Earnings Call Transcript - SE Q3 2021

Operator, Operator

Good morning and good evening. Welcome to the Sea Limited Third Quarter 2021 Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Ms. Min Ju Song. Please go ahead.

Min Ju Song, Group Chief Corporate Officer

Hello, everyone, and welcome to Sea's 2021 third quarter earnings conference call. I am Min Ju Song from Sea's Group Chief Corporate Officer's office. Before we continue, I would like to remind you that we may make forward-looking statements that are inherently subject to risks and uncertainties and may not be realized in the future for various reasons as stated in our press release. Also, this call includes a discussion of certain non-GAAP financial measures, such as adjusted EBITDA and net loss, excluding share-based compensation. We believe these measures can enhance our investors’ understanding of the actual cash flow of our major businesses, when used as a complement to our GAAP disclosures. For a discussion of the use of non-GAAP financial measures and reconciliation with the closest GAAP numbers, please refer to the section on non-GAAP financial measures in our press release. I have with me Sea’s Chairman and Group Chief Executive Officer, Forrest Li; Group Chief Financial Officer, Tony Hou; and Group Chief Corporate Officer, Yanjun Wang. Our management will share strategy and business updates, operating highlights, and financial performance for the third quarter of 2021. This will be followed by a Q&A session in which we welcome any questions you have. With that, let me turn the call over to Forrest.

