Since the lows in November, Sea Limited’s (NYSE: SE) share price has more than doubled from $40.66 to $88.07 at the close before its 1Q23 earnings was released.
This is quite remarkable considering less than a year ago, Sea’s cash burn pulled the company’s sustainability into question.
In September 2022, the company announced significant cost cutting measures and its CEO and top management would not take any cash compensation until the company reached self-sufficiency. Perks were significantly reduced, business class flights were banned, hotel and meal expenses were capped and anecdotes indicated that toilet paper in restrooms was reduced to one-ply.
Since then, the efforts have paid off, delivering strong 4Q22 results to closeout FY22 with revenue and earnings beating expectations. Sea continued on a positive note, maintaining profitability in 1Q23, albeit in a weaker fashion.
In our previous writeup, we said:
“Some of us may get the feeling that Sea has exhaust all avenues in cost cutting and are not sure if the company can grow with the current cost baseline.
Time will tell if Sea is on the right track and able to continue on its path of sustainable growth, generating profits for its shareholders.”
1Q23’s results places our concern into the forefront.
SEA 1Q23 financial results
| P&L in US’m | Mar’23 | Dec’22 | Sept’22 | Jun’22 | Mar’22 | QoQ Variance (%) | YoY Variance (%) |
| EPS in US’$ | 1Q23 | 4Q22 | 3Q22 | 2Q22 | 1Q22 | 1Q23 vs 4Q22 | 1Q23 vs 1Q22 |
| Digital Entertainment revenue | 540 | 949 | 893 | 900 | 1,135 | (43%) | (52%) |
| E-commerce and other services revenue | 2,260 | 2,231 | 1,977 | 1,756 | 1,500 | 1% | 51% |
| Sales of goods | 242 | 272 | 286 | 287 | 265 | (11%) | (9%) |
| Total revenue | 3,042 | 3,452 | 3,156 | 2,943 | 2,900 | (12%) | 5% |
| Net income/(loss) | 87 | 423 | (569) | (931) | (580) | (79%) | N.M. |
| EPS/(Loss per share) | 0.16 | 0.77 | (1.01) | (1.68) | (1.04) | (79%) | N.M. |
| Adjusted EBITDA for Digital entertainment | 230 | 258 | 290 | 334 | 461 | (11%) | (50%) |
| Adjusted EBITDA for E-commerce | 208 | 196 | (496) | (648) | (743) | 6% | N.M. |
| Adjusted EBITDA for Digital financial services | 99 | 76 | (68) | (112) | (125) | 30% | N.M. |
| Adjusted EBITDA for Other services | (22) | (25) | (77) | (73) | (65) | (12%) | 66% |
Looking at SEA’s financial results;
- total revenue declined by 12% on a QoQ basis mainly due to the drag from the Digital entertainment segment as revenue plunged 43% QoQ.
- The E-commerce segment held its ground with a 1% growth QoQ.
- Net income declined QoQ from $423 million to $87 million.
- Adjusted EBITDA was a notch higher at $507 million in 1Q23 as compared to $496 million in 4Q22.
What does this all mean for SEA Limited going forward?
1) Strong E-commerce performance is even stronger
Market place revenue from e-commerce grew 46% YoY from $1.3 billion to $1.8 billion and was flat QoQ.
Similarly, YoY Adjusted EBITDA delivered strong turnaround.
Looking at its QoQ performance, despite the flat revenue, Shopee’s Asia markets adjusted EBITDA declined from $320 million in 4Q22 to $276 million in 1Q23. Its other markets improved from a loss of $124 million to a loss of $68 million, hence contributing to an overall gain of $11 million, underpinned by continued improvements in its Brazil market.
As there were $80 million of accruals embedded in 4Q22’s results, 1Q23’s results actually improved by a noteworthy $91 million!
Sea has attributed the better performance to improved monetisation and a focus on operating processes, especially its logistics capabilities. By working with its delivery provider, Sea was able to improve average delivery time by more than half a day. Sea has also worked to improve its first and last mile hub.
Investors should note that Sea has not disclosed its gross orders and GMV data which could indicate that these metrics have not done as well.
2) Cash balance continues to increase
This is the second quarter in a row where Sea has achieved operational cash self-sufficiency with $0.3 billion generated for 1Q23, a notch above 4Q22’s.
Note: 4Q22’s decline from 3Q22 was because Sea repurchased some of its outstanding convertible bonds, otherwise it would have seen its cash position increase by $0.2 billion.
3) Sea tightens its belt even further
In 1Q23, Sea was able to continue reducing its cost of revenue, sales & marketing expenses as well as General & Administrative Expenses as compared to 4Q22 and 1Q22. It also reduced its R&D expenses as compared to 1Q22 with the only significant increase to expense being its provision for credit losses.
Reduction in cost of revenue was supported by a continued improvement in gross margins in the E-commerce segment from 43% in 4Q22 to 46% in 1Q23, a good example of what operating leverage can do. Digital Entertainment’s gross margin declined from 74% in 4Q22 to 68% in 1Q23, also a good example of what a lack of operating leverage can do.
Sales & marketing expenses declined 60% YoY and 16% QoQ as Sea continued cost cutting in all 3 of its major segments in an attempt to further optimise operating costs.
4) Consistent growth trajectory in Digital Financial services marred by higher credit allowances
Revenue for the Digital Financial Services segment increased by $33 million QoQ from $380 million to $413 million.
However, allowance for credit losses increased $42 million, from $239 million to $281 million.
5) The worst of its lot – Digital Entertainment is still declining
Revenue plunged 43% QoQ from $950 million to $540 million. Bookings continued declining, down 15% QoQ and 44% YoY.
Although quarterly active users increased 1%, stemming multiple quarters of decline, it seems like Sea has still lost more then it gained as quarterly paying users ratio plunged to 7.7%.
This means that in the previous quarter, there were 43.7 million paying users while this quarter there were 37.9 million paying users, a 5.8 million decline or 13% decline. As revenue declined much more, this indicates that paying users are also spending less in game.
While there are new games in the pipeline such as Black Clover – Rise of the Wizard King, investors will do well to expecting the continued decline in this segment without any new blockbuster games.
It is only the beginning for SEA
Some may take the perspective that the one-ply toilet paper in Sea’s restrooms was the key to success as it demonstrated the single-minded focus on profits and the mindset to achieve its goals.
Sea’s pivot to focus on sustainable growth, efficiency and profitability has shown in its bottom line, maintaining positive net income for the second quarter in a row.
CEO Forrest Li has said that he continues to remain highly confident in the long term opportunities in the markets which Sea operates in and the company’s ability to capture those opportunities profitably.
After the results were released during premarket hours, the stock went down 10%. It is clear that the market is looking for more from Sea.
Turning profitable was the first step, Sea now has to deliver on stronger sustainable growth and higher profits. More importantly, with the Digital Entertainment segment handicapping the overall performance, Sea has to fix this segment to keep its flywheel of Garena, Shopee and SeaMoney going.
