3 Risks of Sea Ltd Investors Should Know About Before Buying Shares

In Southeast Asia, with the rising population, improving economic fundamentals and accelerating technology adoption, investors are more bullish on the tech sector than ever.

The hottest Southeast Asian tech stock this year is undoubtedly Sea Ltd (NYSE: SE).

Albeit with its positive outlook, in this article, I’ll take a look at the three main risk factors investors should assess when pondering whether to buy or to sell the stock.

1. Overvaluation

The share price of Sea Ltd has more than tripled since the beginning of the year. For a still loss-making company, it’s currently trading at a price-to-sales (PS) ratio of 23x.

Looking at some of the big-name Chinese peers, Alibaba Group Holding Ltd (NYSE: BABA) (SEHK: 9988) is currently trading at 9x, Tencent Holdings Ltd (SEHK: 700) is trading at 11x, and Pinduoduo Inc (NASDAQ: PDD) is trading at 23x.

One can easily conclude that a 23x PS multiple is justifiable since it’s in line with Pinduoduo, an equally young Chinese e-commerce company listed in the US.

But more often than not, young companies don’t necessarily equate to strong growth when one takes into account the competition it faces and the power bigger players can have to stall the young companies’ growth.

Whether the valuation of Sea Ltd is justifiable or not, just looking at the premium it has over Alibaba and Tencent makes one nervous.

It makes you wonder whether a bubble is being formed and about to burst (to be fair, the same concern goes for Pinduoduo).

2. GMV

The e-commerce platform of Sea Ltd, Shopee, is proud of being the largest e-commerce platform in Southeast Asia in 2019, by gross merchandise value (GMV).

This is, without a doubt, a significant milestone for Shopee, as a newcomer in the e-commerce scene to overtake the two other strong players – Tokopedia and Alibaba-backed Lazada.

But GMV doesn’t equate to revenue as GMV measures the total sales volume that transacts through a platform. It doesn’t factor in things such as returns, cancellations, discounts, etc.

In an extreme scenario, companies can hire someone to make a lot of orders and then return or cancel all the orders later. The GMV will still have a nice bump, even though it doesn’t earn anything.

There has been a lot of criticism in recent years over GMV since it can be easily manipulated, as in the case of Luckin Coffee Inc (OTCMKTS: LKNCY).

Given the misleading nature of GMV, both Alibaba and JD.com Inc (NASDAQ: JD) (SEHK: 9618) have decided to only publish their GMV figures once per year instead of every quarter.

That said, GMV figures of Shopee could well be genuine. But for investors, it’s always important to dig deeper to truly understand it rather than just catching the headline number.

3. Sustainability

Sea Ltd currently has three business segments – Garena (online gaming), Shopee (e-commerce), and SeaMoney (Fintech).

The only business segment that is generating positive EBITDA is Garena. Cash flow generated from Garena is used to finance (together with equity and debt) the aggressive expansion of the e-commerce and Fintech segments.

The management expects the company to continue to be loss-making since the expansion is heavily subsidised by the company.

As such, looking at the historical financial results, the stronger the growth the company achieved, the higher the net loss the company had.

Over the past few years, thanks to the popularity of groundbreaking startups and charismatic entrepreneurs, investors have grown more used to loss-making companies.

But for a public company to be loss-making for the past five years, one has to ask what the end game is and if the company can achieve growth without sacrificing its profitability.

If the market only focuses on the always hopeful outlook and avoids seeing the reality that is right in front of our eyes, isn’t that another Dutch tulip mania in the making?

Foolish bottom line

Sea Ltd could well be the next Tencent in Southeast Asia. But as a smart investor, we need to always ask ourselves these difficult questions, especially during the good times.

As Warren Buffett rightfully put it – be fearful when others are greedy.