Forrest Li, Chairman and Group Chief Executive Officer

Hello, everyone, and thank you for joining today's call. Sea aims to connect communities, empower consumers, and support small businesses so that more individuals can benefit from the growth of the digital economy. We are achieving scalable efficiency while building stronger connections within our ecosystem. As we continue this progress, we are also expanding our total addressable markets. We are excited to report another strong quarter across all our businesses in Q3, showcasing our ability to seize new and attractive opportunities. For the third quarter of 2021, we recorded triple-digit growth in GAAP revenue and gross profit. GAAP revenue rose 122% year-on-year to $2.7 billion, and gross profit grew 148% year-on-year to $1 billion. In addition to our solid financial and operating results for the quarter, we have launched numerous initiatives to empower our users to take advantage of the digital economy. For instance, in Indonesia, we intensified efforts to provide local SMEs with the necessary resources to build successful online businesses, including access to international markets via Shopee. We recently launched Shopee Export MSME Campuses in Solo and Bandung, giving local businesses vital resources and training to enhance their ability to scale and sell internationally. These facilities offer inventory management systems, marketing support such as photography studios, management courses, and personalized training with our Shopee team. In Malaysia, we collaborated with the government to digitize rural sellers and boost their e-commerce sales. Partnering with the Malaysian Communication and Multimedia Commission, we utilized rural Internet centers nationwide to offer free e-commerce training to local entrepreneurs. Since July 2021, we have trained over 6,000 rural sellers. Additionally, as part of the Shop Malaysia Online program, we worked with the government to promote more than 280,000 online and offline local brands and sellers, further encouraging local SMEs to engage in the digital economy. In Thailand, we are collaborating with various agencies to launch projects focused on enhancing digital entrepreneurial skills among young entrepreneurs through prizes, training, and mentorship. Similarly, in Brazil, we have been focusing on onboarding local SMEs to help them thrive online. I’m pleased to report that since welcoming local sellers in mid-2020, over 1 million have registered with Shopee. We recognize that the pandemic continues to pose significant challenges in all our markets. For example, during the strict lockdown in Vietnam in Q3, we quickly adapted to serve our users while prioritizing the safety and health of our employees. We engaged actively with governments to ensure the well-being of our team while continuing to serve both sellers and buyers effectively. We have also launched initiatives to assist government containment and vaccination efforts. In Indonesia, for instance, we've integrated the National Contact Tracing System into our app for easier access. In Malaysia and the Philippines, we introduced reward programs for vaccinated users to boost vaccine uptake. These initiatives illustrate our fundamental mission: to ensure that the benefits of technology and digitization are accessible to all. As more people in our community embrace the digital economy, we are committed to meeting the needs of more consumers and small businesses, reinforcing our role in fostering a healthy and sustainable digital economy. Now, let’s examine the performance of each business segment, starting with digital entertainment. In the third quarter, Garena solidified its position as a leading game developer and publisher by deepening engagement with our growing global user base. We reported bookings of $1.2 billion, a 29% year-on-year increase. Adjusted EBITDA rose 22% from last year to $715 million. We had 729 million quarterly active users, up 27% year-on-year, and 93 million quarterly paying users, an increase of 43% from last year. Our paying user ratio also improved to 12.8% from 11.4% a year ago. Garena now serves some of the largest gaming communities globally, and we are committed to creating excellent experiences that engage users and foster connections. In particular, Free Fire’s large and highly engaged user base presents an exciting opportunity for growth. We continue to generate high-quality and diverse content to provide fresh experiences for our users. For example, we introduced new content that expands the storylines within the Free Fire universe, launched a themed event around a popular character, and collaborated on our first movie partnership to introduce exclusive in-game content. We are also looking for creative ways to engage our community outside the game, such as showcasing Free Fire at Sao Paulo Fashion Week. Additionally, we launched new game modes and introduced Garena, a mode designed for friendly competitions among users. One of the highlights of the quarter was the global celebration of Free Fire's fourth anniversary, including a new theme song that has garnered over 60 million streams. We recently launched Free Fire MAX, providing an enhanced gaming experience while ensuring that players of both Free Fire and Free Fire MAX can compete seamlessly. This launch incorporated a map editor feature, allowing players to create and share custom maps. Although Free Fire MAX is in its early stages, it will play a significant role in our ongoing efforts to boost engagement among our users. Free Fire has been well-received globally, ranking second for monthly active users among all mobile games on Google Play. Additionally, it has maintained its position as the highest-grossing mobile game in Southeast Asia, Latin America, and India for several quarters. With Free Fire's growing popularity, we see tremendous opportunities to enrich user experiences on this platform. We have an exciting calendar of eSports events approaching, including championships in Asia and EMEA that we believe will further engage our community. Our global presence across diverse markets enables us to capture promising long-term opportunities in online gaming, and our partnerships with studios worldwide have accelerated. Now turning to e-commerce, Shopee is growing rapidly, outpacing the overall market as we provide greater value to our sellers and buyers. In Q3, Shopee achieved GAAP revenue growth of 134% from last year, reaching $1.5 billion, with gross orders totaling $1.7 billion — a 123% year-on-year increase. This marks our ninth consecutive quarter of triple-digit year-on-year order growth. Shopee's GMV increased to $16.8 billion, up 81% from last year, and our revenue as a percentage of GMV rose to 8.6%. With Shopee's performance, we are raising our full-year 2021 e-commerce revenue guidance to between $5.0 billion and $5.2 billion, representing over 135% growth. Our focus on deepening user engagement has proven effective. We have introduced incentives for sellers, launched features to help them enhance their engagement with customers, and celebrated the anniversary of Shopee Premium, which has doubled its brand partnerships since launch. Our recent shopping festival was a huge success, particularly noting increased participation from consumers in smaller towns, showcasing Shopee as the leading marketplace. Globally, Shopee ranked first in the shopping category on Google Play in terms of total time spent in-app for the third quarter. Shopee also led the shopping app category in Southeast Asia and Taiwan. In Brazil, Shopee made good progress, ranking first by download and total time spent in-app, and second by average monthly active users. Although Brazil is still a developing market for us, we are focused on understanding our growing community of buyers and sellers. In Q3, Shopee's total and adjusted EBITDA loss per order was $0.41. We remain committed to investing efficiently for sustainable growth, and we noted improvements in adjusted EBITDA losses in several markets. We are cautiously exploring how to maximize our opportunities as we have recently launched Shopee in new countries, including Poland, France, Spain, and India. Moving to digital financial services, SeaMoney reported excellent results, with total payment volume on our mobile wallet services growing by 111% year-on-year to $4.6 billion. Quarterly paying users increased to over 39 million, up 120% year-on-year. We aim to expand the number of use cases for our mobile wallet, which is driving consumer adoption and attracting more merchants, creating a positive feedback loop leading to efficient growth for SeaMoney. We are also launching early-stage initiatives in buy-now-pay-later, digital banking, and insurtech while focusing on sustainable growth. The opportunities for SeaMoney are significant, and we believe we are well-positioned to address them with our robust technology, insights, and relationships. Lastly, I am pleased to announce the appointment of Chris to Chief Group President, effective January 1, 2022. Chris is a remarkable leader who has significantly contributed to Sea's progress and will oversee our Shopee and SeaMoney businesses while working on long-term strategic initiatives. In closing, our commitment to serving the needs of our communities through technology is more crucial than ever. In the coming quarters, we will continue to focus on connecting communities, enabling consumers, and empowering small businesses to benefit from the digital economy. Now, I will invite Tony to discuss our financials.

