Sea – Monster in the Making

In conjunction with the launch of the Paper Portfolio last August, Capital Flywheels published a deep dive on Sea.

This felt necessary not only because the Paper Portfolio launched with a (largest) 7% position in Sea but because Capital Flywheels had not seen a company as exciting and mis-priced as Sea since…Shopify in 2016, Apple in 2014, or Facebook in 2012. What all of these companies had in common were tremendous potential (of the generational kind) married to misunderstood business models and business dynamics that led the average investor to see risk and instability instead of opportunity. In actuality, in each of these cases, the companies had far more going for them than observable to the passing eye.

A year later, the deep dive still stands incredibly well, but a lot has also changed, including a lot more interest / experts in Sea in social media! As a testament to the enormity of what Sea is building, not only does the prior deep dive not need any negative corrections, the updates that are necessary are only because the story has gotten even better than expected.

Fast-Forward into the Future

As a company focused on games and e-commerce, it was already clear a year ago that Sea is very well positioned for the future.

Gaming is the fastest growing entertainment category globally, and younger generations are much more open to gaming as an entertainment form than older generations. Not only are almost all young boys gamers, almost all young females are gamers, too. This is something that many older folks (such as the average investor) do not understand, yet. And this is further compounded by differences in habits between the developed world and the emerging markets. Whereas games are often looked down upon as a hobby for children in the West (particularly the US), the East (including Sea’s dominant geography, South East Asia) does not have this stigma due to the the lack of history with consoles and prior generations of games. Games are simply a new form of entertainment. And games, conveniently, happen to also be more accessible and cheaper than alternatives like movies and TV. Games are available any time, anywhere via smartphone and many games are free-to-play.

As exciting as the game story is / was, Capital Flywheels was infinitely more excited by the e-commerce story. E-commerce is the future. And if that wasn’t clear enough already, you will hear me continue to hammer away at that point repeatedly in (every?) future Tidbits post for the foreseeable future. E-commerce is a generational shift in how retail is done. And it will be as transformative for the world as much as anything transformative before. E-commerce remains the single most attractive vertical for investments in Capital Flywheels’ opinion because the addressable market for e-commerce is easily larger than any other vertical out there. In any given country, consumption tends to represent ~60-70% of GDP. The vast majority of that consumption is related to products and retail. And e-commerce is consistently taking share…with the opportunity to eventually mediate 30-40-50% of GDP of any country on earth. The world’s leading e-commerce businesses are large, but the world has seen nothing, yet…

Despite how well positioned Sea already appeared to be a year ago, the story has actually gotten better.

No one knew that COVID-19 was coming. And COVID-19 has been the greatest accelerator for digital-first businesses the world has seen since at least the creation of Android and cheaply available smartphones more than a decade ago.

While there were already growing concerns around the maturation of Free Fire (Sea’s self-developed game) a year ago, COVID-19 has breathed new life into Free Fire and has helped the game continue to power on to new heights. According to the company during the latest earnings call, Free Fire reached a new monthly revenue record in July 2020. Despite being a 3 year old game, the game continues to find new legs. More impressively, the game achieved >500 million active users in Q2. A year ago, Free Fire only had ~500 million registered users. This implies that Free Fire’s registered user base is now materially higher.

Capital Flywheels is a fan of context. Context helps us, as humans, understand scale better (because there is a lot of evidence that humans lose the ability to interpret scale when numbers get really small or really big¹). While investors are now aware that Free Fire is a very large game, for context, Capital Flywheels would like to point out that >500 million active users (and potentially >600-700 million registered users) puts Garena in the realm of “Tencent-scale”. Tencent has ~1.2 billion users of WeChat and QQ. Tencent’s gaming properties likely have somewhere around 800 million users.

Not only has COVID-19 super-charged Sea / Free Fire into rarefied air, Sea was already making very, very impressive progress in expanding into other geographies. Whereas the deep dive last year highlighted the potential to extend into new geographies, Sea has already achieved significant success in Latin America, India, and parts of the Middle East. Free Fire absolutely dominates in some of these geographies. And a significant reason for the success is Sea’s impressive focus on developing a wider ecosystem, encompassing esports as well as live streaming.

For example, Brazil’s Free Fire tournaments are beginning to rival the interest in soccer (in a country that worships soccer). Even one of Brazil’s most popular soccer teams is officially competing in Free Fire tournaments:

In November, the Free Fire World Series (FFWS), one of the world tournaments Garena organizes, returns to Brazil. The first edition took place in Rio de Janeiro, and the champion was Corinthians–yes, the same Corinthians of the popular Brazilian soccer team.

Source: Latin America Business Stories (LABS)

Of course, Sea did not have to invent these ideas. Sea already has a very impressive partner (Tencent) to emulate. However, whereas Tencent has primarily relied on investments to extend their ecosystem (e.g. investments in HUYA and Douyu for esports / game live streaming), Sea is doing all of this in-house. And the learnings and ecosystem richness will continue to compound and compound.

For example, Sea is currently experimenting with a game live streaming app called BOOYAH! in India:

Garena has launched BOOYAH!, its platform for gaming videos, in India. The app is available on both Android and Apple-based devices, along with a web version that is accessible through PCs. The name BOOYAH! is also the term for a win in a game of Free Fire – the battle royale developed by Garena. While the app could potentially be used for any and all games, the themes, features, and release seem to be centered on positioning it as the platform for Free Fire content creators. 

Like other streaming platforms, BOOYAH! offers similar features such as chatting with other users, the ability to livestream, and more.  Users will be able to broadcast gameplay on the app as well as to major streaming platforms such as Facebook Gaming, YouTube Gaming, and Twitch. Users will be able to re-stream and chat with viewers on all platforms simultaneously at no additional cost.

