Under no circumstances is this investment advice. I cannot guarantee accuracy of any information included. I am not a professional investor.

SEA Limited is an enormous, exciting venture that has attracted a lot of attention. There are many incredibly well researched pieces about the company available online. This report provides an overview which may serve as a starting point for anyone who is interested in the company.

SEA limited represent a pioneering force that is applying pressure for rapid development in Southeast Asia. They are based in Singapore.

Loaded up with profits from their ongoing gaming business (Garena Free Fire is among the top 3 mobile games in the world), SEA started the trading company Shopee, facilitating e-commerce in a fragmented region where barriers exist between different governments and cultures. For my overview on e-commerce in Southeast Asia, click here

At this stage, Shopee has not made a profit, but is in the process of rapid growth and breaking ground as they build out infrastructure and attract customers by marketing heavily and offering their services at a low price. E-commerce is the most important part of SEA Limited- it is the source of most of their expected future revenue. As such, this report will focus on Shopee.

SEA also run a mobile payment platform that has a supporting role in developing trade and Shopee in Southeast Asia.  

Management

Mr. Forrest Li is the founder, chairman and CEO of SEA Limited. He is well known as the richest man in Singapore, which is remarkable due to his age (43). Mr. Li is largely self-made. He took out a loan to pay for his study at Stanford, and his ambition was heavily influenced by his time living in the USA. He is also an avid gamer.

Mr. Li started Garena, the gaming business, in 2009 after forming relationships with several angel investors, and went on to create Shoppee in 2015 after Garena’s success.

Other directors and senior management are also relatively young. They have connections to many high-profile companies and institutions globally and are exceedingly well equipped to drive SEA Limited in the right direction.

Executive directors are well aligned through substantial shareholding, and renumeration includes share-based payments for management and some employees.

Strategy

The overall goal of SEA Limited is to improve quality of life for consumers and small businesses with technology. The product strategy is similar in both the gaming and e-commerce businesses and is based on fulfilling consumer desires with simplicity and accessibility.  

This was initially done with the gaming business, which Mr. Li believes to be the new form of social interaction. Garena Free Fire is a very simple game that can be learned rapidly. The mechanics allow for new players to enjoy a level of success and grow their skill in a satisfying way. Interactivity is encouraged, and players can speak to one another freely. The game is exceptionally efficient, accessible to anyone with a phone, and built around the most essential features (the things that the user most desires). It contains a marketplace, upon which advertising is used to encourage sales of in-game items.  

Shopee also aims to improve the quality of life for consumers, though in a more tangible way as discussed in the industry section. The strategy for the service shares the same framework as Garena Free Fire- it is based on the most essential features and uses intelligent advertising to drive profits from the marketplace. And it is also mobile based, allowing everyone to participate. The winning combination of simplicity, accessibility, and audience engagement appears to be successful in Shopee based on their exceptional growth to date.  

The product strategy is augmented by vivid engagement campaigns- large events, collaborations within pop-culture, and high production value advertising attract customers to both platforms. The ongoing exposure helps to solidify both Shopee and Free Fire as trusted, integrated elements of culture and society.

These platforms also work together to drive growth. Users of one platform are often pushed toward the other, through links or advertising. The similarity between the platforms allows for successful business strategies to be transferred between them. And, by analysing data about user behaviours on both platforms, SEA Limited can refine their advertising and other strategies to a far higher level.

Shopee lost the company $1.4b in 2020, although management state that the operation could be easily optimized for profit rather than growth. The gaming business (which consists of Free Fire, other games, and some highly profitable distribution rights) covers a large portion of these losses, delivering over $1b of income.

Therefore, the strategy going forward is to maintain the gaming revenue, while driving growth in Shopee as far as possible. This goes beyond Southeast Asia, making strides into South America, Greater Asia, and Europe. SEA’s third arm, the payment platform, is a means of facilitating this growth.

Quality of Earnings

SEA Limited are unprofitable. However, their revenues are high-quality and growing rapidly.

E-commerce is estimated to have penetrated 48.8% of the Southeast Asian market today, with Shopee owning 57% of that. This allows significant future growth, although it indicates that the maximum possible growth within Southeast Asia is limited. However, Shopee is working its way into markets in South America and Europe, and revenue per user is expected to increase.   

Revenue from Shopee comes from a few different sources, and predominantly from organic users of the platform. A large portion is from advertising, which is highly targeted and effective because it incorporates the behaviour of the user and inspires a response that is very easily carried out, as the audience are already primed and set up to make purchases. The payers themselves are incredibly diverse, coming from many different age groups, social demographics, and locations. Payers also include corporations like Samsung, with whom Shopee have agreements for facilitating sales through the platform.

While management claim that Shopee could provide positive earnings whenever necessary, the level of profitability is unclear. Both revenue and costs within the segment are growing at an exponential rate, and the gap between the two appears manageable. Overall cost efficiency is improving each quarter.

