Can Sea Limited Be Another E-Commerce Winner?

To date, we've done pretty well with e-commerce stocks here at GreenDot Stocks.

One of our first picks, Mercadolibre (MELI), is up 92% in a year and a half, trouncing the S&P 500 by 57%.

Recent pick Coupang (CPNG) has also done quite well, appreciating 60% in just 3 months, 53% better than the market at large.

So it gives me some measure of excitement to look at another stock in the mold of these two big winners. Just recently appearing in the Green Screens, we have Sea Limited (SE). Can this one live up to the lofty success we've seen with our previous two? Let's take a closer look.

Sea's Unlimited Business

Comparing Sea Limited to Mercadolibre or Coupang is pretty straightforward, as all 3 are giant online marketplaces in their respective geographies. For Mercadolibre, that's Latin America. For Coupang, it's South Korea. And for Sea Limited, we're looking at Southeast Asia.

The company's marketplace is known as Shopee, and it is the largest in the region by a wide margin. 73% of the company's revenue at large comes from its e-commerce arm. That revenue can be broken up further into 2 parts. 70% of e-commerce sales come from the typical transaction fees on completed sales, as well as advertising fees to promote listings. The remaining 30% come from logistics and shipping services under the firm's SPX Express offering.

Like both Mercadolibre and Coupang, there is more to Sea Limited than just a marketplace. The company also offers financial services, primarily a digital wallet and "buy now pay later" loans under the SeaMoney brand. Similar to how eBay integrated PayPal, or Mercadolibre built Mercado Pay, SeaMoney started as an easy way to pay on Shopee, and that is still a key use case. But, like the others, SeaMoney is seeing increased use off-platform, an exciting development for the long-term. This is a very profitable business with margins exceeding 30%.

Now, here's where things take a slight turn. Sea Limited also has an important and large gaming business known as Garena. Garena is an online gaming platform driven by the battle royale game Free Fire (think Fortnite). Tens of millions of gamers still play Free Fire daily. Almost 6 years after it was launched, in Q1 2024 it re-gained its position as the most downloaded mobile game globally - impressive! Gaming accounts for 14% of Sea Limited's revenue, and is by far its most profitable unit at a 57% profit margin.

The Growth and Recurring Revenue Story

Sea's has been a bumpy growth ride since the pandemic year of 2020, which was as good for this company as it was for most other e-commerce and online gaming firms. Still, the 3 year compound annualized growth rate since then is very good at 44%. Growth seems to be picking back up, too, with a +23% revenue figure in the most recent quarter vs. just 5% for all of 2023.

Southeast Asia has a burgeoning internet economy, the fastest growing in the world, with 19% growth in 2023. E-commerce sales in the region are expected to grow from $58 billion in 2022 to $160 billion by 2030 - a solid 13.5% long-term annual rate. The story is similar for the region's online gaming industry, which is expected to grow 9% annually over the same period.

Underlying industry growth is the baseline for a growing business, and with its leading market share in both categories, Sea Limited's management is aiming to exceed underlying market growth. This would put the firm comfortably in the 10-20%+ annual growth bracket we are looking for.

Longer-term, Sea has shown a desire to expand geographically. It made a push into Latin America a few years ago, and while it didn't go well for the most part, the firm is still growing operations in Brazil. Overall, growth potential looks good.

Over 85% of revenues can be considered reasonably recurring. Marketplace-driven transaction, shipping, and payment processing fees all fall under the "toll booth" model of recurring revenue. Interest collected on short-term loans is also recurring. The gaming unit is a bit less so, generating most of its sales from in-game items and "season passes" that are one-off purchases.

Is There A Moat?

E-commerce has developed into a "winner take most" model in nearly every region across the globe, with clear dominant leaders emerging, chased by a few smaller, less profitable runners up. For example, in the U.S., Amazon dominates, but is challenged by smaller online operations from Walmart and Target.

This appears to be the situation evolving in the SE Asia region. Shopee is a clear leader, with 50% overall market share and double the merchandise volume of its closest competitor, Alibaba-backed Lazada. Other competitors like Temu and newer competitor TikTok Shops also are in the game.

However, despite a big competitive push last year, Shopee remains the champ. Other big names that tried to enter the region, like JD.com and Shein, have both thrown in the towel. After a cutthroat 2023, Shopee is again growing at double the underlying market in 2024 and taking back share.

Why is this important? Simple. Dominant marketplaces generate a powerful NETWORK EFFECT. Scale attracts both sellers and buyers for mutually beneficial reasons: buyers come because it has the widest selection of products and prices, and sellers come because that is where the most buyers are. This extends into the payments business, too. Buyers want to use SeaMoney because it is convenient, and sellers want to support SeaMoney payments because that is what buyers want to use.

The network effect is one of the most powerful moats in business, and one that takes a very long time to penetrate. I believe Shopee has already begun to assert this in the region. Management is doubling down on customer service and pricing to consolidate its lead. Over the long run, I believe Sea Limited does have a meaningful network advantage over current and prospective competitors.

Management and Financials

Sea Limited is led by 46-year old founder and CEO Forrest Li. He's been at the helm since the beginning, in the process creating Indonesia's largest tech company in less than 15 years. He owns a 20% economic stake in the company (worth a massive $7 billion dollars), and 70% voting stake through his sole ownership of Class B "super-voting" shares.

I think it's fair to say that his interests our aligned with ours as far as stock appreciation!

Financially, Sea Limited is in excellent shape. The balance sheet has over $6.5 billion in net cash, and while it has been a bit of an up-and-down story with cash flow, currently the firm is solidly cash flow positive at a margin of about 11%. Sea has been an organic grower and as a result, its cash returns on investment are outstanding at over 50%.

No concerns here, we have heavily invested founder leadership and a culture of growing organically with manageable debt.

Risks

Sea Limited would fall under the "medium-high" risk category.

Competition is a key risk. We saw in 2023 how competitive challenges can drive the firm to lower prices and increase spending to maintain its lead. This led to mediocre growth, lower margins, cash-flow negative operations, and a falling stock price. While Sea seems to have turned the corner in 2024, there is no guarantee that new, international competitors may enter the fray and start the process all over again.

The gaming unit is also a bit of a wildcard. Free Fire is a 6-year old game now, and we haven't seen any major new follow-up for it. While this unit is a small portion of revenue (14%), it is a big contributor to operating profits (close to 70% of profit dollars). If gaming revenues continue their longer-term decline, and the e-commerce operation is not able to improve profitability, it will not bode well for Sea's cash flows - and stock price.

Finally, we have to mention the geographic risks here. Sea Limited's biggest territories of Indonesia, Vietnam, Thailand, and the Philippines are all considered emerging economies. While that is good for growth potential, we don't have a lot of history for what might happen in this region during a global recession. There are also geopolitical risks to consider when dealing with firms outside of the U.S.

Conclusion

I'm a big fan of dominant e-commerce operations as investments. They have consistently demonstrated outstanding, durable network effects all over the world, giving their owners the opportunity to expand into adjacent areas like financial services. Sea Limited's investment case is very similar to long-term winners like Amazon, Mercadolibre, and Coupang. Combine that with founder-led leadership and a fast-growing region, and the recipe for investment success looks good here. It is a "green dot" stock!

Now, let's consider a price. I've modeled for 16% annual growth over the next 5 years, offset by a 6% annual share dilution. The discount rate is 13%, which is quite high but I think accurately models the risks inherent in the competitive picture and the reliance on the gaming unit for profitability. All together, the fair value price is $72. That's right about where the stock trades at present. We will add Sea Limited to the Watch List today and wait for a better price to jump in.