Sea Ltd. A Controversial Situation

For all the “cash grab”  accusations that have been directed at the thousands of Initial Coin Offerings (ICOs), they represent chump change compared to Sea Ltd. (NYSE:SE) The Singapore based company went public just last October raising $880 million.  That placed a value on the total company of almost $2.6 billion by our calculations.  That is a huge valuation for a company that was losing $200+ million at the time.

Sea Ltd. was fortunate in convincing top underwriters to do their offering. The list included no less than Goldman Sachs, Morgan Stanley and Credit Suisse.  The opportunities for Sea Ltd. look pretty awesome as we describe below.  The financials reports of Sea Ltd reveal a different story.

On February 28, Sea Ltd. reported full year 2017 revenue of $414 million, up 19.8% year over year.  The company racked up a whopping $561 million loss, a 149% increase over the previous year.  Not many companies can afford to lose more money than they generate in revenues.  Sea Ltd. is one of those rare few, and that has investors nervous.  Is Sea Ltd simply misunderstood or is the stock a ripe target for short sellers?

How They Generate Revenues

Sea claims to be the leading internet company in Greater Southeast Asia, or GSEA, based on their number one market share by revenue in the region’s online game market, their number one market share in the region’s e-commerce market, and their position as a leader in the region’s digital payments market by e-wallet.

That is a lot of market leadership when Sea revenues were less the $400 million annually.  It appears everywhere we read the company claims market leadership but qualifies this by limiting the time period such as “June 2017” or in small regions.  That sort of language always makes me wince.

Huge Addressable Market

It is not difficult to appreciate the enormity of the GSEA market. Here are a few stats from the October prospectus.  GSEA contains 585.3 million population generating $3 trillion in GDP.  If that were not enough, there are 315.4 million Internet users and 237.1 million smartphone users.

That is the overview, here is what made Sea Ltd. appealing to initial investors back in October.  The size of the online game market is $3.5 billion growing at 19.6%.  The e-commerce market is placed at $23 billion growing just under 30% followed by the $6.5 billion electronic payment business showing a 30+% expansion.  That is pretty impressive stuff.

The Business Model

Sea has created  an integrated platform consisting of digital entertainment (focused on online games), e-commerce, and digital financial services (focused on e-wallet services), each localized to meet the unique characteristics of GSEA.

Sea operates with three main platforms that also serve as consumer brand names. These include Garena (Video Games), Shopee (e-commerce) and AirPay (financial services).

Garena

The Garena platform is a gaming network where Sea creates exclusive licenses with developers.  Online gaming licenses typically run three to seven years.  During this period fees are charged to platform members of which Sea retains 65%-80% of gross billings.  Other related services include video content such as live streaming of online gameplay, chat and online forums. Finally, Garena claims they are the GSEA leader in eSports.

All in all there is little doubt the markets that address are large and growing. Eventually we will come to how Sea makes money.

Shopee

Think of Shopee as a small but rapidly growing Amazon, Ebay or Alibaba wannabe. Shopee is a third-party marketplace that connects buyers and sellers.  They do not hold inventory.  Management believes buyers choose Shopee because they trust the brand to
provide easy access to a wide range of products coupled with strong customer service.

AirPay  

The AirPay platform provides digital financial services.  Through the AirPay e-wallet, consumers use either the AirPay App or one of 177.9 thousand registered retail partners,
to make payments to a wide variety of product and service providers.

During the first half of 2017, transactions for AirPay e-wallet totaled nearly $475 million. The AirPay App is available in Thailand, Vietnam and Taiwan, and AirPay counters are operating in Thailand, Vietnam, Indonesia and the Philippines. This leaves considerable territorial expansion opportunities for the future.

Management is in the process of integrating AirPay with Garena where it recently processed 40% of aggregate gross billings.  AirPay provides payment services to Shopee as well.

Use Of Proceeds

The IPO raised gross proceeds of $880 million for approximately 32% of the Class A shares. Based solely on this, underwriters placed roughly a $2.6 billion valuation on Sea Ltd. This excludes 151.5 million Class B issued and outstanding shares.  The value is not determinable at this time.  Accepting the vast market potential for the company’s services, what did investors get in return.  Let’s dig into the financials starting with the Use of Proceeds statement taken directly from the October prospectus.

“The primary purposes of this offering are to create a public market for our Class A ordinary shares in the form of ADSs for the benefit of all shareholders, retain talented employees by providing them with equity incentives and obtain additional capital. We plan to use the net proceeds of this offering primarily for growing our business, including user acquisition, content procurement and research and development, as well as for working capital and other general corporate purposes.”

What would have been nice is if there was some mention of how a huge chunk of the proceeds would be used to pay down a mountain of debt: about $674 million of long term debt. Little wonder investors are nervous.

There is absolutely nothing wrong with paying off debt especially if it results in a benefit to equity shareholders.  However, with the company losing money at nearly $561 million, it is a bit challenging to find how shareholders come out ahead.  Based on analyst projections, Sea Ltd. is not likely to make a profit until at least 2020 and that means they will be in a negative cash flow position for quite a while.  

Featured image courtesy of Shutterstock.

Author:
James Waggoner is a veteran Wall Street analyst and hedge fund manager who has spent the past few years researching the fintech possibilities of cryptocurrencies. He has a special passion for writing about the future of crypto.