As discussed in the industry section, profitability will ultimately come down to how intelligently Shopee can provide value to their users. Their company-wide strategy, which focuses on the common sources of value across all audiences, along with the synergies and data gained from each segment, gives them a decent chance of optimizing for significant profitability in the future.

The competitive dynamics in e-commerce favour Shopee, as they are largest provider in Southeast Asia today. Their competitors, including Alibaba-owned Lazada, are smaller and provide users with fewer products/customers within the region. However, the efforts that SEA Limited have undertaken to increase the use of e-commerce may make life easier for these competitors. Once the way has been paved, other well-resourced companies may follow.

SEA Limited aim to continue their aggression in an adaptive fashion- they will respond to external events if necessary. Currently, Shopee’s growth is fuelled by income from the gaming business.

Garena Free Fire provided over $1.1b revenue in the last quarter at a 70% gross margin. It has an enormous player base, and new players are quickly matched with up to 50 others of  a similar skill level. The game is reliable, efficient, and introduces novelty in a sustainable way. It allows for the introduction of new formats and ongoing collaborations with cultural phenomena like TV shows, comics, and celebrities. It has been adopted as an e-sport, with 5.42m viewers in 2021. User growth is less rapid than it has been in the past, but in-game prices are very low compared to other top games like “Clash Royal”, and it is likely that margins in this operation will continue to expand.

Free Fire’s longevity is important because their other sources of revenue in gaming are less certain. In this fiercely competitive and heavily invested space, the same level of success in another title is not likely.

Revenue also comes through a distribution agreement with Tencent, the largest gaming company in the world. Tencent own 22.9% of SEA Limited, and the two work together. However, the current agreement will be revisited in 2023 and the outcome may not provide SEA Limited with the same income that they currently enjoy.

It is essential to consider the relationship SEA Limited has with some of their subsidiaries. The corporate structure uses VIE’s, which grants control without majority ownership. The structure is common but means higher risk of regulatory disruption and conflict with subsidiary owners, inherently lowering the quality of earnings.  

Capital Allocation

SEA Limited have a bold capital allocation strategy, and a willingness to pursue new lines of business to achieve the company vision and generate high returns on capital. Throughout the success of their gaming segment, SEA Limited have allocated most of the profits earned toward expanding Shopee. Their approach is prudent- few lines of business have been entered, but each has proven successful and provided access to new customers, strengthening their network, and has also improved their offerings. SEA Money, for example, allows for unbanked people to access financial services to use Shopee. 

SEA Limited have various methods of increasing their core capacity. Building out infrastructure is important across the business, in the form of facilities, hardware, and software. But due to the capital-light nature of their technology industries, SEA Limited’s major investment is in acquiring users through marketing. The total marketing spend for 2020 was $1.7b, compared to revenue increase of $2.2b since the previous year. As a trend, revenue is increasing more rapidly than the marketing budget, which indicates that the expense may be worthwhile despite its major impact on profits.

Another way that the company increase capacity is through acquisitions. Phoenix Labs, a game developer, was recently acquired primarily for their top tier American development staff. SEA Limited recently announced a billion-dollar allocation toward the pursuit of strategic acquisitions and improving their capital allocation with a new division “SEA Capital”. Their large cash position allows them to move opportunistically, and when combined with management’s eye for strength, this new division is promising.

SEA Limited do not pay dividends, nor have they materially bought back shares to return value to shareholders. Instead, they participate in dilutionary activities. They have issued shares for the purpose of raising capital a few times, most recently raising $6b this year which diluted the share value by 7%. Employee share programs are also used. These activities have cost shareholders dearly, but the capital provided has been used to good effect.

SEA Limited use significant debt, usually about equal to the previous year’s revenue. They currently owe $4.1b. The company maintain a total cash & equivalent position that far exceeds this debt, currently $12.5b.

Valuation

From the perspective of an acquirer, SEA Limited shares are very expensive. The most generous liquidation value of total assets minus liabilities is around $8b, compared to a market cap of $124b. There are many possible scenarios in which SEA Limited fail to make any positive returns in the future. Should this occur, shares would be effectively worthless.

Maximum future revenue from Shopee in Southeast Asia can be estimated by looking at the predicted value of the e-commerce market and making an assumption about Shopee’s market share. A mid-range prediction found on “Statista” estimates a $210b market in 2025. Shopee should hold 60% of the market, meaning a potential $126b in revenue. This is an extremely high expectation, but the figure is in line with a doubling of revenue each year, something that Shopee has managed to accomplish so far.

Hopefully Shoppe earns a profit beyond 2025. As discussed, the margin is difficult to predict, but 10% appears possible. If net profit was $12.6b at a PE of 20, this would produce a market cap of $252b for Shopee alone, which is more than double the current market cap of the entire company today.

