SEA: Southeast Asia's Little Tencent Completely 'Takes Off'?

The Southeast Asian Little Tencent $Sea(SE.US) delivered another very strong second-quarter report before the U.S. stock market opened on the evening of August 12. The growth of core indicators under its two main segments—GMV and loan balance—far exceeded expectations, with the growth side performing exceptionally well. However, due to a resurgence in expenses, the profit margins of various segments generally declined quarter-on-quarter this season. Yet, due to the strong growth, the final profit still beat expectations, with the positives outweighing the negatives. The key points are as follows:

1. Explosive GMV growth, the biggest highlight: The most critical indicator of the most crucial segment—Shopee GMV—saw a year-on-year increase of 28% this season, significantly accelerating by about 7 percentage points from the previous quarter. Although some Wall Street firms were already optimistic before the earnings (e.g., JP Morgan expected a growth rate of 24%), the actual performance was even stronger than the optimistic expectations. Moreover, this season's growth was entirely driven by more "healthy" order volume growth (+32% yoy), with a decline in average order value being a drag.

2. Southeast Asian e-commerce continues to improve monetization: This quarter, Shopee, Lazada, and TikTok Shop continued to work together to improve monetization rates in Southeast Asian countries. Reflected in the financial report, Shopee's platform business monetization rate reached 11.3% this season, up 0.5 percentage points year-on-year (though the rate of increase has begun to narrow).

With strong GMV growth, Shopee's revenue this season increased by 34% year-on-year, significantly accelerating quarter-on-quarter and far exceeding the market expectation of 28%.

3. Rapid market expansion, Monee also accelerates growth: The second most important financial segment's revenue this season was $880 million, a year-on-year increase of 79%, also significantly accelerating quarter-on-quarter and far exceeding market expectations.

Behind this is the total value of loan balances, both on and off the balance sheet, which saw a net increase of $1 billion this season, compared to $500 million and $700 million in the previous two quarters, showing continuous acceleration. Based on some research, Monee has largely completed its penetration of users within the Sea ecosystem and is expanding to corporate users and consumers outside the ecosystem. From this season's performance, the progress seems to be good.

4. Garena's expected cooling after the "celebration": After delivering "explosive" results last quarter with the Naruto collaboration, this season's performance of the Garena gaming segment was largely an expected cooling.

After some player sentiment was exhausted, this season's monthly active users nearly stagnated in growth quarter-on-quarter, and paying users decreased by 3 million, with the payment rate turning downward. The year-on-year increase in average payment per user also declined quarter-on-quarter from 15% to 5%.

Due to the above impacts, the year-on-year growth rate of game business revenue slowed to 23% this quarter. However, although there was a noticeable cooling compared to the previous quarter, the market had already expected that the collaboration effect would not be sustained, and the actual revenue growth of over 20% is not considered poor and slightly exceeded more conservative expectations.

5. Strong growth but profit under pressure: Summarizing the above three major segments, e-commerce and financial segments showed strong growth, and the gaming business performed better than conservative expectations. This season, Sea's overall revenue grew by 38% year-on-year to approximately $5.26 billion, also significantly accelerating quarter-on-quarter, and beating market expectations by about 4.6%.

However, as some investment banks predicted, Sea is returning to an investment expansion cycle, leading to pressure on gross and EBITDA profit margins this quarter, narrowing quarter-on-quarter.

6. E-commerce gross margin decline, possibly due to logistics impact: Firstly, in terms of gross profit, the narrowing of the e-commerce business's gross margin quarter-on-quarter (a decline of 2 percentage points) dragged down the company's overall gross margin, which slightly decreased by 0.4 percentage points from the previous quarter to 45.8%. Based on research, Dolphin believes this is due to increased investment in logistics and freight subsidies (possibly partly to counter Meli's progress in lowering the free shipping threshold). Fortunately, the gross margins of other segments continued to improve slightly.

7. Expenses return to expansion: Compared to gross profit, the impact on the expense side is more significant. This quarter, the total of four operating expenses increased by 26.5% year-on-year, significantly accelerating quarter-on-quarter, and significantly higher than the market expectation of 18%.

