Sea Limited (SE) - Q2'24 review - Building an Evergreen Franchise

Garena looks more like an enduring cash-cow, Shopee maintains dominance and turning profitable in Q3, SeaMoney is executing prudently. I am still a buyer at 21x FCF and at 52-week high.

Aug 15, 2024

Hi, I am Trung. I deep-dive into market leaders with my sleep-well checklist. I follow up on their performance with my Thesis Tracker updates, and when the right price comes, I buy them for the Sleep Well Portfolio, which I am building for my daughters to redeem in 2037. I disclose my reasoning for all BUY and SELL (ideally never). Access all content here.

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Hi Sleep Well Investors,

The transformation Sea Limited made post-COVID is showing incredible results (deep dive, buy alert). The three segments are growing at a 20%+ rate with an improving bottom line. Together, they generate roughly $1.9B of free cash flow (Garena: $1.2B, Shopee $0, and SeaMoney $660M) annually, contributing to an already healthy $9B cash balance.

The only pickle in Q2’24 was no mention of the India relaunch (no analyst asked the question!). However, the thesis is still a massive upside in increasing take rate, particularly in the Ads segment, improving moat in logistics, and SeaMoney's durable 20% growth.

Below are the key highlights, followed by deeper commentaries.

Three standout highlights:

Garena is an evergreen enterprise with 100M daily active users (648M monthly active), and Firefire continued to be the most downloaded mobile game globally in Q2. Investment in Garena’s game-creating tools is an excellent step to reduce reliance on Firefire.
E-commerce dominance - take rate increasing, logistics improvements, positive EBITDA from Q3, ads upside, limited competition from TMall and Temu.
SeaMoney saw 40% growth in loans to $3.5B and 58% in customers to 21M while improving the loss ratio.

Before we discuss each segment in detail, I’d like to ask you to spread the word so that more long-term investors like you can benefit from Sleep Well Investments’ high-success-rate research.

So far, the nine buys have made an average return of 23%—no significant losses.

The biggest win was selling CrowdStrike at $381/share to buy Sea Limited a month ago and then rebuying CrowdStrike at $205/share (pairing with adding to Fortinet as a hedge) after CrowdStrike demonstrated sufficient evidence for me to believe it is owning the mistake and executing steps to change for the better.

Of all the recommendations, even buying without considering valuation or following my buy alerts has had an average return of 20%, with only three notable losses. Again, the result shows that you will likely sleep well here.

Above, you can still achieve good results without investing in the Amazon of the world, where you can get coverage from 100s of analysts anyway. I am all about finding less-covered businesses, observing them patiently, and buying at a reasonable price so you can enjoy an edge before the significant funds. I spend 100% of my time researching sleep-well businesses and executing my buys/sells with discipline.

Below is the timeline of my deep dives, tracking, and buys. All-access is in my spreadsheet and is available to annual members.

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Garena - evergreen gaming fanchise

Booking grew 21% YoY; Free Fire was the most downloaded mobile game globally in Q2’2024, and more than 100m DAU on Free Fire every day throughout the quarter. Notably, there were 649M Quarterly Actives Users - higher than the peak of COVID, meaning gamers are not only returning to Garena but new gamers have been added. Garena now has a $1.2B EBITDA run rate.

Garena demonstrates that Freefire is an evergreen franchise and not just a COVID craze. The 650M quarterly active user base is still expected to increase and improve monetization; management expects to sustainably grow both by >10%. The return of India Freefire would add an instant 40M users.

More importantly, I really like that Garena is developing its game creation tools to reduce its reliance on Freefire.

we are not building only building the game content and we are continually focused on building on the game creation tools (with aids of AI) within the Free Fire ecosystem
we remain confident to deliver the double digit growth for Free Fire for both monetization side and also on the user growth side. - Q2’24 cc

Shopee

Shopee was last reported to have a 50% market share in Southeast Asia, an incredible achievement given that it only started in 2015. After nearly ten years, it has only begun to break even in the past two quarters, thanks to the drastic pivot to profitability post-COVID. And from Q3 '24, management expects it will become adjusted EBITDA positive.

