Sea Limited (SE) - Overcoming Sea Change Challenges, Time To Own The Business

Sea overcame a perfect storm to reemerge as the most dominant tech titan in SEA, execution risks reduced, undervalued at 25xFCF with 20% durable growth.

Hi, I am Trung. I deep-dive into market leaders. 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) transactions (1st, 2nd, 3rd, 4th). Access all content here.

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Sea Limited (SE) is a $40B Southeast Asian e-commerce/fintech/gaming success story.

Sea’s growth is nothing short of phenomenal. From humble beginnings, Forrest Li and Gang Ye founded Garena, a gaming platform that ignited a global phenomenon with Free Fire, enjoyed by half a billion players with its fast-paced action and freemium model. Garena’s success blossomed into Sea Limited / ‘Sea,’ a digital empire encompassing e-commerce (vertically integrated with its own logistics and advertising) and fintech.

Shopee, Sea's e-commerce arm, conquered Southeast Asia's burgeoning internet market with 50%+ market share thanks to its mobile-friendly interface, broad SKUs, strategic integration with social media, and competitive pricing. SeaMoney, the company's financial services arm, is seamlessly integrated with Shopee, offering users an intuitive and convenient one-stop shop for digital payments and financial solutions.

Since 2014, sales have compounded 62% annually and are expected to generate at least $1.5B in free cash flow annually.

I have owned Sea since 2020 and feel comfortable sharing my thesis with you today. It will replace CrowdStrike as my top position in my PA, and I will add it to the Sleep Well Portfolio this week. Below are all the deep dives and performances.

Why own Sea Limited now?

First, Sea’s phenomenal success has met with crushing depths post-COVID (FY2022 cash burn of $2B). The fall culminated in several internal and external pressures, from (i) economic headwinds, which saw its Gross Merchandise Value (GMV) growth slowing from 85% in 2021 to a mere 28% in 2023, (ii) Free Fire's sharp decline as user downloads dropped from 240 million in 2021 to 150 million in 2023, with revenue dipping proportionally, casting doubts over its durability. (iii) Overambitious, cultural, and local competition miscalculation, leading to ineffective global expansion plans into India, Europe, and Latin America, drained resources from Sea's core markets. (iv) Sea’s aggressive marketing and promotional campaigns at the expense of long-term profitability were deemed unsustainable. Coupled with geopolitical turbulence in the war in Ukraine, it further disrupted supply chains and compounded Sea’s existing challenges, added fuel to the $2B cash burn fire in 2022. Sea’s sharp slowdown was a stark reminder that even the most formidable tech giants are not immune to the market's vicissitudes.

I have watched my share ownership fall 80%+ from $370/share in 2021 to $33/share in Oct 2023. This translates to a staggering $170 billion wiped off the company's market capitalization, leaving me questioning the future Sea.

Today, Sea’s has found the balanced formula to grow sustainably. In the past six quarters, it has proven it has the grit to overcome the ‘sea change’ challenges above and has worked on building defensive qualities to fence off more resourceful competition. The achievement is a testament to its visionary leadership and ability to adapt and capitalize on the region's rapid digital transformation.

As a result, Sea’s has earned my sleep-well label, which I wasn’t entirely comfortable calling it a few years ago.

As we advance, Sea will have three durable cash-generating businesses at the current run rate of over $1.5B free cash flow. Importantly, Sea shows clear evidence of reinvestment opportunities that will expand the empire's resiliency.

Sea Limited revenue and free cash flow

Best of all, the market has not given enough credit, valuing it at just 25 times free cash flow for a tech titan with multiple years of 20% growth and margin expansions. Together with future multiple expansions, Sea’s value is well-positioned for outsized long-term gains.

Here is a quick overview of the segments and how they make Sea a sleep-well pick.

Garena, the gaming segment / Digital Entertainment, owns Free Fire, the most successful battle royal game in the past seven years; it attracts nearly 900B views on TikTok, 300B (!) more views than the next most popular games (Roblox and Fortnite), has 595M quarterly active players and 49M paying. After a roller coaster post-COVID, Garena has stabilized and is en route to generating $1B of free cash flow annually for the near future. Adding to the $4B net cash, Sea can redirect this excess cash to fortify Shopee and SeaMoney.

Shopee, with a $85B gross merchandise value (trailing 12-month GMV), commands over 50% market share in Southeast Asia. Shopee is more dominant than Amazon's (AMZN) 38% share in the US or Mercado Libre’s (MELI) 30% in Latin America. The monopoly-like share is a testament to Forrest Li’s leadership and superior local knowledge compared to competitors. Since the last few quarters, Shopee has been breakeven in the core market - South East Asia. Future success is supported by 15%+ e-retail growth, improving logistics and unit economics in live-commerce business thanks to more rational competitive behaviors following Tiktok's merger with Tokopedia.

SeaMoney / Digital Financial Services, the fast-growing and high-margin fintech segment, offers credit services to Shopee sellers (SME loans) and buyers (buy-now-pay-later and short-term cash loans). SeaMoney empowered 18 million Southeast Asians to participate in the digital economy, bridging the gap between traditional finance and the world of mobile transactions. It is a direct benefactor of Shopee’s success. SeaMoney generated $500M of free cash flow in the last 12 months and has durable 20%+ growth thanks to Shopee integration, disciplined risk management (decreasing non-performing loan ratio of 1.4%), and growing monetization in insurance and mobile wallet services.

My simple and conservative sum-of-part valuation of Sea indicates an undervalued enterprise of $44B compared to the current market cap of $40B. I value:

• Garena at $12B (12x EBITDA, low range of industry 12-20x EBITDA),

• Shopee at $25B (2.5x EV/Revenue, lower than peers at 3x), and

• SeaMoney at $7B (15x EBITDA).

I believe the market hasn’t appreciated the value in

(i) Garena’s durability, especially if Free Fire is relaunched in India, and

(ii) Shopee’s scale advantage and defensive quality in SPX, its own logistics, and

(iii) a higher advertising take rate towards the end of FY2024, a 0.5% increase, leads to $400M of ad revenue alone.

(iv) a higher multiple as time will show Sea is an enduring enterprise.

Lastly, Jeff Bezos often says that free cash flow per share is the ultimate financial measure. Sea’s free cash flow per share is only starting to move upwards.

Sea Limited's free cash flow per share

Details of my analysis are as follows:

1. Overcoming challenges

2. Garena

   1. Staying power

   2. Free fire upside in India

3. Shopee

   1. Improving unit economics

   2. Moats vs. competition

   3. Market and take rate growth

4. SeaMoney

   1. High margin

   2. Disciplined execution

5. Simple valuation

6. Sleep Well Scores

7. What to track

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Check out my research, including FREE write-ups, in the link below.

🗝 The Key To Sleep Well

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1. Overcoming Challenges

Since its inception in 2009, Sea has encountered the following challenges: