Equity Analysis /
Singapore

Sea Ltd: Drowning in a sea of despair

  • Sea has lost most of its value post-pandemic; growth prospects have diminished for its core e-commerce & gaming business

  • We lower our FY 22-23 earnings forecasts on weaker operating performance and GMV per order (fall by 10% in FY 22)

  • We cut our target price to US$71 (from US$120), implying a 20% downside. Reiterate Sell

Sea Ltd: Drowning in a sea of despair
Nirgunan Tiruchelvam
Nirgunan Tiruchelvam

Head of Consumers Equity Research

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Tellimer Research
15 March 2022
Published byTellimer Research

We cut our DCF-derived target price on Sea Ltd (SE US) to US$71 (from US$120), implying a 20% downside.

We cut our FY 22-23 earnings forecasts as follows:

Sea Limited: Earnings revision table

Forecast vs Consensus

We cut our earnings forecasts for the following reasons:

  1. Sea Ltd's gaming business is likely to generate weaker operating performance. The digital entertainment (gaming) segment disappointed in Q4 21 and we are negative on the segment's prospects going forward. The gaming segment is excessively dependent on a single game, Free Fire, which has been banned in India and is losing traction in the rest of the region.

  2. We expect that the average GMV per order for Sea Ltd will fall in FY 22 by 10%.

We cut our SOTP-derived valuation due to the following reasons:

  1. Sea Ltd is a sitting duck in the China Tech sell-off. China Tech has lost 75% of its value in the last year – this is similar to the 1990s dotcom collapse in magnitude.

  2. The peer group average P/Sales multiple for gaming (digital entertainment) has fallen by 44% in the past three months.

  3. The peer group average P/GMV multiple for e-commerce has fallen 74% over the past three months.

Sea Ltd: SOTP

Our SOTP valuation is corroborated by our DCF valuation. Also, the growth prospects for Sea's core e-commerce and gaming businesses have diminished.

Sea Ltd: FCFF valuation

Concerns

  1. E-commerce is burning cash at a frenetic pace. Covid-19 has caused a spike in e-commerce revenue and GMV, up 89% yoy and 66% yoy in Q4 21, respectively. Even if you take this into account, it would continue to generate EBITDA losses in the next two years.

  2. Sea's EBITDA generation is dominated by its gaming business, which has weaknesses. The gaming unit is largely an agency business (meaning that most of the games are not their intellectual property). This is in contrast to regional gaming giants such as Tencent, NetEase and Activision. Also, over 24% of its gaming revenue comes from a single game – Free Fire. Gaming loyalty is fickle and fashions can change quickly.

  3. Sea has made a costly foray into e-payments. We forecast this business will generate US$1.49bn in adjusted EBITDA losses in the next three years.

  4. Sea has been indisciplined in the use of its capital. E-payments will be a dampener on the FCF generation.

Risks to our Sell recommendation

  1. There could be a reversal of Tencent’s programme of disposing of its overseas associate stakes.

  2. The gaming business could receive a boost from the launch of a new game that matches Free Fire's popularity.