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Gaming, e-commerce and e-payments king of South East Asia with a young, all-star, management team

September 24, 2020

Sea Limited/ SEA Buy @ $155  MV: $50.6bn  Next figures: 18 November No of times recommended: 4  Price when first recommended: $79.80

Sea Limited (I’m guessing the name stands for South East Asia) is an incredibly fast-growing Internet business, quoted on Nasdaq but based in Singapore and with its principle operations in Greater South East Asia (GSEA), which embraces Indonesia, Taiwan, Vietnam, Thailand, The Philippines, Malaysia and Singapore. In 2017, at the time the company floated these countries had some 585m people and around US$3 trillion in nominal GDP.

Sea Limited has three businesses, Garena for online video games, Shoppee, an e-commerce platform and Sea Money for digital payments. The company was founded in 2009, near the dawn of the Internet era in GSEA and has used its early start to become the number one player in the area with each of its three businesses.

The business was growing fast even before the Coronavirus lockdowns and growth has since accelerated. Based on the forecasts in the table below group sales are forecast to rise roughly 20-fold between 2017 and 2022.

The management team, which includes the two founders, is both young, mostly in their 30s, with CEO and co-founder, Forrest Li, having recently turned 40 and very able. Li himself has a degree in  engineering from Shanghai University and an MBA from Stanford Graduate School of Business.  Other top executives have similar qualifications. The chief corporate officer, Yanjun Wang, who answers questions at the analysts’ meetings, qualified with a JD (Juris Doctor) from Harvard Law School and with an economics degree from Harvard University. You can imagine how excited they are as a team about the growth they are achieving and the opportunities ahead.

My impression is that they already have such a lead in each of their three businesses that they cannot be caught. North America has key players like Amazon and PayPal, China has Alibaba and others but Sea Limited, which is nearly 40pc owned by Chinese gaming giant and super shrewd investor, Tencent, already looks like the unchallenged king of the Internet in GSEA.

This is exciting because on all sorts of metrics, population, GDP, Internet usage and mobile phone ownership, GSEA is growing fast creating a powerful following wind for Sea. I have included a table below to give the flavour of what is happening.

Sea started life in 2009 as Garena, a games company. The name was changed to Sea Limited in 2017 to reflect the rapid growth of new businesses, especially the e-commerce platform, Shoppee. Given the size of the respective markets being addressed it seems likely that eventually Garena will be the smallest of the three businesses. At the moment it is the business generating the profits and cash flow that are funding large early losses in the ecommerce and digital payments businesses.

Like so many business in the Internet space, Sea is spending as fast as it can to become the leader in its region, making it a classic example of the battle for territory strategy that I have suggested before is now the key indicator of success for technology-focused businesses. However they have not forgotten that ultimately they need to make money. The business is already generating enough cash that it is virtually self-funding and in the latest report, Q2 2020 for the period ending 30 June, gross profit more than doubled to $201m. This is before spending on sales and marketing, research and development and general administration. Net all that out and you end up with losses between $300m and $400m depending how you do the figures but it does point to a business that will be profitable one day and increasingly does not need external funding to keep expanding.

Those losses are not really losses. They are investments in growing the scale of the business(es), which could pay off dramatically in the future.

Each of the three businesses, looked at individually, is a spectacular success story,

Garena, the video gaming business, includes a mixture of in-house games developed by the company and games for which Garena acts as the publisher and provides a range of other services. Garena operates a freemium model so the games are available free but add-ons need to be paid for. The company is not only good and developing and finding new games to publish but is also becoming increasingly skilled at monetising them.

The first game developed by Garena is called FreeFire and has been a spectacular success. Monthly paying users more than doubled in July, so after Q2 had ended and during the quarter the game hit a peak of over 100m daily active users, was the highest grossing game in Latin America and SE Asia and ranked third globally in mobile downloads according to a research service called App Annie.

I couldn’t find a geographical breakdown in the Q2 figures but in fiscal 2019, so pre-Coronavirus, Sea generated $283m of turnover in Latin America, up from $14.7m the year before and $1.85m in 2017. The Rest of Asia excluding SE Asia had sales of $489m in 2019, up from $133m two years earlier and $230m the year before. The Rest of the World had sales of $25.3m in 2019 versus $1.1m the year before. The broad message, especially on the games front, is that Sea Limited is fast becoming a global business and a serious force in the world of video games. Out of total group turnover of $2.9bn in 2019, $797m came from outside SE Asia and in a sign of things to come the group has recently acquired a games development business in Canada.

The spectacularly fast-growing e-commerce business, Shopee, highlights another aspect of the way Sea operates. When the management set up the e-commerce platform, a bit like Facebook with their businesses, they didn’t monetise it at all to start with, just recruited buyers and sellers to the platform to create activity and scale.

What they then do, having generated a lot of activity on the platform, is monetise it. They describe this in the prospectus: “We began monetising our e-commerce business in 2017 in Taiwan and Indonesia by offering sellers a cost-per-click advertising service to feature and promote their products in search results generated by Shopee buyers, and by charging sellers in Taiwan commission fees for transactions completed on Shopee.”

