Sea Limited (NYSE:SE) stock highlights one of the biggest divergences in the market right now. Despite what some investors think, SE stock is a buy.
There are quite a few investors who believe that stocks are in a bubble, or something close. Of late, that sentiment has gained some traction. While major indices have held up, we’ve seen big-time pullbacks in a number of growth names. SE stock hasn’t been an exception. It’s now down some 17% from all-time highs reached just last month.
Skeptics believe that decline — and others like it — are just the beginning. After all, Sea Limited remains unprofitable. In fact, Wall Street consensus doesn’t foresee positive earnings until 2023. Yet, almost incredibly, Sea has managed a market capitalization of some $120.8 billion.
To some investors, that’s the end of the story. A $120 billion valuation assigned to an unprofitable company means a bubble. It’s as simple as that.
But of course, it’s not actually that simple. Good investors and in particular good growth investors should be looking forward. SE is not valued just on its 2021 or 2023 results, but for the entirety of its future.
And the fact is that Sea’s future is bright. Now, growth investors have a chance to be part of that future at a nicely cheaper price.
SE Stock and the Three-Legged Stool
Let’s not pretend: $120 billion is an extremely healthy valuation. But for that valuation, investors are getting not one, but three attractive growth stories.
For example, Sea Limited owns game developer Garena, which constitutes its Digital Entertainment segment. That segment drove about 46% of revenue in 2020 (Page 2).
It’s a great business that’s growing at an impressive clip. Revenue in 2020 increased 77.5% year-over-year (YOY). Active users in the fourth quarter were up 72%. Even better, the base of paying users more than doubled. In Q4 2019, only about 9% of active users were paying. By the most recent quarter, the proportion was 12%.
Garena dominates markets in Asia and Latin America. Globally, the big driver has been Free Fire, the most-downloaded game in the world for this past year, according to figures cited by Sea.
But Sea isn’t just a gaming company anymore. Now, its Shopee e-commerce platform operates in similar markets. Sea’s e-commerce segment saw revenue of $2.2 billion, an incredible 160% increase in 2020.
Finally, there’s a fintech angle here, too, as Sea has developed a mobile wallet benefiting from steadily increasing adoption. Total payment volume reached $7.8 billion last year.
Alone, any one of these businesses would be dearly valued for a company. Sea has all three. It has also moved into investment management to help startups on its platforms as well as off. It’s even developing an artificial intelligence (AI) lab.
So, this simply is one of the most innovative companies in Asia. It’s not difficult to see why investors are excited, or why SE stock has risen some 1,350% since its 2017 initial public offering (IPO).
Is Sea Limited Too Expensive?
Again, though, this is an unprofitable company with a $120 billion market capitalization. So, some investors will believe that even all this good news is priced in. All in all, we need to take a closer look.
After digging, yes, on a consolidated basis, Sea Limited is unprofitable. But that’s largely because of the substantial investments being made in its growth.
In 2020, for instance, the company’s Digital Entertainment segment posted adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) of $2 billion. The rest of Sea Limited lost nearly $1.9 billion on the same basis.
However, the rest of Sea isn’t in the red because those businesses aren’t attractive, or aren’t valuable. They’re in the red because Sea is spending to build out fintech and to build out AI.
These investments seem like they will pay off, given the current trajectories of those businesses. Meanwhile, there’s a case that Digital Entertainment on its own would easily be a $60 billion business. That 30x EBITDA for a business growing the top line at nearly 80% hardly seems onerous.
Meanwhile, Shopee’s 2020 revenue was roughly three-quarters of Shopify’s (NYSE:SHOP) $2.9 billion in 2020 revenue. Shopify currently has a market capitalization above $141 billion. The two businesses aren’t quite apples-to-apples, but it’s not hard to argue that a standalone Shopee would also be worth tens of billions of dollars.
Add in the other opportunities and it’s not difficult to argue that SE stock is undervalued fundamentally. So, this is not a case of the market blindly paying up for revenue growth.
Taking the Long View
To be clear, SE stock does have some risk. The pullback in the last few weeks shows that investors may have to ride out some volatility. There’s going to be no shortage of competition for its mobile wallet and the AI efforts. Plus, while its gaming business has impressed, it only takes one miss to make that segment look less attractive.
But the rewards here are huge. It’s not just that Sea Limited has three businesses (at least). It’s that all of these efforts are able to complement one another. The mobile wallet works with both the gaming and the e-commerce businesses. So, Sea can profit by investing in companies that improve its ecosystems. On top of that, the company’s impressive track record of innovation suggests that management will find more opportunities for growth going forward.
Those opportunities aren’t visible in the company’s 2020 or 2021 numbers. But that’s fine. In fact, that creates the opportunity.
Some investors look quickly at the headline numbers and the market cap and move on. They shouldn’t. There are plenty of reasons why Sea Limited should have a market cap over $100 billion and why investors should expect upside from here.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.