Everything for survival! Tencent SEA is fighting against all odds.

On the evening of March 7th, before the US stock market opened, SEA Donghai Group released its Q4 2022 financial report. Overall, the company went all out to achieve breakeven as soon as possible. The surprising performance of achieving full profitability this quarter was truly remarkable. The key points are as follows:

1. All business segments and group profits have turned positive: Due to the previously only profitable Garena game segment being in dire straits, the overall cash flow situation of the group was precarious. The company and the market's only focus was on when it could turn a profit. The most critical information in this financial report is that in this quarter, the group as a whole achieved a profit of 343 million US dollars at the operational profit level, while the market still expected a loss of 390 million US dollars. The breakeven point was two quarters earlier than expected by the selling party.

   Moreover, on a structural level, all three major segments of gaming, e-commerce, and digital finance achieved profitability this quarter, with e-commerce and finance segments achieving operational profits of 110 million and 62 million US dollars respectively. This signifies that all three segments are now self-sustaining, and the group's operational cash flow has turned positive by 320 million yuan. The concern over whether the company will survive has been completely relieved.

   Although the cost of such amazing profitability was the collapse of growth, the company achieved a total revenue of 3.45 billion US dollars this quarter, with a year-on-year growth rate slowing to a "pathetic" single-digit number of 7%. However, currently, the importance of growth still needs to make way for profitability.

2. Shopee's "self-mutilation for the sake of survival" e-commerce strategy: Under the strategy of putting profitability first, Shopee announced its exit from the last market in Europe, Poland, in January, declaring that Shopee has closed all markets outside of Southeast Asia and Brazil. Financially, Shopee's GMV this quarter was 18 billion US dollars, a year-on-year decline of 1%, and the number of orders dropped significantly by 15% year-on-year, which means that the average order value has significantly increased, and the company has sharply reduced product discounts.

   Despite such a dismal performance in GMV, the revenue growth rate of e-commerce still reached a high of 32%. The reason behind this is the 3P e-commerce business cash realization rate of Shopee, which increased sharply by 160 basis points to 10.3% over the quarter, accumulating a 3.2% increase for the entire year of 2022. Such a leap in cash realization rate shows SEA's determination to seek profitability, but it has also significantly suppressed users’ enthusiasm for shopping.

3. Garena game business still performing poorly: The number of active users, paying users, game revenue, and income are all continuing to decline. The number of active users and paying players decreased by about 80 million and 8 million quarter-on-quarter, respectively. The per-user payment for this quarter decreased by 12% year-on-year, and even core users are unwilling to pay. Finally, game revenue was cut in half this quarter to 540 million yuan, with the decline continuing to expand. The only good news is that since e-commerce and finance segments are now self-sustaining, the game segment no longer needs to be subsidized. Even if the game segment performs badly, the market can ignore it. 4. SeaMoney Digital Finance: After shifting its business focus from payment to more convenient lending, SeaMoney achieved a revenue of 380 million yuan this quarter, which exceeded the market expectations by 9%. Its revenue growth rate was as high as 92%. It is amazing that it has achieved profitability within only two years of extensive expansion and is still in a high-growth period.

5. Huge Increase in Gross Profit, Dramatic Decrease in Expenses, and All Achievements Aligned with Profits: Through the "desperate" monetization operations (subsidy reduction in e-commerce and lending in financial services), the gross profit rate of the company's e-commerce + digital finance business increased by 14 percentage points to 39% on a quarterly basis. The overall gross profit margin of the group also increased significantly by 10 percentage points, reaching nearly 1.7 billion yuan, which far exceeded the market's expected 1.17 billion yuan, while the gross profit margin of the gaming business remained unchanged.

In terms of expenses, marketing expenses plummeted by 61% year-on-year. Among the various business segments, the sales expense ratio of the e-commerce segment is only 18%, and the sales expense ratio of the digital finance segment has even directly decreased from 40% to 8%. The company's sales expenses alone have squeezed out a profit margin of 12%. It can be seen that the company has basically given up marketing promotions for the sake of profits.

Originally, the most inflexible R&D expenses also directly decreased by 15% year-on-year. The main reasons were personnel streamlining and the cancellation of accruals reversal worth about 130 million yuan. The final R&D cost rate also decreased by about 6 percentage points on a quarterly basis.

Although administrative and management expenses still increased by 66% year-on-year due to severance costs, bad debt impairment after transitioning to lending business, and equity incentives, the overall operating three expenses ratio decreased by 15 percentage points on a quarterly basis. The company finally achieved the feat of directly increasing its operating profit margin from -16% to +10%.