This is huge! I don’t know what the stock price will be, but I am a keen buyer of the business after knowing Shopee will be profitable this soon!

This is another milestone, given how cut-throat competition has been in the past year. It shows that Shopee has successfully fenced off competition, maintained market share while increasing the take rate to 12% (vs. 8-10% for TikTok and Temu and 18% for Mercado Libre), and generated profit.

A good surprise for me was that Brazil (at approximately 10% of revenue) looks profitable already. As a result, it is revising guidance for Shopee’s 2024 full-year GMV growth rate to mid-20% (from 15%).

Brazil’s unit economics continued to improve as we achieved a positive contribution margin per order of $0.09 for the quarter as compared to a loss of $0.24 in the second quarter of 2023.

Let’s look at some further commentaries:

On competition

we do expect the overall competitive landscape […] continue to come into a more rational stage even compared to where we are right now, which will drive the overall industry probability to improve.

Management wasn’t concerned with Temu (PDD) and Tmall (BABA), mainly because they only do well in the US and Europe, given their cheaper and lower cost base. In Southeast Asia, they have a limited pricing and operational cost advantage compared to Shopee. Take Shopee in the Philippines, for example. Operation and shipping costs are even lower than those of their Chinese counterparts.

[…] the impact to our business is probably rather limited from what we see. I think for two reasons:
A great strength for Tmall or other cross-border players entering to the U.S. or European market is their pricing. They typically carry a significant price advantage compared to the existing players.

if you compare our pricing to their pricing in the market that you mentioned, Philippine, Thailand or Malaysia, we actually have a much better pricing advantage compared to them. It was mainly because we actually operate in a very competitive environment for quite a long time. And we are being -- essentially having a very competitive seller landscape domestically for quite a while. And also compared to a more developed market, where the operating cost is much higher compared to the freight cost in China, the operating cost for our sellers in our market domestically is probably cheaper than operating costs in China, if you take a person in Philippines to operate a warehouse or operate a shop, they are probably cheaper than a Chinese person.

Temu and Tmall are also not a concern to Shopee because cross-border commerce is a smaller part of the region's business.

CB (cross-border) by nature is a smaller part of our businesses in our market. If you look at the market like Philippines, Thailand, Malaysia mentioned, majority of the e-commerce transaction happen to be a domestic selling rather than cross-border selling, right? There are many reasons to constitute that, of course. But as a fact, that's how the market landscape evolved to, for the better efficiency and cost structure that the domestic e-commerce offers.

The two points above are more or less applicable to TikTok’s merchants if they sell products from China. Additionally, TikTok does not have Shopee's logistic prowess, so their cost structure can not be as low.

Ad take rate

Increasing the Ad take rate is a significant part of my thesis. With a GMV of nearly $100B, a 0.5% take rate increase will generate $500M of revenue and potentially $300M of free cash flow. Shopee’s ads take rate is about 2-3% lower than mature peers' and 6% lower than the overall e-commerce take rate of Mercardo Libre.

There is a lot of room to increase here. And it’s expected to take shape within quarters, not years!

I think there are still opportunities to further increase that, although probably not in the magnitude that we see in the early part of the year. There's another part of take rate, which we think that is also having a sizable opportunity is on the ad side.
we do believe that we will start to gain the benefit in the next few quarters, probably wouldn't take a few years.

Management is starting to share more metrics on ads -

In 2Q 2024, sellers who pay for ads increased by more than 20% YoY
In Indonesia in June 2024, 1 in every 4 active streamers paid for Live Ads

SPX - logistics

Logistics is a source of competitive advantage for e-commerce players. SPX is Shopee’s in-house solution, similar to Amazon’s FBA. Management has started sharing more metrics for SPX, and Q2’24 shows that SPX is improving sequentially.