Specifically, marketing expenses increased by 30% year-on-year, and management expenses also increased by 37% due to bad debt provisions. This reflects the increased investment in e-commerce to optimize fulfillment timeliness and experience, as well as the increased customer acquisition costs and bad debt expenses brought by Monee's rapid growth outside the ecosystem.

8. Profit margin under pressure, but profit amount still beats: Focusing on the company's adjusted EBITDA indicator, this season's profit margin was 15.8%, narrowing by 3.6 percentage points quarter-on-quarter, and 0.1 percentage points lower than expected, clearly showing the pressure on profit margins. By segment, whether due to logistics investment impact or increased marketing expenses, the profit margins of each business segment declined across the board this season.

The most watched e-commerce business's EBITDA margin as a percentage of GMV narrowed from 0.92% to 0.76% quarter-on-quarter, underperforming the market expectation of 0.85%. This is not good news.

However, as mentioned earlier, the market had some expectations for the decline in profit margins this season. And due to the performance on the growth side far exceeding expectations, the final profit amount was still nearly 4% higher than expected.

Dolphin Research's View:

Based on the above analysis, although the increase in expenses led to pressure on profit margins, making Sea's performance this season not flawless, how the market views the "neutral" objective situation of significant expense growth often depends on the quality of business and revenue growth.

If growth is strong, the market is likely to interpret the increase in expenses as the company seeing a very optimistic demand outlook, requiring increased investment to drive business growth. Conversely, if business growth is poor, the increase in expenses would be seen as "wasteful spending" in the absence of growth.

Clearly, in the case of Sea's significant acceleration in GMV and loan balance growth in the financial business this season, the market is unlikely to overly focus on the short- to medium-term expense growth and profit margin pressure, and it can be considered a reasonable behavior.

Looking at specific businesses,

1) In the e-commerce business, according to recent sell-side research, the competitive landscape in Southeast Asia remains stable, with no parties intending to increase subsidies to capture market share. On the contrary, Shopee, Lazada, and TikTok Shop have tacitly chosen to jointly improve monetization rates, growing revenue and profit together. This means that the Southeast Asian market is likely to maintain a stable competitive environment in the foreseeable future.

In this scenario, as long as there are no black swan events that significantly impact overall consumption, Shopee, as the market leader, is likely to continue steadily increasing market share and monetization levels, maintaining an excellent performance trend.

In terms of profit, due to Meli lowering the free shipping threshold in the Brazilian market and intending to increase direct competition with Shopee, and Shopee itself intending to enhance fulfillment capabilities, the speed of profit margin improvement in the e-commerce business may indeed temporarily slow down.

However, investment in fulfillment is a short-term potential profit suppressor, but in the long term, it is an important part of establishing competitive barriers in the e-commerce business. If the pressure on profit margins is due to logistics investment rather than a decline in monetization rates, it will not be a major issue.

Considering the significant increase in order volume growth this quarter, the year-on-year decline in average order value, and the rise in the proportion of fulfillment costs, Dolphin speculates there may be two reasons: one is that the improvement in fulfillment timeliness has driven the growth of consumption scenarios such as same-day or next-day delivery. If this is the case, the growth rate of e-commerce order volume will structurally shift upward in the future.

Two, if the company has increased subsidies such as freight or product discounts, leading to the above changes, then the growth boost this season may be more temporary. Dolphin will focus on whether management explains this in the conference call and which situation is more likely.

2) In the relatively opaque financial business, according to some research, the Monee business has nearly fully penetrated Sea's own ecosystem users, and future growth will focus more on expanding to external consumers and small and micro enterprises. Although there is no clear judgment on how large Monee's long-term market space is, in Southeast Asia and Latin America, where banking services are very underdeveloped, Monee, which has just begun to expand to external users, clearly still has considerable space. Therefore, "pure" growth may not be the biggest issue.

The more likely concern is when the continuously increasing customer acquisition costs and profitability from single users will no longer be advantageous after accelerating the expansion of external users. Additionally, whether the pressure of bad debt risk management will become a bottleneck as users and scale continue to grow.