Source: Esports Obvserver

And on the e-commerce side, I think we all already personally know how much more important e-commerce has become due to COVID-19. This is also true in the emerging markets where Shopee operates.

But Shopee has also gotten better beyond just COVID-19 acceleration. Shopee is starting to do things that I think should be considered innovative even when compared against larger Chinese peers. Shopee’s platform is branching out into much wider category mix and includes grocery as well as food delivery (in addition to experiments they’ve done in the past to get gamers to buy in-game items on Shopee). Shopee is shaping up to be a general commerce platform rather than just retail products.

In addition, perhaps a function of Sea’s entertainment roots, Shopee is exploring a very interesting mix of commerce and media. Whereas social e-commerce in China is more like QVC 2.0 (product live streaming), Sea is bringing together media and commerce that is much more metaverse-like.

For example, K-Pop concerts on Shopee:

Source: Youth.SG

The fusion of media and entertainment and commerce is a highly interesting mix and puts Shopee closer to what Instagram, TikTok, and Snapchat are experimenting with in the crossover realms of entertainment and commerce. (Shopee also recently launched Stories for merchant pages, for example).

Sea has quietly launched Shopee into Brazil / Latin America as well. The company has been quiet / coy about their intentions in Latin America. So far, the company claims that it is intended only to be a cross-border business (e.g. shipping items from China / Asia to Latin America) and hence targeting users that want cheap products but are willing to wait weeks. However, given Sea’s ambition, I have no doubt that the company is potentially working towards something bigger.

Embracing Platform Potential

Capital Flywheels believes platforms are often mis-priced because investors do not adequately capture the potential for “new legs” in their valuation / modeling. Platforms have incredible potential to muscle into adjacent areas / verticals in a way that other businesses do not. This deserves a premium. While this potential has value, few investors are willing to embed that value into a stock without seeing the possibilities first.

I believe similar dynamics surround Sea. By virtue of controlling the dominant entertainment and e-commerce platforms in South East Asia, Sea has enormous potential to launch new adjacent businesses, but investors do not price these into the stock. This creates significant potential for superior investment returns.

One such area that Capital Flywheels highlighted last August was payments. While Sea did highlight Airpay at IPO, Sea largely stopped mentioning it shortly after IPO. Airpay was not getting much traction. And investors mostly gave up on Airpay because other digital wallets were gaining significant traction. These wallets were controlled by ride hailing companies such as Grab and GoJek as well as well funded competitors from Alibaba / Ant Financial. However, this view overlooked the power of the platform. By virtue of controlling two of the largest verticals in the South East Asia digital space, Sea can dictate what payment options are used for two of the largest verticals.

Earlier this year, Sea revealed that they have made significant efforts on a new unified offering called Sea Money. In a very short period of time, Sea Money has now gained significant traction amongst users both online and offline. Sea Money, while not required for Shopee purchases, has now penetrated ~40% of transactions. Sea Money has gone from no users to ~10 million at end of Q1 and now ~15 million at end of Q2. This is extremely impressive! In comparison, Mercadolibre’s digital wallet only achieved ~8 million users at end of Q1 after about 2 years of significant efforts to drive adoption and only slightly more than 9 million at the end of Q2.

A lot of the growth in adoption has been funded by promotions and discounts. This may be concerning to investors, but it overlooks the qualitative value of payments, which Capital Flywheels has highlighted in a series of payments-related posts. The long-term value of payments is incredibly high and is worth the investments necessary to drive adoption in the near-term. The only vertical that can rival the size of e-commerce in the long run is finance / fintech. Every country’s financial sphere is as large or larger than consumption / commerce. The only question is whether the regulations are worth the economics.

A Bright, Bright Future

Sometimes I can get overly enthusiastic. This may be one of those situations. Or, Sea could truly turn out to be one of the most exciting generational opportunities that I believe it is.

What makes me incredibly optimistic is that Sea operates in one of the largest geographies in the world (e.g. Indonesia is the 4th most populous country in the world; Sea is also making extremely strong progress in India and Brazil) with almost no meaningful competition. Sea faces a large number of peers, but most of them are private players that are starting to struggle and are running out of cash. Sea mentioned on the latest earnings call that they understand these dynamics and therefore want to keep pressing to make sure peers cannot raise any money to compete. There is no other meaningful geography in the world where the internet appears so likely to be dominated by just 1 player…Sea has that potential in one of the largest and most dynamic economic regions in the world.

Furthermore, while China was the fastest growing economy of the last 3 decades, China is maturing and is slowing. Indonesia and India are very likely to grow faster than China once COVID-19 is behind us. Sea would not only dominate one of the largest geographic regions on Earth but would be levered to the fastest growing economies as well.

Lastly, Chinese companies like Alibaba are the most fearsome direct competitors to Sea at the moment. But for good or worse geopolitics is cutting off Chinese companies from many parts of the world. For example, many Chinese apps have been banned from India. This will distract many Chinese companies. Their distraction will likely be a boon for Sea.

Disclosures: I own shares in SE. I have no intention to trade any shares mentioned in the next 48 hours.

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¹ For example – Capital Flywheels finds that the scale of Apple is almost incomprehensible to the average person. It is not an overstatement to say that Apple is the most incredible business ever seen on Earth. Apple generated ~$275 billion of revenues in the last 12 months selling essentially just 3 products (iPhone, iPad, Mac). That is almost $1 billion per day ($0.75 billion to be precise). For context, Amazon sells everything on Earth and only generated marginally more revenues in the last 12 months at $320 billion ($0.88 billion per day). Apple, selling 3 products, almost outsold Amazon selling everything on Earth. Another comparison that tends to violate all the narratives of the human mind – Apple, a hardware company, has slightly higher EBITDA and net income margins than Google.