Longqiao Dolphin's Viewpoint:

Overall, continuing the trend of marginal rebound in the company's performance in the previous quarter, and with the focus of the company and the market fully shifting to profits, the company exceeded expectations this quarter in terms of time frame (two quarters ahead) and quality (all business sectors independently achieved profitability) and accomplished the goal of achieving a balance between profit and loss, which is what the market most wants to see. It also marks the official turning point for the company.

With overall profitability, the market no longer needs to worry about whether Shopee's e-commerce business can be profitable or not, and there is no longer the concern of the company's blood-making points collapsing after the gaming sector. Therefore, the valuation will undoubtedly see significant recovery in the short term. Then, after the survival issue is addressed and valuation is restored, both the market and the company itself will return to the thinking of how to improve the overall scale and profitability of a normal company. Currently, the game sector lacks new products and the fundamental problem of old product lines remains unsolved. In the overseas e-commerce market, which was already struggling due to traffic regression and inflationary pressure, balancing monetization and profit is also a major issue. Overall, after the repairs, the company still needs to cherish and protect itself.

The following is a detailed analysis of the financial report:

1. All sectors are profitable! Survival comes first.

Because the Garena game sector has already deteriorated and the overall cash flow of the group was precarious, when and if profit could be turned around became almost the only focus for the company and the market. Thus, this time, our evaluation of SEA's performance will prioritize from the perspective of profitability and revenue growth is relatively secondary.

In terms of profit alone, SEA's performance this quarter is excellent. The group's overall operating profit has directly turned losses into gains, reaching USD 343 million, far exceeding market expectations of USD 390 million in operating losses. Structurally, the gaming, e-commerce, and financial sectors have all achieved profitability this quarter, declaring that all three sectors can survive independently. Specifically,

1. Gaming sector: achieved operating profit of USD 400 million in the fourth quarter, although it decreased by nearly USD 60 million quarter-on-quarter and fell by 53% year-on-year, it still looked bleak. However, the gaming sector was no longer expected to do well; since e-commerce and finance can already make profit, it no longer needs to be subsidized by the gaming sector. Therefore, the poor performance of the gaming sector does not affect the overall situation.

2. E-commerce sector: the decrease in losses of the e-commerce sector is the core of the company and the market's most important concern. Originally, foreign investment bankers expected that the earliest reversal point of loss for the Shopee sector would be in 2023 Q2, but the company exceeded its target this quarter, achieving an operating profit of USD 110 million. The adjusted EBTIDA profit of USD 196 million is far better than the market's expected loss of USD 350 million.

3. Financial sector: In addition, the financial business, which officially started in 2020, has achieved profit this quarter, with an operating profit of USD 62 million after just 2 years of development. As the business gradually shifts from payment to lending, the profit has come much earlier than expected.

4. Group level: In addition to the core business, the large-scale reduction in layoffs and new business investment such as Shopee food at the group level has significantly reduced the undistributed operating losses from USD 80 million last quarter to USD 30 million.

With the company's profitability turning positive, operating cash flow also turned around from the situation of not being enough to cover expenses, achieving a net inflow of RMB 320 million this quarter. The positive turnaround of cash flow also officially declares that the question of whether SEA can survive has been basically resolved. The market's most critical concern for SEA has also been resolved, that is, whether and when it can become profitable. Next, let's take a look at how the company quickly achieved profitability and what price it paid for it?

II. Shopee E-commerce: Making Profits at All Costs

Due to the company's strategy with profitability as the highest priority, the situation of the Shopee e-commerce sector can be summarized with one word: "Survival". Previously, the company exited from European countries, such as France, and abandoned localized operations in the South American market, except for Brazil, and switched to pure cross-border e-commerce mode. In January of this year, Shopee officially launched in Poland, the last market in Europe. Thus, Shopee's previous vision of globalization has been completely abandoned.

Reflected in financial data, Shopee's GMV for this quarter was US$18 billion, a year-on-year decline of 1%, and a significant decline from the previous quarter's US$19.1 billion. Following in the footsteps of the gaming sector, Shopee's growth has shifted from slowing down to shrinking.

From the perspective of price and volume, as the global e-commerce market is already influenced by the backflow of offline and high inflation, and Shopee has actively exited many markets, the order volume of Shopee this quarter has decreased significantly by 15% to 1.7 billion.

From a price perspective, after gradually contracting towards core markets (Southeast Asia and Brazil), Shopee's overall ARPU has continued to rise and reached US$10.6 this season, a 16% increase from the previous year. The Dolphin believes that such a significant increase in ARPU cannot be explained by market purification, the company should have significantly reduced price subsidies for its products. However, the reduction in subsidies will naturally lead to a decrease in user orders.