Tony Hou, Group Chief Financial Officer

Thank you, Forrest. And thanks to everyone for joining the call. We have included detailed financial schedules together with the corresponding management analysis in today's press release, and Forrest has discussed some of our financial highlights. So, I will focus my comments on the other relevant metrics. For Sea overall, total GAAP revenue increased 122% year-on-year to $2.7 billion. This was mainly driven by growth in the scale of our e-commerce business as we continue to deepen the engagement with our users, as well as the growth of the digital entertainment business, especially in Free Fire. Digital entertainment bookings grew 29% year-on-year to $1.2 billion. GAAP revenue was up 93% year-on-year to $1.1 billion. The growth was primarily driven by the increase of our active user base and deepened paying user penetration as we continue to engage the community through quality content and immersive experiences. Digital entertainment adjusted EBITDA was $715 million. This represents year-on-year growth of 22% and was able to support top-line growth. On e-commerce, our third-quarter GAAP revenue of $1.5 million included GAAP marketplace revenue of $1.2 billion, up 151% year-on-year, and GAAP product revenue of $0.3 billion, up 82% year-on-year. The strong results demonstrated the deepening penetration of e-commerce and our ability to capture the significant growth opportunities. E-commerce adjusted EBITDA loss was $684 million as we continue to invest to fully capture the opportunities in our markets. We remain committed to continuing investing in a prudent and sustainable manner and growing the ecosystem to serve our users better. Digital financial services GAAP revenue was $132 million, an increase of 818% year-on-year from $14.4 million in the third quarter of 2020. The growth was primarily due to increasing traction as we continue to expand our suite of service offerings. Adjusted EBITDA loss was $159 million compared to a loss of $149 million in the same period of 2020. This was primarily due to our continued efforts to drive more user adoption. Returning to our consolidated numbers, we recognized a net non-operating loss of $13 million in the third quarter of 2021 compared to a net non-operating loss of $74 million in the third quarter of 2020. Our non-operating loss in the third quarter of 2021 was primarily due to interest expenses on our convertible notes, partially offset by foreign exchange gains. We had net income tax expenses of $101 million in the third quarter of 2021, which was primarily due to corporate income tax and withholding tax recognized in our digital entertainment business. As a result, net loss excluding share-based compensation was $448 million in the third quarter of 2021, compared to $346 million for the same period in 2020. With that, let me turn the call to Min Ju.

Min Ju Song, Group Chief Corporate Officer

Thank you, Forrest and Tony. Our management team here today, Forrest, Tony, and Yanjun are now ready to open the call for questions. Operator?

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question today will come from Alicia Yap of Citigroup. Please go ahead.

Alicia Yap, Analyst

Hi. Good evening, management. Thanks for taking my questions. Congrats on the solid results. Two questions here. First, I guess Forrest mentioned Shopee entering Europe, for example, Poland, and also more countries in that time. Can you elaborate on what is the target you wanted to achieve, especially from the European countries? What kind of KPI will you monitor to assess that your progress is well achieved and potentially evaluate the investment further? And then the second question is on Free Fire. With the Free Fire quarterly addition of active users slowed down to single digits in the third quarter, will this suggest more or less a saturation of penetration of the Free Fire user total addressable market? Or is there room for further acceleration with new game launches and additional content within Free Fire? Any color you could share would be appreciated. Thank you.

