might continue the stranglehold of Indonesia’s digital economy. 

E-Commerce giants are also flocking to Vietnam to capitalize on its fast-growing digital economy. For instance, Alibaba has invested US$400 million in Masan Group to aid in the ramping up of its online groceries business. At the same time, local online retailer, Tiki, has also received US$193 million from investors like JD.com.

Risk 3: Intensifying Competition from banks & other Tech Rivals

Similar to the E-Commerce industry, the FinTech industry has its fair share of competition. Apart from rivalry from traditional banks, the high growth in online financial services has lured tech firms with deep pockets into digital banking. For example, in Indonesia, the FinTech scene is being led by traditional banks launching their version of internet banking followed by strategic mergers and acquisitions (M&A) made by tech firms. 

On top of competitions from traditional banks, Sea also faces intense competition from tech rivals as well. Companies like Grab is leading the charge on financial service offerings. Grab’s e-wallet accounts for 23% of SE Asia’s Total Payment Volume (TPV) in 2020. The snippet below will allow you to have a complete view of the different financial services offered by the 2 businesses. 

What would Beansprout do?

• Sea’s valuation is still higher than its peers. With the headwinds listed above, it seems like much of Sea’s growth has already been priced in. Since Sea is currently EBITDA and Net Profit negative, we will be valuing SEA based on a Price/Sales ratio. Sea is currently trading at a FY21E Price/Sales multiple of 7.0x, a slightly higher multiple as compared to its peers that are trading at an average of 5.4x and a median of 5.7x. With all the concerns discussed, patience might be required for the stock to find its footing once again.