A difficult time ahead for the sea
Investors in sea ltd. (SE -5.44%) have fallen on hard times as the stock has fallen more than 80% in the past few months. Struggles in India, a difficult macroeconomic environment and economic reopenings have hurt Sea’s gaming, e-commerce and digital payments businesses.
The effects were clear when Sea reported second-quarter results with revenue growth slowing to 29% year-over-year and its net loss doubling. Worse still, there seems to be no end to Sea’s recent challenges.
Garena’s woes continue into final term
Once-performing Garena, the company’s gaming segment, has struggled in recent quarters as user engagement wanes amid economic reopenings.
Garena’s second quarter results highlight some of its challenges. Bookings fell 39% year over year to $717 million. This is the third consecutive quarter-over-quarter decline after the games division hit a peak in bookings of $1.2 billion in the third quarter of 2021. The decline in bookings resulted from lower Quarterly Active Users (QAU) and Quarterly Paid Users (QPU).
Garena’s weakening performance is appalling for Sea, as the parent company previously relied on cash flow from the subsidiary to fund growth in the e-commerce and digital finance segments. With Garena’s profitability rapidly declining, Sea’s adjusted earnings before interest, tax, and amortization (EBITDA) deteriorated year-over-year from a loss of $24 million to a loss of $506 million – the gaming segment can no longer offset the losses of other segments.
On a slightly positive note, Garena’s QAUs stabilized at 619 million after hitting a low of 616 million last quarter. At their peak in Q3 2021, QAUs totaled 729 million. The drop is partly due to India’s decision to ban Garena’s hit mobile title Free fire, although the financial impact of the ban was small. If QAUs remain at this level or improve, Garena’s booking trend could reverse in the coming quarters.
Free fire remained the top-grossing mobile game in Southeast Asia and Latin America in the second quarter, suggesting that the struggling performance is likely an industry-wide issue rather than company-specific.
A Pivot in Shopee’s Growth Strategy
As Garena’s bookings plummet, investors are hoping Shopee, Sea’s e-commerce unit, can pick up the slack to support the company’s growth.
So far, Shopee has done well, recording impressive growth. In the most recent quarter, unit revenue increased 51% year-over-year to $1.7 billion, driven by 27% growth in gross merchandise value (GMV) to $19.0 billion and an improvement in Shopee’s take rate. Still, Shopee’s high growth rate caused the business unit’s adjusted EBITDA to deteriorate further: a loss of $648 million versus a loss of $580 million last year.
Shopee’s mounting losses stem from its decision to invest in expanding its business in Latin America and strengthening its lead in Southeast Asia. Historically, Sea could afford these losses thanks to Garena’s ever-growing cash flow. Today, such a strategy becomes too cumbersome, as Garena’s adjusted EBITDA fell 55% to $334 million last quarter.
Thus, the tech company is shifting its focus from a growth-at-all-costs strategy to a focus on efficiency, profitability, and cash flow management. On a positive note, this signals that Shopee’s losses should decline in the coming months, which is crucial as Sea needs to conserve cash to survive in a tougher operating environment.
The downside of this change is that Shopee’s growth may also slow in the coming quarters. Management also decided to suspend its full-year 2022 guidance for the e-commerce segment as part of the change in strategy.
What future for Sea?
In 2021, the sky was the limit for Sea. Garena was generating huge cash flow, while Shopee was expanding everywhere: in India, Europe and Latin America.
Today, Sea’s outlook looks bleak as Garena’s profitability continues to decline, while Shopee’s growth is also expected to decline in the coming quarters.
The strategic pivot is paramount to deal with Sea’s exorbitant cash burn rate. To put it into perspective, the company has consumed $4 billion over the past three quarters, reducing its balance of cash and short-term investments to $7.8 billion. At this rate, it will run out of cash in less than two years!
I think Sea’s decision to slow down is rational and prudent. At the very least, it will allow the company to consolidate its recent growth, build up its reserves and capacity, and then resume its expansion. It’s a marathon, not a sprint.