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Company managers announced Friday the firm it had been awarded a full digital bank license in Singapore, a first for that country. It’s a big step toward digitalization and further growth.
Unfortunately its business structure and regional fragmentation appear to be fatal flaws.
On paper Sea Limited has everything momentum investors are looking for. It operates in three fast growing sectors and has become the dominant player in Southeast Asia, a market of 670 million people. Tencent, a leading Chinese internet company, owns almost 20% of Sea shares after taking a 3.3 million share stake in 2017. And managers have laid out an ambitious plan to grow the business.
Forest Li, chief executive officer told Nikkei Asia in October that he saw the business growing into the equivalent of Alibaba, Ant Group and Tencent Holdings in the region. Investors have bought in all the way to the ecommerce/payments/online games comparison.
Yet Sea’s businesses -- Shoppee, Sea Pay and Garena --- don’t hold up to close scrutiny.
Shoppee began operations in 2015. The ecommerce platform has never been close to profitability. That might have something to do with the logistics of delivering packages to countries separated by bodies of water. By contrast, Alibaba ( (BABA) - Get Report) was profitable only three years after it was founded in 1999.
Sea Pay is another money loser. The business is plagued by the diversity of cultures, currencies and bureaucracies in Southeast Asia. Scaling the business does not reduce costs. It means more expenses to replicate country specific infrastructure. Managers at Ant Group are only active in China, a mostly homogenous country with one currency and a single state government.
Even Garena’s business is problematic. Although the online game unit has made money since it was founded in 2009, 80% of revenues come from titles licensed from other publishers.
These structural issues are Sea’s biggest flaw. And it is fatal.
Despite its corporate roots in Singapore, Sea’s complicated corporate structure is based on variable interest entities, a conglomerate structure practiced by many Chinese firms. VIEs are essentially an accounting loophole to allow corporations registered in the Cayman Islands to move profits and losses between various shell companies.
If VIE seems vaguely familiar it might because the instruments gained attention during the Enron accounting scandal. The energy trading company used Cayman Island VIEs to legally hide losses. Eventually the financial accounting standards board closed the loopholes, but not before Enron investors lost everything.
The regulatory risk for Chinese companies is real, especially as global trade tensions grow and American policymakers take a harder look at Chinese accounting.
For now investors are looking past potential red flags.
The award of a digital bank license from the Monetary Authority of Singapore is a big credibility boost for Sea Pay. It’s an attribute Li was quick to play up last week, according to a press release posted at in the Wall Street Journal.
Shares trade at 25.5x sales and a 129.7x book value. The heady numbers are the result of a huge 394% rally in 2020 as the pandemic goosed online games, shopping and payments.
The company reported in August that second quarter sales rose to $882 million, up 102% year-over-year. Despite the gains, the company still managed to lose money as sales and marketing expenses shot up 95% to $383 million.
Investors should also be aware Sea is now facing headwinds to growth.
The pandemic is under control in many parts of Southeast Asia. Singapore listed 13 cases Monday. Vietnam posted only 1 new infection.
As economies in Southeast Asia return to normal, sales growth at Sea is virtually certain to slow. That would be an extremely negative development for shareholders.
Investors should not buy shares at current levels. Shareholders should reduce longer-term exposure.
Now trading at $187, the stock would be more palatable in the $140 range.