In terms of revenue, this quarter achieved revenue of US$2.1 billion, slightly higher than the market's expected US$2.03 billion. The growth rate also stabilized at 32%. In the situation of a year-on-year decline in GMV, such a significant increase in revenue growth is still considerable, mainly due to the company's reduction in subsidies and increase in cash conversion rate.

After calculation, Shopee's 3P e-commerce monetization rate in this quarter has increased by 160 basis points to 10.3% compared to the previous quarter, and has accumulated an increase of 3.2% in 2022. Out of the approximately 1.8 billion 3P income, 1.1 billion comes from "efficient monetization," such as commissions and advertising fees, which has greatly increased by 54% and is significantly higher than the overall revenue growth. The "inefficient monetization," such as logistics and other service revenues, was about 700 million, a year-on-year increase of 29%.

In order to achieve profitability as soon as possible, the simplest and most effective approach that Shopee can take is to improve its monetization rate. According to investment bank statistics, after universally increasing the commission rate or payment processing fee in the third quarter of last year, Shopee raised the monetization rate by more than 1% again in markets such as Vietnam, the Philippines, and Malaysia at the beginning of this year. Such high-frequency and large-scale monetization rate changes show the company's determination to make profits, and even have the meaning of "fishing in a depleted pond."

However, Tokopedia, the second-ranked e-commerce platform in Indonesia and the largest market in Southeast Asia, also increased its monetization rate twice last year in May and December, with commission rates for "Regular Merchants" increasing from 0.5% to 1%~3.8%. This shows that in Southeast Asia, after the pandemic bonus recedes and income slows down, monetization rate increases to achieve revenue and profit are a common practice among e-commerce platforms. Therefore, Shopee's rapid increase in monetization rate should not significantly damage the competitive landscape, but will further lead to the slowdown of the e-commerce industry in Southeast Asia.

Third, Garena Games: No signs of improvement, prospects still bleak

As for the Garena Games division, it remains a mess, with both active users, paying users, game revenue, and income continuing to decline, with no sign of improvement.

First of all, in terms of user data, Garena's quarterly active users have once again decreased by more than 80 million compared to the previous quarter, and the number of paying players who actually contribute income has also decreased by about 8 million. The user loss situation is becoming more serious and the payment rate continues to decline. (But it is consistent with market expectations) The market expected that both active users and paying users would stop falling, but the user loss situation in this quarter was significantly worse than expected.

To make matters worse, the average single user payment this quarter compared to the same period last year has dropped by 12% to $12.5, a decrease from the previous quarter. Initially, with the core group of players purified, the single user payment rate should have stabilized. However, this quarter's unexpected sharp decline may imply that the game has lost its popularity, and even core users are unwilling to pay.

At the earliest stages, due to the decrease in both the number of users and single user payments, the game revenue for this quarter fell by 51% to 540 million yuan. The decline has not improved, but instead has continued to expand.

Translated into finance terms, the confirmed revenue of the game segment this quarter was US$950 million, a decrease of 33% compared to the same period last year. Although the revenue seems to have increased quarter-on-quarter, in fact, a deferred income of as much as 400 million was confirmed this quarter. Excluding "eating old seeds," this quarter's actual revenue has also shrunk by 50%.

From the current situation, it seems that Garena's existing games' collapse is almost inevitable. It is nearly the only way to revive this segment by launching a successful new game.

4. SeaMoney digital finance: More than just payments, expanding to loan business

Due to the company's shift towards loan-related businesses in the digital finance segment, the data disclosed in this quarter is still related to loan businesses: 1) the company's outstanding receivables balance as of the end of this quarter was $2.1 billion, and 2) at the same time, the bad debt rate overdue for more than 90 days rose from 4% in the previous quarter to 5%.

In terms of financial data, SeaMoney's digital finance business achieved revenue of 380 million yuan this quarter, which was 9% higher than market expectations, and its revenue growth rate was as high as 92%. Even more crucially, even in the early stages of revenue rapid expansion, this segment has realized a positive operating profit, indicating that the company's transformation towards loan businesses is "shameful but effective."

V. Overall Performance: Revenue Growth Slows Down, Profit Surprisingly Increases

Due to the significant deterioration in revenue growth in the gaming and e-commerce sectors, the company's total revenue was 3.45 billion US dollars, with a year-on-year growth rate slowing down to only single digits of 7%, which is quite miserable. From the perspective of the expectation gap, although the actual revenue exceeded the market expectation by about 400 million, it was mainly due to the financial game of the gaming sector significantly confirming deferred revenue, and the actual performance was basically the same as the market expectation.

