I think SE presents a compelling risk/reward opportunity today if one is willing to take a 5 years view (but then again, that is the case with many stocks today). This remains the case even when assumptions are conservative. However, given people’s tendency to over-extrapolate, SE could see near-term downside - flows still trump fundamentals in the short term and the stock could collapse if the company misses expectations.
The purpose of this post is to brainstorm what I think are several risks to the asset and to gather community feedback. I fail to see the value in writing another SE bull case post.
My questions are bolded below.
Let’s start with Garena.
My key concern with this asset is that it’s impossible to know if this will wind up being a Fortnite 2.0. As a reminder, Fortnite’s earnings declined 80% in 2 years (until Covid bailed them out) after peaking in 2018. The gameplay is very similar and the buying psychology and behavior are also similar.
On top of the natural boom/bust nature of gaming, we have the issue that Garena is coming off a Covid peak. How might we size the risk from a double whammy effect of lapping Covid and the commencement of the “bust” part of the earnings cycle?
We are already starting to see this with management guiding bookings to $3 billion in 2022. Garena generated $4.6 billion of bookings in 2021 and made $2.8 billion of profit, at a cost of $1.8 billion. How much of this cost will stick as bookings decline? As a reminder, Garena cost did not decline in 4Q21 even as bookings declined. It might even go up as Garena invests in attempts to offset the decline of Free Fire? If costs don’t decline, this implies an EBITDA of $1.2 billion or a decline of nearly 60%!
How much conviction do we have that bookings will not continue to decline after 2022? The 2022 guide was for the full year so the business might be exiting 2022 at a run rate lower than $3 billion.
How might inflation kill the emerging market (EM) consumer, especially the young EM consumer?
How do people get comfortable with the TAM? I understand that the market is big and investors like to quote eCommerce spend as a share of retail spend. However, groceries account for more than half of retail spend, and this is something SE would likely have trouble capturing without aggressive investment into logistics. My back of the envelope calculation suggests that the share of verticals that SE focuses on hovers slightly above 30% exiting 2021, yet people are guiding to 40% by 2022. Will expansion into new verticals like groceries and food delivery be necessary to keep the growth going? Even before that, would this foray be sufficient to offset growth deceleration as legacy verticals begin to see saturation?
How do people get comfortable with disaggregating SE growth between what is structural and what is Covid? How do people get confidence that the guide (which I think implies 40% GMV growth) is achievable? 2021 saw the benefit of Covid AND share gain AND incremental penetration, resulting in Shopee gaining $27 billion of GMV. Looks like management is guiding to $27 billion of additional GMV again despite Covid turning from a tailwind to a headwind and lower incremental share gain as SE is already 60% of the market. How is that achievable and what does management see that we don’t that gives the confidence in that forecast?
It seems to me that many have done a top-down build to forecast SE. But does that top-down build accurately capture the effects of Covid on the business? Covid was truly transformational in how people spent their money, especially in South East Asia. It shifted budgets to eCommerce in a major way as there was little else for people to spend on. How would eCommerce spend be affected when people start to budget for their travel again? That Korea or Japan or Europe trip is not going to pay for itself. I would not be surprised if discretionary budget spent on Shopee doubled during Covid and that could go all the way back. How many of Shopee purchases are really essential in nature?
What happens when consumers see rapid inflation in food and oil which represent a large percentage of their income? To what degree would they pull back on their Shopee budget, which is largely discretionary?
How much of Shopee spend was on purchases like furniture or consumer electronics which have long refresh cycles and take away from future periods?
Shopee Latam and other markets
I have frankly done very little work in this segment, but how do people get confident that this GMV are not empty calories? $2 EBITDA losses on $10 AOV is sizable. Is there enough profit pool in the system to support meaningful profitability for Shopee?
Why hasn’t MELI been more aggressive in going after Shopee? What are they saying and what are they doing? Are they just being negligent?
How would the investor base, especially the bulls, react if SE missed their guide? Will credibility be hit and how might that impact multiples?
I would love to get some thoughts . Thank you all. I am also thinking of organising a SE group chat for both bulls and bears. DM if you are interested. This is for buy-side investors as I am trying to keep the conversation focused.