UOB Kay Hian analysts John Cheong, Jacquelyn Yow and Heidi Mo have initiated coverage on Sea Limited with a “hold” call and target price of US$58.77 ($79.21).
In their note, the analysts point out that Sea’s share price has recovered after its 3QFY2022 ended Sept 30 results announcement with a narrower net loss. Despite this, they remain doubtful that the company’s cost rationalising exercise could continue to improve profitability with slower growth from the digital entertainment and e-commerce segments.
They highlight headwinds for the digital entertainment segment, which is Sea’s only profitable segment. “Sea has lowered its 2022 booking guidance by 10% to US$2.6 billion-US$2.8 billion. It has faced headwinds recently, such as India banning Free Fire and Riot Games taking back distributorship from Garena, Sea’s digital entertainment arm.
“We foresee further deterioration in the segment’s revenue and profitability as users spend less time and resources on gaming and the segment focuses more on internally-developed games. Also, heavy reliance on a single game, Free Fire, is a risk to be noted. For FY2022 and FY2023, we foresee a 28% and 13% decline in the segment’s operating profit,” they add.
UOBKH is also cautious on Sea’s e-commerce segment profitability. Sea expects its e-commerce arm Shopee to reach ebitda breakeven by end-2023. However, it is cautious on the slower sales growth, weaker consumer spending power and potential loss of market share.
“Interestingly, Shopee’s sales and marketing expenses per new order surged from US$1.40 in 1QFY2020 to US$6.70 in 2QFY2022, indicating higher customer acquisition costs. We attribute the huge jump mainly to the new peripheral market expansion in Latin America,” say the analysts.
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Meanwhile, the risk of potential divestment of Sea’s stake by its second-largest shareholder Tencent — which has 18.6% shareholding — should not be taken lightly, the analysts highlight.
Garena’s earnings may also be affected if Tencent decided to distribute their games by themselves. Out of the current 15 games published by Garena, six were developed by Tencent, the analysts point out.
Moving forward, Sea’s huge amount of convertible notes due in 2025-2026 puts its financial strength at risk, say the analysts. By end-2025, Sea would have US$1.1 billion worth of convertible notes, which would be due at a convertible price of US$90.46 per share. In the following year, another US$2.9 billion would be due at the convertible price of US$477.01 per share.
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“Sea’s adjusted net cash position as of 3QFY2022 is only around US$3.1 billion, after deducting US$4.2 billion from its total cash position of US$7.3 billion. To recap, Sea’s net cash outflow for 9MFY2022 alone already reached US$3.2 billion. Even at a reduced burn rate from 2023 onwards, Sea’s financial strength is weaker than it appears,” they add.
UOBKH’s target price of US$58.77 is based on a SOTP-valuation which pegged the Garena at 8x FY2023 P/E, Shopee at 1.8x FY2023 P/S and Sea’s digital financial services segment SeaMoney at 3.5x FY2023 P/S.
Shares in Sea closed US$1.25 higher or 2.01% up on Dec 13 at US$63.52.