31 Comments
Aug 31, 2022Liked by Punch Card Investor

“Adjusted EBITDA loss per order before allocation of HQ-costs” is one of the most imaginative Non-GAAP figures that I have ever encountered. How far is the pathway to TRUE profitability after they reach breakeven on this adjusted level?

In Q4/2021 we were able to put together some pieces that could lead us closer to an answer for the above question. They reported gross orders of 2.0 bn, whereof more than 140 million were recorded in Brazil, i.e. the remainder of approximately 1,860 million were recorded majorly in the SEA/Taiwan region (ignoring minor markets like Mexico, Chile, and Colombia). Furthermore, for Q4/2021 they reported “adjusted EBITDA loss per order before HQ-costs below US$2”. Difficult to say whether it is closer to US1.99 or US$1.51. Let’s assume the middle point of US1.75 (Q1/2022 came In at US$1.52).

Q4/2021 adjusted EBITDA loss before HQ-expenses in Brazil is likely to amount to 140 million orders x US$1.75 = US$ 245 million. For the range of US$1.51-1.99, the adjusted EBITDA loss would amount to US$ 211-279 million.

In the same quarter, an adjusted EBITDA loss per order before allocation of HQ-expenses was US$0.15 for SEA/Taiwan. Multiplying this with the number of orders in this region, we come up with an adjusted EBITDA loss of around $US280 million. Interestingly, they achieve pretty much the same results both in Brazil and SEA/Taiwan, although the latter is 13x bigger than Brazil based on the number of gross orders.

Adding both, we end up with an adjusted EBITDA loss before HQ-costs of around US$490-558 million. Total adjusted EBITDA for the E-Commerce segment was negative US$878 million, which implies around US$320-403 million in HQ expenses!

In Q2/2022, the number of gross orders again amounted to around 2.0bn. If we assume the same number of orders as in Q4/2021 and adjusted EBITDA loss per order before HQ-costs of US$0.01 for SEA and US$1.42 for Brazil, we end up with an adjusted EBITDA loss before HQ in the amount of approximately US$106 million for both markets combined. As the total adjusted EBITDA was negative US$648 million, we can assume HQ costs in Q2/2022 of around US$542, an increase of 35-70 % compared to Q4/2021. This is mainly driven by the increase in other opex (R&D and G&A) in the E-Commerce segment which increased by around US$145 million compared to Q4/2021 according to my calculations.

The largest driver for breakeven on segment level is of course SEA/Taiwan. Assuming a steady-state for Brazil and HQ costs and the number of orders in both regions, adjusted EBITDA PROFIT per order before HQ costs need to come in at around US$ 542 million / 1,800 million orders = US$0.30 to breakeven on the segment level. The actual number would be lower when they bring down HQ costs and the negative EBITDA-impact from Brazil, i.e. increasing the number of orders disproportionately to the decline in loss per order in Brazil.

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Thanks Alex for this comprehensive comment. Think you completely hit the nail on the head. I was doing the same exercise for Q4 (before they stopped reporting the actual order numbers for Brazil) and got to the same conclusion around massive HQ costs, which have only been increasing since. This is why I've stopped bothering with this adj. ebitda ex HQ cost crap and just decided to take the entire bottom line and cashflow through the DCF. It's the only thing that matters at the end of the day. Besides, they could be shifting and allocating costs between categories, segments, regions, etc in any way possible and you would just have no idea. For example if they declare that they've reached EBITDA POST-HQ for SEA region breakeven next year (as per their guidance), but ofcourse the business will probably still be running huge losses, could that mean they were just allocating costs to international operations or something else? Maybe I'm a bit skeptical but in this sort of climate I feel like these are valid questions to ask.

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This is what also derived, that they need 2-3% uptake in take rates via commissions or advertising or cutting promos etc. or about 0.30 per order more overall

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They will prob be optimising all of these levers. Apparently the company has mentioned to analysts separately that they think they can reach double digit take rates in SEA, so that would imply 2-3% increase from today's levels, most of which should be high margin commissions/advertising which should fall to the bottom line. Plus continued reduction in logistics costs with scale and continue pairing back vouchers like they have been doing. Anyway that's the vision. Let's hope they can get there.

