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Sea Ltd: Cost cuts will not stem the sea of red. Downgrade to Sell

  • Sea’s path to profitability will require a lot more than job cuts

  • The Digital Entertainment segment is in freefall because it is dependent on a single game – Free Fire

  • We downgrade Sea to Sell with a new target price of US$60

Sea Ltd: Cost cuts will not stem the sea of red. Downgrade to Sell
Nirgunan Tiruchelvam
Nirgunan Tiruchelvam

Head of Consumers Equity Research

Tellimer Research
21 June 2022
Published by

On 17 June, the media reported that Southeast Asian tech giant Sea Ltd (SE) is cutting its headcount in ASEAN and Latam. The layoffs are focused on ShopeeFood and SeaMoney and could amount to a 5% fall in headcount. If so, this would equate to an average cUS$400mn fall in COGS in FY22-24. Sea Ltd is also departing from Spain.

Our view is that these job cuts are unlikely to stem Sea Ltd's structural difficulties. Garena (the digital entertainment segment) is under pressure, as its revenue is almost exclusively derived from a single game – Free Fire. Free Fire seems to be in freefall due to the fickleness of the gaming user base.

Digital Entertainment's Q1 22 operational metrics such as QAUs (quarterly active users), paying users and adjusted EBITDA margins declined. Digital Entertainment EBITDA was down 40% yoy in Q1 22. And remember that India’s ban on Free Fire will be reflected from Q2 22. New game launches such as Moonlight Blade are not due until FY23.

We adjust our forecasts to reflect these factors. The key changes to our operating assumptions are as follows:

Operating Assumptions

Downgrade to Sell with a target price of US$60

We revise our forecasts and reduce the terminal growth rate to 2.0% from 2.5%. We cut our target price to US$60 (from US$72) and downgrade our recommendation to Sell (from Hold) for the following reasons:

  1. The gaming business is likely to generate a declining EBITDA loss of US$2,289mn and US$1,494mn in FY22 and FY23. The dependence on a single game is the main weakness.

  2. The e-commerce and digital financial service businesses are generating strong revenue growth. However, both of these segments are unlikely to be EBITDA profitable until at least FY25. The market is less forgiving of unprofitable businesses in this tech rout.

Adjusted EBITDA - Segmental breakdown

Forecast vs Consensus

Sea Ltd: Earnings revision table (US$ Mn)

We value Sea Ltd using a sum of the parts methodology. We have reduced the valuation multiples used, in order to reflect the current bear conditions for the peer group. We cut the P/Sales multiples for digital entertainment from 3.81x to 2.07x, lower the P/GMV for e-commerce from 0.23x to 0.16x, and reduce the P/TPV for digital financial services from 0.12x to 0.10x.

Sea Ltd: SOTP

The DCF valuation corroborates the SOTP methodology.

Sea Ltd: FCFF valuation

Sea Ltd: Income statement

Sea Ltd: Balance sheet

Sea Ltd: Cash flow statement