Yanjun Wang, Group Chief Corporate Officer

Thank you, Alicia. Happy to. In terms of the e-commerce expansion, as we mentioned, our focus first and foremost is on our existing markets in Southeast Asia, Taiwan, and a new growth market in Brazil, where we have achieved a very strong presence. We may, of course, from time to time, test the waters in new markets in other parts of the world, given our past experience operating in many different markets, including the highly diverse markets in Southeast Asia, Taiwan, and Brazil, which are also quite different from other markets in Asia. We believe that we have gained deep operational experience in operating in different markets as well as an understanding of our business model focused on mobile-native, social commerce-driven, and long tail categories that are especially relevant to local sellers and buyers who might be underserved in their existing markets. However, we remain very humble. Being humble is one of our core values, in fact, and we constantly tell ourselves that we need to carefully evaluate all these market opportunities that we've learned. At the same time, we should develop localized and tailored solutions for each market, so we wouldn't make any assumptions. We believe that, while hopefully, our entrance could add value to the markets, we could see potential new growth areas that could further promote local e-commerce growth together with our peers. However, we haven't set any fixed KPI; I think it's still at a very nascent exploratory stage. We are optimistic about Shopee's long-term growth because we believe there is a global demand for our business model in servicing small business sellers and underserved consumers through our model. In terms of Free Fire growth, of course, we have enjoyed very strong growth. Free Fire is perhaps the world's largest mobile game in history so far, and we continue to see a strong user base. In fact, if we look at our metrics across the board, they have improved not only year-on-year but also quarter-on-quarter, even with tough comps during the - especially during the past periods where most of our markets were deeply affected by COVID. Now, as vaccination rates increase across the world and our communities adapt to the situation, I think there's more of a normalized approach now. We're looking to sustain our existing strong user base in current markets and explore new growth opportunities in markets that we haven't deeply penetrated, especially with the launch of Free Fire MAX and new features, including tools for user-generated content such as Craftland, and other tools and features we might introduce to the game in the future. We are further focused on building out our strong IP and platform. Now, with more than 700 million quarterly active users and growing, we believe that this platform itself can be further enhanced to include more modes, more features, and different ways of entertaining and socializing among our user communities, as well as introducing more online and offline collaborations with ips, including the Fashion Week that Forrest just mentioned, to further build out this IP as well as the platform and maximize the long-term potential of Free Fire. We will continue to focus on that as well as continue to build out our game pipeline with more diversified genres from our self-developed pipeline and publishing, as well as our investment pipeline. So that's our focus in the near to longer-term. We continue to see long-term potential for the game.

Operator, Operator

Our next question today will come from Piyush Choudhary of HSBC. Please go ahead.

Piyush Choudhary, Analyst

Yes. Hi. Good evening to the entire management team. Congratulations and thanks for the opportunity. Two questions from me. Firstly, Free Fire MAX was launched in late September. So, could you give us some insights on user engagement? How is that option in time spent, how different is it from Free Fire, and how does it impact your 2022 outlook? Second question is on Sea Capital. Could you give us an update on how much of the initial $1 billion capital is already deployed? And there were some media news around investment in Forte; is that correct? And if yes, then what's the strategic rationale for the same? Thank you.

Yanjun Wang, Group Chief Corporate Officer

Thank you, Piyush. In terms of Free Fire MAX, it is still at a very early stage. We already see some positive and encouraging signs within our expectation of deeper engagement with users who have higher-spec phones and that can enjoy higher resolution pictures and more features, etc. But very importantly, we ensure that users of Free Fire and Free Fire MAX can play together in the same game, and also, users can use the same account to log in to both versions. Within Free Fire MAX, we have introduced features such as Craftland, which allows users to edit maps and customize them to make them available for other users. This is our initial attempt to create more user-generated content tools for our community engagement and bringing more creativity from our community into the game itself. I think there are a lot of exciting developments that are to be rolled out in Free Fire MAX and also in Free Fire. We are very much looking forward to the fourth quarter and ahead to continue to grow this game. In terms of Sea Capital, we don't specifically disclose investment amounts. It's important to focus on supporting our ecosystem as well as innovations as the core mission not just of Sea, but also the different arms of Sea, including Sea Capital, where the team will continue to, as we mentioned before, focus on supporting innovation, supporting founding teams, and enabling all communities through technology that align with our mission to serve all communities with technology. The Forte investment is part of that effort as well.

Operator, Operator

Our next question will come from Piyush Mubayi of Goldman Sachs. Please go ahead.