Currently, Dolphin tends to believe that Monee's profitability and market space have undoubtedly not been fully priced.

Finally, from a valuation perspective, since Sea is still in a high-growth period and has not yet reached a stable profit margin level (especially in the e-commerce segment), Dolphin believes that the best approach to valuing Sea is to use range valuation or scenario valuation. The main factors affecting valuation prediction differences are how high the stable profit margin of the e-commerce business will be and how large the financial business's space is (how long can the revenue growth rate of tens of percent be maintained).

Therefore, Dolphin adopts a scenario-based approach for Sea, providing a baseline valuation and an optimistic valuation for reference.

1) In the baseline scenario, using 2025 earnings as the basis, the gaming segment is given 13x adjusted net profit, the e-commerce segment 20x EV to EBITDA (implying a 2% EBITDA to GMV profit margin), and the financial business 18x adjusted net profit. After deducting unallocated headquarters costs (recorded at 10x in the valuation) and adding back net cash, the neutral stock price is estimated to be around $160, not much different from the pre-earnings price.

2) In the optimistic scenario, we shift the valuation basis to 2026 and raise the e-commerce business's valuation to 20x EV to EBITDA (margin rising to 2.5%), and the financial business's valuation multiple is also raised to 20x adjusted net profit. The gaming business valuation remains unchanged. In this scenario, the estimated stock price is about $210, with some room compared to the current price.

If the company's e-commerce business can continue to maintain around 20% GMV growth in the next 2-3 years while also achieving the above profit margin expectations, and the financial business continues 30%-40% revenue growth, and the gaming business does not underperform, then Sea will still have considerable upside potential.

The following is a detailed interpretation of the financial report:

I. Shopee E-commerce: GMV growth explodes again

The most important Shopee e-commerce segment showed extremely strong growth this quarter, arguably the biggest highlight of this performance. GMV reached $28.6 billion, a year-on-year increase of nearly 28%, significantly accelerating from the previous quarter. Although some sell-side analysts expected growth to accelerate this quarter (e.g., JP Morgan expected 24% growth), the actual performance was even stronger than the optimistic expectations.

Moreover, this season's strong GMV growth was entirely driven by more "healthy" order volume growth (year-on-year growth of 32%), while the average order value slightly declined (year-on-year about -3%), which may imply slightly increased discount efforts or further downward penetration of the platform's user and product structure.

In terms of revenue and monetization, recently, Shopee, including Lazada and TikTok Shop, have been rotating to improve monetization rates in multiple countries. This season, reflected in the financial report, Shopee's platform business monetization rate reached 11.3% (up 0.5 percentage points year-on-year, though the rate of increase has begun to narrow).

With strong GMV growth and a continued rise in the take rate, Shopee's revenue this season increased by 34% year-on-year, accelerating again quarter-on-quarter, and far exceeding the market expectation of a 28% year-on-year growth rate. In summary, Shopee's performance on the growth side was very strong.

II. Monee Financial Business Accelerates Expansion

The financial segment confirmed revenue of $880 million this season, a year-on-year increase of 79%, with the growth rate accelerating again, also far exceeding market expectations. The main driving force behind this is the total value of loan balances, both on and off the balance sheet, reaching $6.8 billion this season, with a net increase of $1 billion quarter-on-quarter, accelerating from the net increases of $500 million and $700 million in the previous two quarters.

It is evident that the strong revenue growth in the financial segment is driven by robust credit business. Based on some research, Monee has largely completed its penetration of users within Sea's own ecosystem and is beginning to expand to corporate users and consumers outside the ecosystem. From this season's performance, the progress in expansion seems to be good.

Moreover, as the credit business expands, the proportion of bad debts over 90 days past due continues to decline, reaching 1% this season, narrowing by 0.1 percentage points quarter-on-quarter. It is evident that the overall credit quality has not deteriorated.

However, it is also worth noting that this season's financial report confirmed bad debt provisions of $320 million, continuing to increase by 94% and 15% year-on-year and quarter-on-quarter, respectively. Although this is generally in line with the growth rate of loan balances, it is not a major issue, but it will still drag on the segment's profit margin.

