If you’ve been investing long enough, simple pattern recognition can point you toward winning investments. It helps to quickly separate the signal from the noise. Over the past decade, this has helped me more than quadruple the market’s return…
Today, I’ll tell you about my next investment: Sea Limited (NYSE: SE). While I’m still getting to know the company, there’s enough to like that it warrants an investment by me. Read below to find out how I select stocks, and why Sea Limited is worthy of an investment.
First, a very quick introduction
The “Sea” in Sea Limited comes from the company’s geographical focus: Southeast Asia — namely Singapore, Indonesia, Vietnam, Malaysia, Thailand, Taiwan, and the Philippines.
Beyond that, don’t try to put Sea Limited in a box. It started out as a gaming company, then made a somewhat incredible jump to both e-commerce and digital payments. While I hate making such comparisons, the elevator pitch would be to call it a hybrid of Activision Blizzard, Amazon.com, and PayPal.
The company’s three operating segments are:
- Garena: Short for “gaming arena,” Sea’s video platform is a place to distribute both internally developed games (like the highly popular Free Fire) and third-party titles.
- Shopee: The largest e-commerce platform in Southeast Asia.
- SeaMoney: A digital payment solution to purchase stuff both on and off Shopee’s platform.
With this as a backdrop, let’s dive into the promising patterns I see emerging.
A wide moat
Let’s get some cold, hard numbers down first. Here’s how different parts of Sea’s business have performed over the past three-plus years.
|Division||2017||2018||2019||Trailing 12 Months||Compound Annual Growth Rate|
|Gaming||$365 million||$462 million||$1.136 billion||$1.255 billion||73%|
|E-commerce||$47 million||$270 million||$823 million||$959 million||282%|
|Physical goods||$2 million||$94 million||$217 million||$248 million||751%|
That’s stellar growth, especially from the already impressive gaming division. But I view video games more as a provider of cash for growth in e-commerce and payment solutions than a linchpin for my investment. That’s because video games have narrower moats.
In plain English, a moat is some type of competitive advantage that stops your competitors from taking away your business. Without one, you can become a victim of your own success. Video games are highly dependent upon producing the next big hit, something that Sea Limited has found with Free Fire. But it’s not something I’m betting on the company to sustainably produce.
Instead, I’m far more interested in the trends for e-commerce and digital payments. So far, management has been tight-lipped about SeaMoney’s results. What we do know is that during the first quarter, total payment volume exceeded $1 billion. To put that in perspective, Latin American payment behemoth MercadoLibre processed $8.1 billion in payments last quarter with a similar population total and smaller economies.
But we do have insights into e-commerce: gross merchandise volume (GMV) is the value of all the goods sold on Shopee, while orders are self-explanatory.
|Metric||Q2 2018||Q3 2018||Q4 2018||Q1 2019||Q2 2019||Q3 2019||Q4 2019||Q1 2020||Compound Annual Growth Rate|
|GMV||$2.222 billion||$2.690 billion||$3.425 billion||$3.529 billion||$3.828 billion||$4.573 billion||$5.646 billion||$6.200 billion||72%|
|Orders||128 million||159 million||207 million||204 million||246 million||321 million||441 million||430 million||100%|
Because Sea Limited has the largest market share in Southeast Asia (especially for cross-border sales), it is becoming the de facto choice for shoppers. The trends above make this clear.
That leads to two stellar moats:
- The network effect: As more shoppers come to Shopee, more third-party vendors have an incentive to list on the site.
- Low-cost operations: The logistics of order fulfillment in these island nations can be complicated. As Sea Limited builds out its capacity, it will be able to fulfill orders for a lower internal cost than the competition.
Thus far, Sea Limited isn’t generating any positive cash flows or profits. But that’s OK: It has $3.3 billion in the bank and a modest $1.4 billion in debt. And even then, the debt is in the form of senior convertible notes, which gives the company a measure of flexibility.
At the same time, Chinese behemoth Tencent (OTC:TCEHY) owns 25% of Sea Limited. That means there’s a safety net for additional cash should Sea Limited need it. Given that its primary e-commerce competitor, Lazada, is backed by Alibaba, the stake owned by Tencent is crucial.
The combination of cash on hand and ownership from Tencent lowers the risk of a cash crunch. Given the vast opportunity in both e-commerce and payments (and investment necessary to build out a sea-and-land-based fulfillment network), I’m comfortable with Sea’s balance sheet and cash flow statement.
Leaders with skin in the game
Finally, I’m a big fan of investing in companies run by founders. With Sea, that’s the case. The company was started by Forrest Li over 10 years ago, and he is still the CEO. Insiders, including Li, own 37% of shares outstanding and 46% of the voting power.
So the people running Sea Limited will be rewarded when we shareholders are rewarded, and punished along with us when the stock falls. Over the long run, I like knowing that our incentives are aligned.
Given all this gushing, you might think I plan to…
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