SPX Express improved delivery speed while reducing costs:

In 2Q 2024, >70% of SPX Express orders in Asia were delivered within 3 days, with cost per order declining 8%, a sequential increase from ‘approximately 70%’ in Q1’24. - The aim is to reach 95% of orders delivered within 3 days.
Data-driven tech improvements to return-refund process: >50% of return-and-refund cases in Asia resolved within 1 day, a sequential improvement from ‘45% of cases’ in Q1’24.
Added 900 hubs in Q2; that’s a significant add, and that’s what it takes to maintain market share and competitive advantage over peers, especially the Chinese counterparts, as they rely massively on price (but without the cost advantage, it’s unsustainable)

There is still sizable rooms for us to grow our scale further, which in our space still can reduce the cost and improve efficiencies. Number 2 is more coverage and more density of the coverage. For example, more hubs, some of the hubs can be traditional hubs as you see, some of the hubs can mobile hubs through our innovative way of deploying the hubs with low cost. And if you look at Q2, we actually add about 900 hubs in Q2. And size of them are mobile hubs with low cost operations. Number 3 is we're also doing more automation through our networks. For example, in our SoCs, we are adding more automation solutions either it's for ASM, automatic sorting machines or it's a hybrid solution when there is a smaller SoCs, which will further improve our productivity.

SPX Cost - in Taiwan

The core thing that we are doing in Taiwan is, number one, to shorten our delivery time through our own SPX network. We are covering a lot more next-day deliveries through our own SPX network, which is typically done through a 3PL with much more expensive delivery systems, we are able to do a next-day delivery with much cheaper, in many cases, 40% probably cheaper than the alternative solution in the market. That's one. Second one is to further increase the efficiency of the supply side to work with our sellers to fulfill their orders, not only the delivery side, but also the warehousing side, the procurement side, to do it in a more cost-effective way.

SeaMoney - huge runway to 20% growth

Loans principal outstanding reached U$3.5 billion at the end of 2Q 2024, up almost 40% YoY and 8% QoQ
NPL90+ as a % of total consumer and SME loans principal outstanding improved sequentially to 1.3% in 2Q 2024 (1.4% in Q1’24, Q4’23, Q3’23)
21 million consumer and SME loans active users, up 58% YoY and 14% QoQ in 2Q 2024

There is not much I can add here except that the region’s underbanked population is over 350M of the 700M population. Only Singaporeans enjoy a modernized banking system, and 70% of the population has access to credit. The market size is estimated to be $150B; traditional banks dominate 90%. If you follow how fast Mercado Libre and Nu Bank are in Latin America, you can see what kind of growth is ahead for SeaMoney.

So far, SeaMoney is growing prudently. It focuses on shorter-duration loans with an improved loss ratio each quarter.

One is the duration of our lending products. Second one is the ticket size you mentioned. So in general, our duration is rather a short duration rather than a very long duration. By short duration, we were talking about just a few months in average, right? And our ticket size also compared to many other lending products, our ticket size is more on the smaller side. So in the combination of both will help us to be a lot more agile in terms of how we manage our portfolio, manage the portfolio in terms of how much lending we give out, how can we do risk-based pricing for different user bases and also how we do collections and how do we kind of fine-tune our portfolio based on the macro environment

Consolidated financials - $2B free cash flow with $9B cash to grow

Q2’24 added another data point to show Sea Limited is successfully transforming the business into a durable and profitable gaming, e-commerce, and digital banking enterprise. I believe Sea Limited is still cheap at 21x EV to Free cash flow and the prospect of durable 20% growth.

The bottom line is that with a $2B run rate of free cash flow and a $9B cash reserve, there is a lot of buffer for trial and error and execution mishaps. That’s my first focus. Sea Limited is proving it can continue growing and improving profitability simultaneously. Garena’s 650M active users are back growing and printing cash, Shopee is maintaining its 50% dominance with competition softening, and SeaMoney is starting to become an independent franchise; I can’t wait to see what it will be like in the next ten years.