Sea – All at sea

Sea is in for further rough weather.

• Sea has taken a big hit as India has banned its most popular game, Free Fire, creating the concern that the growth of the company could evaporate meaning that its valuation should be far lower.
• Sea is Southeast Asia’s biggest digital ecosystem covering both the Gaming and the Shopping segment and derives the majority of its revenues from Southeast Asia of which India is a part.
• As a result of its founder being born in China (now a Singapore citizen) and Tencent holding an 18.7% stake in the company, it is being treated by the Indian authorities as Chinese.
• The company itself is incorporated in Singapore and is listed on the NYSE meaning that its connections with China are pretty tenuous despite many of its executives being of Chinese origin.
• This is not a big surprise as 76% of Singapore’s population are ethnically Chinese and so, all things being equal, one would expect a similar percentage of its executives to be of Chinese origin.
• However, the Indian government can do what it wants, and it seems to have decided that Sea should be considered Chinese resulting in a ban of its popular game.
• This will certainly hurt revenue growth but not nearly to the extent that the share price reaction is pricing in and so I suspect that there is a lot more going on here than just India and China issues.
• At its peak, the company had a market capitalisation of $200bn with forecasted revenues for 2021 of $10bn meaning that it was trading on around 20x 2021 revenues.
• This has since come back to a “more reasonable” 9x revenues, but this still looks high to me.
• This is especially the case when Tencent is trading on closer to 7x revenues and Alibaba is on 3x revenues.
• Both of these companies are very profitable which, at the end of the day, is really the only driver of the fundamental value of equity.
• Sea, by contrast, seems to lose more money the bigger it gets which raises real questions around just how big it would be if it stopped spending all of its profits and more on sales and marketing.
• A company with 700m+ users is already a giant digital ecosystem and should be making money hand over fist.
• Sea is in a position to do this as its gross margins in Q3 2021 were 37% but it will have to stop investing for growth or, as the cynics put it: buying revenue.
• India is a source of long-term growth and the risk that its businesses there get closed down will have an impact on the levels of growth that the company is able to record.
• This uncertainty combined with the return of the buy value and sell growth investment trend is going to keep Sea on the ropes for a while.
• This company could get very interesting as I suspect that it will manage to distance itself from China and it has a very strong position in Southeast Asia.
• However, I think it has further to fall as its fundamentals compared to others are still far from compelling.
• I would prefer Alibaba over Sea and am also beginning to have a think about Pinterest again which has fallen substantially despite its improving fundamentals.
• This is one to keep an eye on.