Vantage Point: Following Q4 profit, Sea Ltd deserves to trade at a premium to peers

Vantage Point: Following Q4 profit, Sea Ltd deserves to trade at a premium to peers

This weekly newsletter chronicles top digital themes and trends playing out in SE Asia, especially Indonesia. We will decode policy and regulatory changes affecting digital economy sectors, crunch earnings data of top players, track developments related to gig economy workers and attempt to piece together ecosystem buildouts in some of the fastest-growing, venture-backed plays. You can access the previous editions of the Vantage Point weekly posts here.

Executive Summary

  • Sea Ltd’s Q4 profit justifies its premium share price
  • GoTo pushing the right buttons
  • Digital banks must watch out for P2P lenders

Sea Ltd’s Q4 profit justifies its premium share price

Even as its peers are still painting a picture of near-term profitability, citing improving contribution margins and adjusted EBITDA, Southeast Asian tech giant Sea Ltd last week blindsided analysts by posting an actual net profit, and a very significant one, of $422.8 million for the fourth quarter of 2022.

This was not driven by accounting wizardry or one-offs but by a more than 61% cut in sales and marketing spending together with a whole host of cost savings in the three-month period.

Sea Ltd also booked a positive adjusted EBITDA of $495.7 million in Q4 2022 versus a $492.1 million adjusted EBITDA loss in Q4 2021. 

To be sure, there was a negative impairment of goodwill of $177.7 million and a $199.7 million gain on the extinguishment of debt and a $130 million reversal of previous accruals for certain expenses but this can be seen as part of a longer-term, cost-cutting strategy.

The quarterly net profit came more than a year ahead of analyst expectations. This underscores the management’s ability to rapidly pivot its focus to sustainable and profitable growth in a short period.

The management stressed that the turnaround was achieved through a collective effort as it shifted its attention to key focus areas and axed, or deprioritised, non-core businesses.

The other key highlight from the results was the fact that despite a massive cut in sales and marketing costs, Sea Ltd managed to grow its gross merchandise value (GMV) and sales by 8% YoY. At the same time, the company also made it clear that it now only looks at GMV as an output and not a key performance indicator (KPI).

Talking too much about GMV falling short of expectations is missing the point, as that had already been flagged in Q3 2021, with more meaningful measures of performance now coming to the fore and likely to remain so for the coming quarters.

Sea also generated $320 million in cash from operations in Q4 2022, underlining the strength of the company’s pivot.

Excluding its repurchase of convertible bonds of $817.2 million during Q4 2022, the company managed to increase its cash liquidity position quarter-on-quarter by $209.8 million, despite the headline number of $6.9 billion reflecting a decline in cash, cash equivalents, and short-term investments of $401.6 million.

Shopee: Sea’s e-commerce division Shopee saw its adjusted EBITDA turn positive in Q4 2022 to reach $196.1 million versus a loss of $877.7 million in Q4 2021, representing over $1 billion turnaround, with only a one-off positive of around $80 million during the period.

Sea Ltd management underlined the fact that all of Shopee’s core Asian markets were adjusted EBITDA positive in Q4 versus only two in Q3 2022, with Q4 2022 adjusted EBITDA booked at $4,320 million.

Brazil saw a dramatic improvement in its unit economics, with the contribution margin loss per order improving 53.9% YoY to $0.47. Management underlined the huge potential for Brazil, where the market takes rates can be as high as 20%.

Digital entertainment: The digital entertainment (DE) segment did not go into terminal decline that some analysts predicted but showed strong signs of stabilisation, with GAAP revenue increasing 6.3% QoQ.

Digital entertainment bookings declined to $543.6 million in Q4 2022 versus $664.7 million in the previous quarter, and adjusted EBITDA stood at $258.2 million in Q4 2022 versus 289.9 million in Q3 2022. However, adjusted EBITDA accounted for 47.5% of bookings for Q4 2022, an improvement from 43.6% in the previous quarter suggesting a stabilisation of this segment.

The quarterly active users were still high at 485.5 million in Q4 2022 versus 568.2 million for the previous quarter, but with quarterly paying users at 43.6 million, representing a paying user ratio of 9% versus 9.1% the previous quarter, a marginal decline.

The average bookings per user in the DE segment were $1.10 in Q4 2022 versus $1.20 in Q3 2022, representing some moderation but the company is focused on stabilising and solidifying its core games and communities, with Free Fire being the key focus. The message was to do less but to do it better. 

Digital Financial Services: Sea Ltd’s Digital Financial Services segment booked a strong performance in Q4 2022 with GAAP revenues increasing 92.5% YoY to $380.2 million, with adjusted EBITDA also turning positive at $75.6 million in Q4 2022 versus a loss of $149.8 million in Q4 2021. The company had a total loan at the end of Q4 2022 of $2.1 billion, net of the allowance for credit losses of $238 million.

The loan portfolio actually declined QoQ which underlines the company’s focus on quality versus quantity for its loan book. Its NPLs declined to less than 2% in Q4 2022, mainly due to the shortening of the write-off period in certain markets from 180 days to 120 days in Q4 2022. Without this change in the write-off period, the ratio would be around 5%.