Although the realization of revenue is indeed mediocre, the company gradually began to turn the situation around starting from gross profit margin. Specifically, except for the "no one cares" entertainment sector gross margin rate remained unchanged year-on-year, the gross margin rate of the company's e-commerce and digital finance business increased by as much as 14 percentage points to 39% quarter over quarter, which is truly amazing. The substantial increase in the realization rate of e-commerce business and the transformation effect of financial sector from payment business with maximum deduction of 3% to loan business with interest rates of over 10% are considerable. The gross margin rate of the self-operated e-commerce sector further increased from 10% to 15%, which intuitively reflects the sharp reduction of the company's discount on goods.

In the end, the company's overall gross margin rate increased from 39% to 49% this quarter. The total gross profit also reached nearly 1.7 billion, far exceeding the market expectation of 1.17 billion.

From the expense perspective, the most elastic marketing expenses decreased by a whopping 61% year-on-year, which shows the amazing cost control. Looking at the business sectors separately, the marketing expenses of the e-commerce and digital finance sectors are rapidly decreasing with a considerably high slope in the proportion of income, and the sales expense rate of the e-commerce sector is now only 18%, which has basically departed from the positioning of "subsidized" platform.

The sales ratio of the digital finance sector has directly decreased from 40% to 8%, which has basically stopped promoting for a new business. As for the "aging" gaming sector, the expense ratio continued to decrease slightly. In the end, the proportion of overall sales expenses to total revenue also decreased sharply by about 12 percentage points to 14%.

However, the internal administrative expenses and research and development expenses continue to expand this quarter, specifically: (1) For technology companies, R&D expenses, which were originally the most rigid, fell by 15% year-on-year this quarter. After abnormal increases in support due to layoffs in the previous quarter, the effects of personnel streamlining began to show this quarter. In addition, about 130 million yuan of accruals reversal was revoked this quarter. The final R&D expense rate also decreased by about 6% compared to the previous quarter.

(2) Administrative expenses continue to increase by 66% year-on-year. Dolphin believes that there may be three possible reasons. First, maintaining a high level of equity incentive expenses (190 million yuan this quarter), followed by the ongoing impact of cost increases due to employee layoffs. Finally, after promoting the loan business, the company also confirmed a loan impairment loss of 240 million yuan this quarter. Therefore, even in the environment of controlling costs, the expense ratio is as high as 15%.

Therefore, although the natural growth of the company's business has slowed down comprehensively, it achieved the feat of all-round profitability in one quarter through "unrestrained" improvement operations (reducing subsidies in the e-commerce sector, and issuing loans in the financial sector) and astonishingly controlling costs (the three expense ratios were reduced by 15% at one go to squeeze out a profit margin of 12% from marketing expenses), due to the nearly 10% increase in gross profit margin.

Combined with the above financial data, it can be seen that the company has achieved a profit of about 340 million yuan.And with that, the company's operating profit margin rose directly from -16% to +10%.

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Dolphin's Research on Sea Group in the Past:

November 16, 2022 Phone Meeting "SEA: Tightening the Belt and Surviving is the Top Priority (3Q22 Summary)"

November 16, 2022 Financial Report Review"Game Lousy, Shopee's Good, Can Sea Return to the Light?"

August 17, 2022 Phone Meeting "SEA: Efficiency First, Regardless of Scale (Phone Meeting Summary)"

August 17, 2022 Financial Report Review"Even with No Growth, Sea is Still in Deep Deficit, How Can it Save Valuation?" On May 17, 2022, Telephone Conference: "Game Business Must Be Diverse, E-commerce Business Must Be Profitable (SEA Telephone Conference Minutes)".

On May 17, 2022, Financial Report Review: "SEA: Games Are Aging, E-commerce Sustains Alone".

On March 2, 2022, 4Q21 Telephone Conference: "SEA Telephone Conference Minutes: Strategic Reversal, Game Entertainment Empowers Diversification, E-commerce Must Increase Efficiency".

On March 2, 2022, 4Q21 Financial Report Review: "SEA Wants To "Segment": E-commerce and Gaming Have Different Fortunes".

On January 5, 2022: "'Little Tencent' Is Scared Away by Tencent's Younger Brother? The Significance of SEA is Different".

On January 10, 2021: "Is Staying in One Place or Crossing the Sea Better? Southeast Asia is Still SEA's "Place of Dragon's Rise"".

On January 24, 2021: "Integration of 'Taobao + Tencent + Alipay', The Ultimate Form of the Internet - SEA's Journey is Worth More Than Billions of Dollars".

Risk Disclosure and Statement for this Article: Dolphin Research's Disclaimer and General Disclosure