Do you like Sea Limited? Here are 2 risks to know before buying
Limited sea (NYSE: SE) has been a hot stock – and for good reason.
On the one hand, the tech company has a proven track record. In just five years, it has grown from a pure gaming startup to a rising force in e-commerce, food delivery, and fintech. In addition, Sea has often exceeded expectations, thanks to its strong execution and a growing total addressable market.
The result: its shares have increased by nearly 2,000% since September 2016. Shares of Amazon, in perspective, increased by around 240% over the same period. But to maintain its momentum, Sea will need to overcome certain risks that could derail its growth trajectory.
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Sea Limited is too dependent on Garena
Many tech investors may be familiar with Shopee, Sea’s rapidly growing online shopping platform. But ask them about Garena – his games company – and you might get questioning looks.
Make no mistake: it was Garena’s success that paved the way for Sea to become what she is today. The game developer and distributor is the main revenue driver for the business, generating billions of dollars in profit each year that he can use to grow his other businesses, such as Shopee and Sea Money. This momentum was clear in the last quarter, with Garena generating $ 741 million in adjusted EBITDA, while other businesses reported an EBITDA loss of $ 765 million.
Garena is one of the largest game distributors in the world with the distribution rights to top titles like Call of Duty and League of Legends in Southeast Asia. But the main driver of its performance is Free fire, a mobile game that he developed in-house. Sea does not detail user counts for individual titles, but it is likely that the majority of Garena’s quarterly active users – 725 million in Q2 – are on the platform to play. Free fire. This means that the bulk of Sea’s profit can probably be attributed to this game alone.
On the one hand, it is an impressive achievement. Garena started in 2009 as a little-known game distributor. He only released Free fire in 2017, and at the time, no one could have predicted that the title would be so successful. On the flip side, a video game serves as the foundation for its digital entertainment business – it’s a concentration risk that simply cannot be ignored.
Until there, Free fire fired on all cylinders. Its user base continues to expand, not only in Southeast Asia, but also in the United States and around the world. This fuels Garena’s ever-growing profits, but investors are counting the days to Free fire begins to lose its relevance. In the gaming world, it’s only a matter of time.
The big question is: can Garena find another hit? The company seems to be working hard to try to create one. In January 2020, it acquired the American company Phoenix Labs, the maker of Intrepid – a highly rated cross-platform game. Sea recently announced that it has expanded the Phoenix Labs team by adding new offices in Montreal and Los Angeles. But game development is notoriously difficult and expensive. If Garena fails to create a replicable title Free fire ‘s success, its future performance (and its ability to support the rest of the business) will be called into question.
Stretching too thin?
While Garena is Sea’s main profit driver, investors are most excited about Shopee.
Building on its success in Southeast Asia and Taiwan, Shopee is now targeting other equally promising markets. For example, it is growing rapidly in Latin America, where it is already one of the most popular shopping apps in Brazil. And earlier this month, Reuters reported that Shopee was planning to launch in India and Europe as well.
But while Shopee has performed well in South East Asia, there is no guarantee that it will be able to translate that experience into victories in these new regions. On the one hand, success in retailing requires a thorough understanding of local markets, which can be very different from country to country.
But even if Shopee overcomes this challenge, it could face a shortage of resources to fuel its expansion. On the one hand, it will have to compete with e-commerce giants like Amazon in a race to attract talent. And on the other hand, Garena still needs to cover the bills, which is not sustainable in the long run.
Keep in mind that Sea is expanding beyond e-commerce to adjacent markets such as food delivery and logistics. These initiatives have the potential to become important sources of income. For example, the company’s ambitions appear to be to transform Sea Money – its fintech arm – into the Ant Group of Southeast Asia. But this business, like the others, will require heavy investment to make it a profitable operation.
So far, the market has encouraged Sea’s endless drive to grow, but there is a real risk that the company will try to do too much, too quickly. This risk should be low for now as Sea still had around $ 6 billion in cash and short-term investments in the second quarter, but investors should be on the lookout for red flags on its balance sheet or in its cash flow.
The sea is not a cheap stock
Many investors believe that Sea Limited could one day be the next Amazon or Tencent. And given his impressive track record so far, he has a real chance of achieving that level of success in Southeast Asia and beyond.
However, the magnitude of this opportunity also explains why the stock is trading at a nosebleed valuation of 25 times sales. This is an incredibly high bar to meet, and investors should carefully consider the risks the company faces before rushing into this growth stock.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of the board of directors of The Motley Fool. Lawrence Nga does not have a position in any of the titles mentioned. The Motley Fool owns shares and recommends Amazon, Sea Limited and Tencent Holdings. The Motley Fool recommends the following options: January 2022 long calls at $ 1,920 on Amazon and January 2022 short calls at $ 1,940 on Amazon. The Motley Fool has a disclosure policy.
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