The transformational metric for Sea Ltd in Q4 2022 was the dramatic decrease in sales and marketing expenses, which fell by 61.2% YoY to $473.6 million, coming from reductions in all segments, with digital entertainment seeing a 60.5% reduction YoY, e-commerce by 54.9% YoY, and Digital Financial Services by 86.9% YoY.

These reductions came from the company’s focus on optimising operating costs and achieving higher cost efficiencies. There has been some impact on growth from this reduction but this has been more than compensated for improving take rates and lower costs. 

Sea Ltd remains positive in the long term, underlining the low e-commerce penetration rates and highly favourable demographics in its core markets. The company will have to keep booking profits but it has proved its worth beyond most people’s expectations, which means it deserves to trade at a premium valuation to peers.

GoTo pushing the right buttons

GoTo continues to push its narrative around “building an enduring, and profitable company”, and has been conducting extensive ongoing reviews of each business area. 

To achieve this, GoTo is looking at the following steps:-

  • Consolidation of certain businesses and teams across the GoTo ecosystem.
  • Scaling down of businesses and projects deemed to be non-core. For example, winding down certain parts of its Mitra Tokopedia business. 
  • Restructuring recruitment functions and reducing hiring needs. 
  • Using technology to accelerate the speed of execution

Last Friday, GoTo announced the layoff of 600 employees following streamlining measures. In November last year, GoTo let go of 12% of the workforce, or 1,300 people.

Given the backdrop of a tech winter and a market-wide switch toward a focus on profits versus market share and headline growth, it should come as no surprise that the company is pushing through with further headcount cuts. 

GoTo is also a relatively new entity and that means there is still significant room to realise synergies and cost savings. The pullback in the availability of funding has undoubtedly forced the company to move more quickly in that direction.

The restructuring at GoTo can be seen as a long-term move where the savings are not one-off but go towards building a more sustainable cost base.

GoTo remains less well-positioned versus its peers in terms of funding with around $1.9 billion in liquid funds at the end of Q3 2022 and last year’s cost-reduction efforts together with the latest announcement should help to at least to extend the company’s runway before it needs new funding. 

Sea Ltd holds $6.9 billion in cash, and cash equivalents and it has also just turned a profit. Grab Holdings has $5.1 billion in liquid funds while Bukalapak has a 15-year runway and Blibli recently made its market debut.

GoTo has certainly been making more effort to communicate with the market, recently announcing that it would further accelerate its path to profitability, as well as giving some basic operational numbers before results, which are not due out until March 20. 

Its Q4 2022 and FY 2022 results may reflect some of the early attempts to cut costs but the real impact should start to become apparent from Q1 2023 with more clarity on the company’s headquarter costs. 

Digital banks must watch out for P2P lenders

Indonesian digital banks are largely yet to be tested for their risk management skills as most of their lending to date has been in the form of channelling, with a substantial portion of this to P2P lenders and more recently Pay Later. This has provided them with a relatively rich seam of business given the high spreads they charge.

Recent evidence suggests that the P2P industry has been facing increased headwinds from rising non-performing loans (NPLs) as inflationary conditions and an uncertain macroeconomic situation put pressure on small-sized borrowers.  

There are currently 102 P2P platforms registered and licensed with the OJK in Indonesia, with at least 21 (nearly one-fifth) having a TKB90 rate below the national average. The TKB90 rate measures loans settled successfully within 90 days of their due date, with the average currently sitting at 97.22%. 

There are a number of fairly well-known names that fall into this below-average category, including Modalku at 92.87%, Findaya-powered GoTo’s GoPayLater and GoModal at 89.39%, and Oiente and Sinar Mas-backed Finmas at 90.1%.  

The worst-performing segment in this case is agritech, with well-documented problems at TaniFund which has a TKB90 of 36.07% and LinkAja-backed iGrow 72.04%. The former’s troubles seem to stem from fraudulent actors using farmers’ identities to obtain loans but underlines the potential level of problematic loans. 

Even well-established player Investree had a below-average TKB90 of 95.99%, having deteriorated in Q2 and Q3 last year as inflationary pressures put MSMEs and individual borrowers in a spot. 

NPLs of major digital banks, however, remain under control, with Bank Jago at only 2.1% and Bank Neo Commerce at 1.9% as of 9M 2022. Any signs of deterioration in loan quality should be scrutinised given the signs that have been appearing among P2P lenders and given the nature of those borrowers. 

The digital banks are making supernormal spreads from these third-party loan partnerships but there is a good reason for this as risks need to be priced into the equation. 

The absolute number of NPLs has increased rapidly towards the end of the year, according to OJK fintech lending statistics which show that NPLs of over 90 days reached 1.4 trillion rupiah in December 2022, more than double of the previous year. 

The longer-term trend is likely to involve a good deal of disintermediation by digital banks as they go direct to borrowers. It is likely that there will still be room for P2P lenders, which are prepared for higher levels of risk on their books but may find it harder to get funding in the future as digital banks gear up to get into direct lending.

Angus Mackintosh, a consulting editor with DealStreetAsia, is responsible for the publication’s Southeast Asia digital economy weekly newsletter and its monthly research reports. Angus is also the founder of CrossASEAN Research and publishes on Smartkarma.

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