Now for the “minimal success” scenario, which assumes no great failures but minimal revenues. This can be taken as a “median”- the highest probability outcome. Looking at the whole business, I find it unlikely that SEA’s revenue will be anything below $80b in 2025. The risks will be further discussed below, but this estimate is based on the strength of Free Fire, their connection to Tencent, and the success of Shopee so far. Remembering Free Fire’s enormous margin, the entire business should exhibit the capacity to earn at least 7% on their $80b, generating a market cap of $84b at a conservative PE of 15.

So, SEA Limited is worth between $0 and $252b in 2025. Given that the company is valued at $126b today but only earned $2.7b this quarter, massive growth in revenues is necessary to make the price worthwhile. An estimate of $84b still requires obscene revenue growth. However, I think Shopee probably will grow exceptionally over the next few years- I don’t think any other company has put in the effort required to dominate Southeast Asia, I think e-commerce is essential in the region, and I think the company will also do well in other locations with Shopee and gaming.

Performance beyond the “median” estimate could provide returns far greater than the losses in a company failure, a few times the current valuation with either significant income or growth in hand. As such, I view SEA Limited as well valued and worth buying at the current price according to my estimation of their strength and taking into account the following risks.

Risks

Competition is the biggest risk to the company. They are proximal to Alibaba, Tencent, and Amazon, some of the most powerful companies in the world.  SEA Limited’s efforts to break ground may not be enough to prevent users from switching to other services in the future.

Lack of profitability is also a huge risk. Given the barriers in the Southeast Asian market and its lower average income, the economics may simply not work out. SEA Limited may be unable to turn a profit in e-commerce unless things change in the region.

Lack of economic growth and adverse geopolitical events. The ASEAN growth story is compelling, but not certain. Global economic factors may prevent growth from occurring quickly enough for SEA Limited to capitalize. Instead of ASEAN growth, negative geopolitical events may cause economic decline. SEA Limited is highly exposed to regional economic conditions.

Gaming segment. Garena Free Fire must continue to provide fuel for Shopee. There is a specific risk in the relationship with Tencent, who could turn around and end their distribution deal with Garena, and simultaneously out-compete the company. Also, the style of gaming may fall out of favour- Free Fire may be exposed as harmful to society. Ultimately, if this segment declines, it would limit Shoppe’s growth capacity, and leave to door open for competitors.

Corporate structure. The non-traditional ownership structure of subsidiaries leaves room for uncertainty of those earnings. Developments of conflict between internal entities would be a sign of weakness and may compromise the entire corporation.

Company specific adverse events like data breaches, illegal activity, resignation or termination of key management, substantial litigation, worker exploitation, and a number of other hazards may potentially occur. Given their rapid growth rate, risks may be overlooked, and a catastrophe is more likely to occur. Because the company is consumer facing, bad publicity could cause customers to turn away en masse.  

Cumulative strategy risk. The path to profitability requires a fairly narrow set of outcomes to occur. While success appears probable, the reliance on a specific set of outcomes is risky. Any interruption to the strategy, due to any of the above risks, would have a compounded negative impact on the growth story of the entire company. With such a lofty valuation, shareholders could be easily burned.

Conclusion

SEA Limited have made a strong entry into Southeast Asian e-commerce but aim to capture the market more completely before optimising for profitability. Shopee and Free Fire have unique, memorable, and positive images that have found a place in different social landscapes across the region.

Free Fire originally targeted an unaddressed market for accessible, simple, reliable, and connected mobile gaming. The game exhibits a strategy to intelligently fulfill consumer desires, and as one of the most popular mobile games on earth, it proves that SEA Limited’s strategy can be successful. Their lines of business work together, which has resulted in rapid revenue growth. There is a clear path to domination in the enormous, currently underserved e-commerce market.

Management is youthful, aligned with the company, and well-connected. The founder understands how US businesses succeed globally and appears ready to make some serious socioeconomic progress by improving quality of trade for millions of customers and small businesspeople alike. And their ventures outside the region, in South America and Europe, are genuinely promising.

However, SEA Limited are unprofitable. Their capital raising activities have negatively impacted shareholders, and their corporate structure carries some unavoidable risks.

The market has placed great expectations for the future, and to meet these, a very specific set of circumstances must unfold. For e-commerce to be profitable, wage growth across Southeast Asia may be necessary within the next few years. Shopee must maintain their dominance by aggressively pursuing new users and fending off competitors until this occurs. And, to cover their losses, the gaming segment must continue to deliver cash uninterrupted.

SEA Limited’s rapid growth into new environments creates a higher risk of something going wrong. An adverse internal event could cause their customers to lose faith in the company, and because their segments are reliant on one another, the failure of one could mean the failure of all.

Despite this, I think the most likely outcome is a reasonable level of success. The company has many unique strengths, and their addressable market is one of the most underserved in the world. The current share price is high, but my rough calculations indicate that SEA Limited could become worth many times more in the future based on Shopee alone. Even in a moderate scenario, SEA Limited should be able to exceed the current expectations of the market.