III. Garena Gaming: Cooling after the Celebration

After delivering "explosive" results last quarter with the Naruto collaboration, this season's performance of the Garena gaming segment was largely an expected cooling.

In terms of underlying user data, this quarter's monthly active user growth stagnated again (a slight increase of 3 million quarter-on-quarter), and the number of paying users decreased by over 3 million, with the payment rate turning downward to 9.3%. After the surge in revenue last quarter somewhat exhausted player sentiment, this season's player activity and payment intention "expectedly" cooled.

Due to the loss of paying users, the year-on-year increase in average payment per paying user also declined from 15% last quarter to 5% this quarter. This quarter's game business revenue growth slowed to 23% year-on-year, but given the extremely high base last quarter, the market had already expected a slowdown this quarter. The actual performance was still slightly better than more conservative expectations.

In terms of non-GAAP revenue, this quarter was approximately $560 million, a year-on-year increase of 28%. Due to less deferred revenue recognition this quarter, the gap between GAAP revenue and revenue growth is not large.

IV. Increased Logistics Investment, E-commerce Gross Margin Declines Quarter-on-Quarter, Dragging Overall

Due to the two core segments, e-commerce and financial business, significantly exceeding expectations in revenue this season, Sea's overall revenue growth rate was 38% year-on-year to approximately $5.26 billion, exceeding expectations by about 4.6%.

In terms of gross profit, mainly due to the narrowing of the e-commerce business's gross margin quarter-on-quarter (platform business gross margin declined by 2 percentage points), the company's overall gross margin slightly decreased by 0.4 percentage points from the previous quarter to 45.8%. Dolphin believes this is mainly due to increased investment in logistics and freight subsidies.

However, the gross margins of the financial and gaming segments continued to improve steadily with scale effects, and from a year-on-year perspective, the overall gross margin still increased significantly by over 4 percentage points. With strong revenue growth driving, the actual gross profit amount increased by 52% year-on-year to $2.41 billion, still a strong performance.

V. Enhancing Experience, Expanding Market, Expense Growth Begins to Rise

Similar to the trend of the quarter-on-quarter decline in e-commerce gross margin, on the one hand, the e-commerce business is increasing investment in logistics capabilities to optimize fulfillment timeliness and experience; on the other hand, Monee's expansion of external customers inevitably increases customer acquisition costs. This quarter, the total of four operating expenses amounted to nearly $1.95 billion, with a significant year-on-year increase of 26.5%, also significantly higher than the market expectation of 18% expense growth.

Specifically, marketing expenses increased by 30% year-on-year, and management expenses, including bad debt provisions, also increased by 37%. In contrast, R&D expenses remained flat year-on-year, indicating that most of the company's expense expectations have shifted to marketing expenses. It is indeed evident that the company has increased spending on customer acquisition.

VI. Under Expense Expansion, Profit Margins of All Segments Narrow Quarter-on-Quarter

Although Sea's performance on the growth side was quite impressive this season, objectively speaking, due to the narrowing of the e-commerce business's gross margin and the significant rise in overall expense spending, the performance on the profit side was not as outstanding.

Focusing on the company's main adjusted EBITDA indicator, the EBITDA profit margin this season was 15.8%, narrowing by 3.6 percentage points quarter-on-quarter, and 0.1 percentage points lower than expected. Due to the growth side exceeding expectations, the actual profit amount was about $830 million, still slightly beating expectations, but the trend decreased by about $110 million quarter-on-quarter. The suppression of profit by expense expansion is still quite evident.

By segment, whether due to increased marketing expenses or logistics investment, profit margins also declined across the board.

The most watched e-commerce business's adj. EBITDA margin as a percentage of GMV narrowed from 0.92% last quarter to 0.76%, underperforming market expectations.

In the gaming segment, due to a decline in player activity this season and increased marketing expenses, the EBITDA margin as a percentage of bookings also decreased from 59% last quarter to 56% this season.

As for the financial business, due to increased bad debt provisions and customer acquisition costs for expansion outside the ecosystem, the EBITDA margin as a percentage of revenue also declined quarter-on-quarter from 30.7% to 28.9%.