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It will be interesting to analyze how they can do this 0.30 more - commissions or advertising or cutting discounts or charging for shipping in Brazil/SEA etc.

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Aug 31, 2022Liked by Punch Card Investor

I think you tackled the decisive points phenomenally.

A lot of Sea investors have been feeling pain lately and clearly we had to adjust our investment thesis. It is much appreciated, that you tackle this directly with your well researched post and valuation.

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Thanks Konstantin! appreciate the feedback as always.

Agree some adjustment of the investment thesis although not majorly, id say the longer term thesis for Shopee and SM are intact. For me its just more the concern around how the costs and cashburn are running uncomfortably high, which is why i feel like the valuation methodology needs to account for this. Can't just simply look at revenue multiples and comps anymore

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Same here, longterm the company still has a huge potential given the convergence of positive macro trends in this region (demograpics, gdp growth, digitalisation).

In addition apart from the absolute performance of the company, one has to consider how well they are positioned relative to their competition. If you look at the financials of Grab (negative gross margin) and Go To (-USD 2bn LTM EBITDA), I see them taking way more pain. Sea could come out of this tough period with an even stronger market position, than they currently have. The need for cost discipline might even be beneficial in the long run.

Would also be interesting to hear your thoughts on the following two developments for Shopee:

-Shein: How do you think that the metriotic rise of the chinese ultra-fast-fashion company Shein has impacted Shopee? It seems that there is a lot of overlap in their main targeted audience (young women).

-Transport costs: How large do you think is the impact of rising transport costs, given the rise in oil prices. I imagine, that wages should not be a problem in their regions.

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Agree they seem to be better positioned than Grab and GoTo. There's probably a bigger question whether anyone can actually make money in this region given we are dealing with such low AOVs etc, you need mass scale to reduce unit costs far enough to become profitable, which is what everyone's been trying to pursue to date. Now everyone seems to be trying to lift prices in unison to reach breakeven. I'm encouraged by the cost cutting as well as i hope it instills a more disciplines and efficiency-oriented mindset going forward.

Re Shein, it's definitely a risk, same with TikTok, that's why i assumed Shopee loses some market share going forward.

Transport costs - i think Q2 would have been the peak of the oil price impact as its receding now, but still Shopee is providing significantly less free shipping and increasingly charging delivery fees, so i think thats how they are managing that.

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Aug 31, 2022Liked by Punch Card Investor

Shopee needs another 2 to 3% uptake in take rates via commissions or advertising or slashing promo discounts (S&M) to make Shopee bottomline turn the corner.

I tend to be optimistic (I need a sanity check for being so optimistic all the time) that they can tweak the model without sacrificing growth too much and optimize the bottomline!

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Aug 31, 2022Liked by Punch Card Investor

What were the hurdles to releasing Undawn? Mgmt seemed confident to meeting 2022 Garena guidance (unless they may end up shooting it down in Nov)!!

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Yea it seems like they are still on track to hit their guidance unless there is a rapid deterioration in the next few months.

Re Undawn, not too sure, theres been no information on it at all although the social media channels are still pretty actively promoting the game. I think I may have heard somewhere something about them waiting for China approval first, so maybe Tencent wants to release it there first before Garena distributes it in SEA? no idea to be honest

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Fair credit for tackling this beast again! For me I’ll always be a happy spectator, but it’s certainly an interesting to watch at least. Never a dull moment.

Sea Limited Podcast revisited? 🥹👉👈

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im like a hopeless addict, i should seriously probably get myself checked.

Wait the podcast is still going?? haha yes would be fun. better yet - can you do a youtube vid on it!

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🤣🤣

That’s a yes to both ! And of course I can 💪

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Aug 30, 2022Liked by Punch Card Investor

Fantastic analysis as always! Great and timely piece.

Do you have any thoughts on how asset securitisation would work, and it's impact on Sea's balance sheet, cash flows, and ability to leverage up its loan book?

