Sea Limited (Sea) offers higher e-commerce growth than its peers. Combined with its businesses in gaming, FinTech and food delivery, DBS Group Research analyst Sachin Mittal has renewed faith in its growth strategy.

In a Feb 21 note, Mittal is maintaining “buy” on Nasdaq-listed Sea with a lowered target price of US$272 ($367.99), down from $278 previously. The new target price represents a 95% upside.

Sea engages in the digital entertainment, e-commerce, and digital financial service businesses primarily in seven countries across Greater Southeast Asia.

Sea offers a 54% e-commerce revenue compound annual growth rate (CAGR) over FY2021-2023, higher than any other major e-commerce player and more than double the average CAGR of 24% of its global peers, writes Mittal.

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This stems from a 38% CAGR in gross merchandise value (GMV) coupled with rising take rates.

Shopee is likely to achieve EBITDA breakeven in Southeast Asia in 2H2022, writes Mittal. “Till 3Q2020, Shopee was able to progressively reduce the EBITDA losses as a percentage of GMV, which touched a low of 3.2%.”

Mittal adds: “During late 2020, Shopee started to ramp up its Brazil operations massively. We have assumed that 3QFY2020 data mainly represents data pertaining to Southeast Asia. At this point, the overall operating expenses as a percentage of GMV was at 9.9% in Southeast Asia. We think that the take rate has to be higher than 9.9% in Southeast Asia for Shopee to breakeven in the whole region.”

Mittal hears that Shopee has been aggressively monetising the existing markets by increasing commission from sellers on the platform while lowering discounts offered to customers. This is also reflected in Shopee’s take rate of 8.6% in 3QFY2021, up 190 basis points in the last year. Shopee has also disclosed separately that it had a positive EBITDA in Taiwan and Malaysia in 1QFY2019 and 2QFY2021, respectively.

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“Based on our estimate, by 4QFY2022, Shopee’s take rate in Southeast Asia could grow by another 140 basis points, to 10.0% higher than 9.5%-10.0% opex as a percentage of GMV. We expect Shopee to generate a low single-digit EBITDA margin in FY2023, which could be deployed to fund Shopee’s expansion into new markets in Latin America and Europe,” writes Mittal.

In September, Shopee tested new shores in Poland. Then, two months later, Shopee entered the e-commerce industry in France and Spain. Before the end of November, Shopee entered the highly competitive e-commerce market in India to compete with the likes of Amazon and Flipkart.

Shopee’s entry into Argentina in January 2022 made the country the 16th region where Shopee operates.

Mobile game Free Fire Max is contributing approximately 20% of Free Fire in-app revenue with less than 10% of Free Fire total user base, notes Mittal.

Since its launch in September, Free Fire monetisation has been on a “rather solid” trajectory, writes the analyst. “Free Fire also gets a substantial portion of its revenue from ad monetisation, where Free Fire Max has a lot of room to improve. Overall, Free Fire topped in gaming downloads in 2021.”

The secret sauce? Garena has optimised its game for low-end mobile devices, designed short game missions of less than 15 minutes to fit with mobile time frames, and created a character and universe around the footballer Ronaldo.

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That said, Garena’s Free Fire has been banned in India following the removal of the application from both the Google Play Store and Apple App Store. The Free Fire application is unable to be downloaded across the popular app stores in India.

“We suspect that it could be due to its alleged affiliations with Chinese company Tencent, as India has been going after Chinese apps. In 2020, India's Ministry of Electronics and Information Technology had previously prohibited many applications owing to alleged data privacy concerns. However, the Indian Government has yet to make a statement,” writes Mittal.

India’s revenue contribution could be less than 5% of Garena revenue, adds the analyst. “In terms of monthly active users, India comprises an estimated 10%-15% of Free Fire’s global user base, but in terms of revenue, India contributes less than 5% of Garena’s global revenue of US$3.4 billion expected in 2021F, as per our estimates.”

Mittal adds: “We project stable gaming bookings over the next few years, conservatively. During 9MFY2021, gaming bookings rose 62%, led by a 43% rise in paying users to 92 milion, due to the lockdown effect favouring Battle Royale games where players operate in teams. Going forward, we project gaming bookings to remain flattish as economies reopen and virtual socialisation might be less of a virtue.”

This is already reflected in 3QFY2021, where quarterly paying users (QPUs) as a percentage of quarterly average users (QAUs) rose only 1.1% q-o-q to 93 million.

Sea is trading at enterprise value (EV) to 12-month forward revenue of 5.0x, compared to its 7.4x historical average.

Mittal’s target price is the sum of US$185 per share for e-commerce and FinTech, based on 7.4x FY2023 revenue; US$71 for gaming, down from US$83, based on 20x FY2022 earnings; and net cash position of US$10 per share.

“Even if e-commerce and FinTech are valued at $134 per share using 7.4x FY2022F revenue, gaming comes free at the current price,” Mittal adds. “Our bear-case target price is US$147 per share. Under this scenario, we assume long-term e-commerce EBITDA margins of 12% (22% under the base-case) due to an irrational competition.”

Shares in Sea closed US$5.20 down, or 4.14% lower, at US$120.52 on Feb 23.

With Shopee in 16 regions, DBS Group Research sees 95% upside for Sea

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