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Sea Ltd: Surfing the e-commerce wave in ASEAN

  • The pandemic lockdown has boosted Sea's e-commerce and gaming revenue

  • Its Q2 results were littered with impressive numbers. We raise our earnings by 14% and target price by 13%

  • Sea is the best capitalised of the three players competing to become ASEAN's super app

Sea Ltd: Surfing the e-commerce wave in ASEAN
Nirgunan Tiruchelvam
Nirgunan Tiruchelvam

Head of Consumers Equity Research

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Tellimer Research
18 August 2021
Published byTellimer Research

After Q1 results we said Sea was set to sweep through ASEAN. And so it has proved.

The e-commerce company released stellar Q2 results and we raise our revenue and earnings forecasts for Sea Ltd (SEA US) in 2021-24 by 17% and 14%, respectively. The increase is due to the continued rising trend in ASEAN e-commerce. Management has increased the annual forecasts for its main businesses and hence we raise our target price by 13% to US$360.

Sea's latest results show it is poised to generate strong growth momentum, as it is well placed to benefit from the heightened demand for e-commerce, gaming and digital services in ASEAN. It also has the potential to become a super-app similar to the likes of Alibaba.

Alongside MercadoLibre, Sea is one of our top picks in the EM tech sector. We reiterate our Buy recommendation.

Results highlights

In Q2 21, Sea Limited generated revenue growth of 159% yoy to US$2.3 billion. Gross profit for the period grew 3.6x yoy to US$931mn. We thought the return of lockdowns in many of its operating markets would benefit the firm, and that has been the case.

The Digital Entertainment segment (gaming) saw a yoy increase of 1.7x in revenue, while adjusted EBITDA increased by 70% yoy to US$741mn. The key driver was an 85% yoy increase in QPUs (Quarterly Paying Users). This represented 12.7% of QAUs (Quarterly Active Users) as compared to 10.0% in the same period last year. Sea’s Free Fire game has maintained its popularity and now has over 1 billion downloads on Google Play.

Revenue from the e-commerce segment increased 160% yoy to US$1.2 billion. Gross merchandise value (GMV) grew 88% yoy, indicating an increase in GMV monetisation rate. Total orders increased 127% yoy to 1.4 billion.

Although the adjusted EBITDA loss for the period expanded to US$579.8mn from US$313.7mn in the same period last year, on a unit economics basis the adjusted EBITDA loss per order declined 20% yoy to US$0.41 in Q2 21.

Digital Financial Services grew sharply. TPV (Total Payment Volume) exceeded US$4.1 billion Q2 21, an increase of 156% yoy, while quarterly paying users more than doubled, up 109% yoy to 32.7mn.

Sea Ltd: Result summary (US$ mn)

Solid balance sheet

The cash burn will ease

Despite the growth in revenue and GMV, the company continued to burn cash as EBITDA losses grew by 42% qoq in Q4 20. EBITDA losses from e-commerce and digital financial services cumulatively clocked in at US$599mn. But we expect the cash burn to ease from FY 21-24.

A key reason for this is that Sea raised US$3bn in a 3% equity issue in December, which will give it enough ammunition to fund its cash burn, as well as acquisitions. Sea has improved its position on our proprietary Cash Sustainability Index (CSI) as a result of its revised forecasts and the recent fundraising.

Earnings revision

We present our updated forecasts below. The main drivers of the increase in our projections are the robust growth from the Digital Entertainment segment and higher growth assumptions for the e-commerce segment.

Sea Ltd: Earnings revision table (US$ mn)

We are much more bullish than consensus in our adjusted EBITDA forecasts, both for this year and in FY22.

Earnings forecast: Tellimer vs consensus (US$ mn)

Valuation

We think Sea is undervalued. We now use a DCF valuation methodology in recognition of the increased cash flow positivity. Other metrics such as SOTP and EV/user support our valuation. It is also cheap on a SOTP basis.

Our DCF-derived target price of US$360 is shown below:

Sea Ltd: FCFF valuation

The SOTP method supports our valuation.

Sea Ltd: Comparative valuation table

Risks to our target price

  • The e-commerce segment may register lower growth rates once the pandemic subsides.

  • The gaming business is dominated by a single game. This leads to concentration risk.

  • ASEAN governments may increase regulatory scrutiny.