Introduction
Last Tuesday, Sea Limited (NYSE:SE) reported its Q3 2022 earnings. From the market reaction, I think it’s clear how these were perceived. The stock shot up 36% following the announcement.
This is of course the result of a raging short squeeze. Many traders were shorting Sea and they had to buy back as soon as possible. But that short squeeze was driven by fundamentals that looked better than before.
In the meantime, the stock has gone down again by 9%.
Let’s dive into the numbers to analyze the situation.
The numbers
As Sea consists of three businesses under one hood, gaming, e-commerce and digital banking, there are always more numbers to go through. We’ll start with the group and then we’ll go over the 3 arms.
Group
The Q3 revenue came in at $3.2 billion, up 17.4% year-over-year, beating the consensus by $190M or 6.3%.
Sea reported non-GAAP EPS of -$0.66, beating the consensus by a whopping $0.29 or more than 30%.
This has become a pattern for Sea. It has almost always been beating on its topline expectations. 14 beats out of 16 quarters.
For EPS, the picture was completely different. The company almost always missed expectations, at least until recently.
As you can see, this is the fourth consecutive quarter management beats on EPS, for the second time by 30%+. That’s the right message to the market, now that it focuses more on the bottom line. Of course, Sea is not profitable yet, but it is showing faster improvements than the market had given it credit for. Net loss came in at -$569.3 million, flat year-over-year, but an improvement of a whopping 38.9% quarter-over-quarter.
Gross profit landed at $1.2 billion, up 21.7% year-over-year. On $3.2 billion in revenue, that means gross margins of 37.5% vs. 37.9% in Q2 and 37% in Q3 2021. This metric is stable.
If you exclude SBC, stock-based compensation, severance packs and lease termination fees, net loss even improved by 49.4% quarter-over-quarter. You can argue about excluding these things, of course, but SBC is not a cash expense and the rest is a one-time expense that will save more money in the future. Impressive to see such a turnaround in just a quarter.
Adjusted EBITDA was -$357.7 million compared to -$165.5 million in Q3 2021, but 29.4% better than in Q2 2022. If you exclude SBC, severance and lease termination costs, EBITDA improved 44.7% quarter-over-quarter.
Sea is still financially stable, with $7.3B in cash, equivalents and short-term investments. The company has $3.74 billion in convertible notes. The biggest part, $2.5 billion, is issued when Sea’s stock price was much higher. They were offered at $318 per share. They have an interest of 0.25%. They have a conversion price of $477. Very well timed, Sea!
I have already said that Sea reminds me in different ways of Amazon (AMZN). You always have to be very careful with such comparisons. I’m not implying that Sea will become the next Amazon; every situation is different. But there are similarities. One of them is that Amazon also issued notes just before the top. $1.25 billion in January 1999 at 4.75% and $655 million in February 2000 at 6.9%, both for 10 years.
This was one of the main reasons Amazon could survive the dotcom crash, while almost all other tech companies went under. Jeff Bezos promised the company would focus on profitability. Does that sound familiar? Bezos indeed turned the company and it became profitable 2.5 years later. The red circle shows when Amazon became profitable on operational cash flow, probably the best metric to track retail. You can also see how fast this goes up after that.
I now hear some people say Sea will have to file for bankruptcy in a few years. That’s very unlikely. If the stock price is still a lot under that price, which is likely, some note investors may want to be repaid in cash. But to start with, Sea has the necessary money up to now; secondly, often there are renegotiations, in which the notes are extended and the conversion prices are brought down.
Forrest Li, Sea’s Founder and CEO, sent out a very clear message to the doubters on the conference call about the notes or convertible bonds, the name he uses here:
We aim to continue to maintain a net cash position, after budgeting for the full retirement in cash of outstanding convertible bonds and assuming no external funding.