I'm not familiar with the accounting nor the regulations to make a good judgement on this front.

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Thanks Michael! If they were to securitise the loans then they would completely come off their books, as it's essentially selling the loans to another party. They wouldn't earn as much revenue on those as a result - i've assumed it's just a small commission on the loan amount., vs. like the 30% interest rate they earn on their loan book today. But in turn it's a lot more scalable as they could originate more loans without the balance sheet constraints. Trade offs. Maybe over time they can move more to that model though as they build up their risk rating algorithms and loan origination credibility

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Aug 30, 2022Liked by Punch Card Investor

Thank you! Yes this makes a lot of sense. Thus far the publicly reported NPLs and credit costs seem quite well contained but Sea may need a longer track record. Not sure how regulation and their bank licenses could factor in this regard too.

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Another year, another 50% drawdown. Glad I read your notes in 2021 and decided to short this stock.

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Ironically the current earnings trajectory of the business (consensus of close to $4bn EBITDA in '25) is far exceeding my forecasts here. So the business is on a much more sure footing now than a year or two ago when there were big questions around liquidity and could it ever be profitable. But the whiplash that this has caused investors is clearly too much, and it's just unclear who the buyer universe is - growth guys are all out probably, but neither is this value investor territory given the reinvestment mode announced yesterday, so it's kinda in no-mans land. Tough game. Anyway i'm just a retail degen shooting the shit. Congrats on the short

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top notch analysis. thanks

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the 100-150$ are assumed for 2033 or for 2025?

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That’s the value today assuming a 12% discount rate and my forecasts out to 2033. So to figure out the price in the future you could roughly take this price and compound it at 12%.

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Fantastic stuff, sharing this on Sunday.

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Thanks Conor - appreciate the support as always 🙏🙏

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Is it reasonable to think Capex will go to 3% of sales? It has been hovering around 8% for some years. Were capex to stay at 8%, the perpetuity value would be 23% lower. More work there is needed, specially to understand how much of the take-rate expansion comes from logistics (Mercado Livre story includes tons of take-rate expansion through logistics). I could envision a world were competitive pressures forces Shopee to be more asset heavy. The disclosures with EBITDA as a main metric are quite weird for a retailer (BABA uses EBIDA).

Nonetheless, great work. The DCF approach is the only correct one, especially because it correctly accounts for the fact that Garena cash flows are being reinvested and not paid to shareholders, therefore making a SOTP doesn't account for that.

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fair question on the capex. I would think that a large portion of this current capex bulge is growth capex, and maybe somewhat one-off in nature, like building out these Brazilian warehouses for instance. They shouldn't need to keep spending growth capex into perpetuity, theoretically it should decline to just some sort of maintenance level in a mature steady state, but yea what that level is quite subjective.

But thank you - and yes i started realising the DCF was the only sensible approach after getting concerns about their disclosures and cost blowouts in other 'unallocated' areas. They can guide investors to whatever metrics they like but the final group earnings and cashflow numbers don't lie

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Could restructuring costs potentially be included in the "others" category?

But as you said, it's really hard to know

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Thanks the up date. Do you have any thoughts on the reduced ownership of the firm by tencent and the overall relationship between tencent and sea. It would seem as if by working together, the two firms could both benefit, yet this does not seem to be happening. tia your thoughts. SC

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I think there is increasing likelihood that the two will drift in more separate directions over time. The prize for Tencent of being able to do its own publishing in the region (despite the setbacks it may initially have) is probably much greater than its current stake in Sea, and there is already evidence of them doing so, eg. Riot Games (owned by Tencent) from 2019 has been trying to do its own publishing in the region (Garena gets to keep League of Legends but), although i dont think it's been overly successful so far. But also Tencent itself has opened a new publishing arm in Singapore, Level Infinite, which i think at this stage is more focused on AAA games but still it gives you a sense of their direction. I think Garena is gearing up to be self-sufficient without them anyway, hence why making investments in other studios etc. Undawn, a game they co-developed together, will be an interesting test case for their partnership, if it ever gets released.

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thank you. Appreciate your reply. SC

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