In Q2 2020 GMV [gross merchandising volume] on the Shopee platfroorm exceeded $8bn (that’s in one quarter), incredible for something which didn’t exist five years earlier. “In terms of monetisation, adjusted revenue grew by 188pc year on year to reach $510.6m. I’m pleased to note that our monetisation rates have largely recovered to pre-pandemic levels. Adjusted revenue as a percentage of the total GMV increased to 6.4pc from 5.1pc for the previous quarter.” This figure of $510.6m for the latest quarter compares with $823m for the whole of 2019.

I am not going into all the details but there are many exciting things going on at Shopee. Just two instances are “In July, we partnered with Google to launch a new service called Google Ads with Shopee. This integration enables brand on Shopee to create Google shopping ads directly in the Shopee brand suite. We also enhanced our in-app Shopee feed with a new feature called Shopee Story. This allows brands and sellers to create and share short-form video content with their followers on Shopee feed.’

Sea is a technology driven company; that’s part of what makes it so exciting and it is increasingly appearing on the radar of some exciting partners. For instance there are over 400 games developers working at Garena, which explains why exciting new releases keep FireFree going from strength to strength and there are other exciting things happening.

“In July, we announced the partnership with Netflix for a special in-game crossover with its global hit show, Money Heist. For this, we have worked with Netflix to create a Money Heist’s same in-game takeover, which is expected to be launched in September. User will be able to enjoy a new game mode inspired by the plot of Money Heist and can purchase virtual skins modelled after the iconic outfits in the TV series.”

The group is also becoming a massive player in e-Sports. “In June, we held the Free Fire Asia All Star event, featuring both professional players and popular online influencers from India, Indonesia, Thailand, and Vietnam, competing across several tournaments. In early August, we hosted an online e-sports event in Latin America called Free Fire Gigantes, featuring the top teams from our pro leads on the Brazil and Latin America servers.”

Another exciting growth area in e-commerce is Shopee Mall, which provides a shop front for bigger retail brands. “Gross orders for Shopee Mall increased at an even faster pace of more than 210pc year on year as more and more global and local brands partner with us to cater to their increasing and evolving demand for online solutions.”  This trend will only continue as Shoppee becomes the platform for reaching shoppers in GSEA.

They are also taking a leaf out of Chinese e-commerce platform, Pinduoduo’s book, by offering a platform for farmers to sell direct to the market . “In Thailand, for example, we have partnered with the government to develop and roll out training and a support program targeting farmers. Our program aims to reach 1.5m farmers in the coming years to enable them to start and scale their business on Shopee. Similarly, in Malaysia, we organised a special online sales festival for durian [a fruit that smells rotten, tastes sweet] producers to ensure they could get their food to consumers while fresh.”

Digital payments is really a no-brainer for a fast-growing, broadly based e-commerce business as we have seen with Alibaba and subsidiary, Alipay, and with South American e-commerce star, MercadoLibre, where its digital payments operation is the sexiest part of the business. Sea Limited is going down the same route, starting with AirPay, which has been renamed, SeaMoney,  as it has spread its wings into other digital payments areas.

“SeaMoney’s focus continues to be leveraging on Sea’s strategic leadership position in some of the largest use cases for digital payments in e-commerce and digital entertainment. We believe its impressive growth in the second quarter underlines the strength of this strategy. Our mobile wallet total payment orders increased to more than $1.6bn for the second quarter, compared to more than $1bn in the first quarter. Quarterly paying users for our mobile wallet services grew by about 50pc quarter on quarter to more than 15m.”

Unsurprisingly the management are bullish on the opportunity ahead.

“We see significant growth ahead in the digital payment and the Digital Financial Services segment, driven by the rapid expansion of the digital economy in our region. Our results for the quarter clearly demonstrate that SeaMoney is in a great position to address the needs of users across the region.”

They are also bullish on the outlook for each of the three businesses..

“We are moving into the second half of 2020 firing on all cylinders. Each of our businesses is successfully adapting to capture the immediate growth opportunity in front of us. Each of them is also ideally positioned for the long-term with a significant runway ahead. We saw sustained and growing user engagement across our platforms through the second quarter and beyond. And this gives us further confidence that the rapid shift to digital lifestyles is a permanent and irreversible change that will drive significant growth opportunity for Sea over the long run.”

What impresses me is (a) what they have achieved in just over a decade (b) the opportunity for a business that is already so dominate in an exciting but slightly off the radar region, Greater South East Asia and (c) what else such a talented and ambitious management team might turn their attention to in future. I don’t think anyone can buy them because they are already the most exciting business in south east Asia and there would be huge opposition to an attempt to steal such a crown jewel. Lucky Tencent came in early, which is why they have such a big stake, one which could start to move the needle even for Tencent, valued at approaching $700bn.

Sea Limited shares are tightly held with over 80pc held by Tencent and management. They are also not cheap but incredibly hard to value. What price for the overwhelming market leader in three such exciting areas of business in South East Asia including a video games business that is spreading its wings globally? My guess is that, just as the name implies, Sea [South East Asia] Limited is going to become a behemoth in the years ahead.

I would say definitely one to put under the mattress and see what happens a decade from now.

US markets seem to be consolidating. It seems some shares raced too high too fast but the underlying fundamentals, especially for technology, remain as exciting as ever.

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