So, Li wants to have a cash position after having paid off all outstanding notes. That means that the company will go fast and that this quarter was just the start of a turnaround. Li added:
I’m confident in our ability to execute well against our stated goals, as we have demonstrated so many times in the past.
Let’s look at the different groups now.
Shopee
Shopee’s revenue was up 32.4% year-over-year to $1.9 billion, 38.8% in constant currency. Adjusted EBITDA for Shopee was -$495.7 million, improving 27.5% year-over-year and 23.5% quarter-over-quarter.
The core marketplace revenue was up 54.1% year-over-year to $1 billion, which is very strong and the main driver of the fast improvements in Shopee’s losses. This shows what Forrest Li has been preaching for years, that scale will bring cost advantages, which shows up in the numbers. The core marketplace mainly consists of third-party revenue and ads.
That marketplace revenue is up much more than GMV shows scale advantages kicking in and ads and other services gaining traction. Shopee has also made its take-rate higher to make its transition to profitability faster.
Shopee’s Sales & Marketing expenses of $575.7M were down by 16.4% year-over-year and 14.6% quarter-over-quarter. Raising take rates, cutting on S&M and still being able to grow revenue by 54%, for the core marketplace. That’s strong.
VAS or Value-added services revenue was up 20.3% year-over-year to $600 million. This mainly consists of logistics. It hides the growth of the core marketplace a bit.
There were 2 billion orders, up 19.2% year-over-year against tough comps. Last year in the same quarter, orders were up a whopping 123%. At the same time, orders were flat compared to the last quarter. Probably, this is because the company slashed the free shipping for most cheap products. This is no problem, I think.
GMV grew 13.5% to $19.1B. On an FX-neutral basis, GMV was up 21.4%. That’s on top of the 80.6% GMV growth in Q3 2021. Quarter-over-quarter growth, though, was just $100 million or 0.5%. I think this is what Forrest Li hinted at when he said on the conference call:
We believe our strong focus on cash flow and achieving self sufficiency as much as possible is the right strategy to pursue at this stage, even though we may see no growth or even negative growth in certain operating metrics in the near-term.
Slashing free shipping, higher take rates for merchants, lower sales and marketing spend, it all adds up to lower growth. Of course, there are two other very important elements here: the macroeconomic environment and the tough comps. In this environment, though, I think Sea is right in focusing on becoming profitable first. Forrest Li explains the strategy:
To be very clear, we remain highly confident about the compelling long-term growth prospects of our businesses and the market. Once we achieve self-sufficiency, we will be in a position to decide to reaccelerate growth again in a much more efficient and a long-term sustainable manner.
Something I have been irritated by for a long time is the exclusion of headquarters expenses in Adjusted EBITDA. From now on excluding HQ expenses will be called contribution margin, as it should be. Glad to finally see that corrected.
Asia markets adjusted EBITDA came in at -$216.8 million, improving by 31.4% quarter-over-quarter. In most Southeast Asian countries, there was already a positive contribution margin for Shopee, including Indonesia, its biggest market. Malaysia and Taiwan recorded positive adjusted EBITDA.
For the other markets adjusted EBITDA came in at 279 million, improving by 16% quarter-over-quarter. While management had previously shared that they wanted to have profitability for Shopee in its core markets in 2023, it added an extra goal now. Founder and CEO Forrest Li:
we are currently working towards adjusted EBITDA breakeven for Shopee overall by the end of 2023.
That includes Brazil. In Brazil, unit costs were $1.03 per order, improving 27.4% quarter-over-quarter. Revenue was up a blistering 225% year-over-year. Management confirmed that Sea would continue to invest in Brazil.
Despite cost-cutting initiatives, Sea will continue investing in its platform and that leads to success. Forrest Li on the earnings call:
The number of brands on Shopee Mall also continued to grow strongly by 36% year-on-year to over 42,000, reflecting more brands recognizing the value Shopee brings to them. Importantly,…
Read More: Sea Limited Stock: Investable Again (NYSE:SE)