Piyush Mubayi, Analyst

Thank you for taking my question. Yanjun, you mentioned normalization after COVID. Could you outline the potential outcomes as we move away from COVID, considering your presence in gaming and e-commerce? It's somewhat unclear. When I examine the e-commerce sectors you operate in, it appears that there could be an economic boost, which should benefit your e-commerce operations. On the gaming side, while there may be increased opportunities for gameplay, this could affect your paying ratios. I can see that in markets like the U.S., the effects might differ. Could you explain what you envision for your company in the post-COVID era and what the appropriate normal figures should be? That would be appreciated. My second question is more broad. You mentioned initially about assisting merchants in expanding and utilizing the platform globally. Could you discuss the current status of this process in building the margin base in countries like Indonesia compared to the cycle we have observed in China and provide an analogy of which stage we are currently in? Thank you.

Yanjun Wang, Group Chief Corporate Officer

Thank you, Piyush. In terms of COVID, I think we are already living in a more normalized time. I believe the Q3 results partly reflect that, in fact. So, we continue to see strong growth from e-commerce sites across various markets. Now, we discussed it before during a few quarters earlier, when COVID hit. There are different scenarios. On the one hand, there are tailwinds coming from social distancing rules where people rely more on online shopping to fulfill their consumption needs because of the rules, as well as for safety measures. On the other hand, if in the longer run, there is a significant impact on economies, there could be downward pressure on overall consumption that could also affect the e-commerce industry as a whole. How much of that impact might be felt by us individually remains to be seen. Looking at our current trends and results, we believe that, on one hand, the step-up in digitalization in our markets, the forming of user behavior to shop online and also sell online by more of the small businesses and even the brands are permanent — are here to stay. While we haven't seen any particular economy being so deeply or permanently impacted by COVID, there is clearly an impact on consumption. At least from our perspective, as the market leader, we continue to grow in our market leadership, especially in our markets, which are generally high-growth with low e-commerce penetration, we continue to see long-term growth potential. On that front, we are quite optimistic about the long-term growth potential of e-commerce. Of course, normalize our stage when we do year-on-year comparisons, the comps will be internally tough for all e-commerce companies. I think Shopee has done—I think our team has done a great job in continuing to grow at a triple-digit rate for so many quarters, and that required a lot of effort. We also applaud our sellers' communities and their efforts in working with us. That naturally leads to the second question on how we grow the merchant base to help them grow more. I think our merchants, especially as we focus on more operational management, the small business sellers; they need more hand-holding and help in managing their businesses. We started with very basic tools from teaching them how to take nice pictures of their products to be sold online and how to describe the products accurately to be picked up by the right QR switches, ranging all the way to inventory management and marketing to maximize sales. We provide various classes for our merchants, as well as setting up many Shopee centers everywhere that we can help them with tools and develop online and mobile tools, game features, and social features to reach them deeply to help them manage their sales. From the platform perspective, we also offer integrated payment and logistic services to streamline the process for them. In terms of international expansion, we have been very focused on helping our Indonesian merchants sell their products globally now that there's demand. For example, our international programs allow their products to be mapped easily onto different markets' UIs, without them needing to learn different languages and do extensive training. We have developed many tools to make this process as smooth as possible. On the gaming side, I think as I mentioned, the post-COVID normalization shows we have a more stable user base. However, even during tough comparisons, we see improvements year-on-year and quarter-on-quarter pretty much across all metrics, which shows the great achievement by our game team. However, in the longer run, we continue to see growth opportunities both in Free Fire itself, through new features, new modes, new collaborations, and new IP introductions. We're very positive on the game outlook as well.

Operator, Operator

And our next question today will come from Venugopal Garre of Bernstein. Please go ahead.

Venugopal Garre, Analyst

Hi, good evening, everyone, and thank you for the opportunity. Yanjun, my first question is about our expansion into new geographies. I would like to know if we are finished selecting the countries we want to explore for global expansion, especially since we've entered several new markets in the last few months. It seems that since we launched, there haven't been significant user awareness campaigns. While social media, particularly platforms like Instagram, is being used, we don’t see many followers. I want to understand your approach to this, whether we are spending time and resources efficiently on user awareness, and what additional spending you are planning for this, especially in the first quarter, given the cost structure for the e-commerce business moving forward. My second question relates to the press release, where it was mentioned that increased costs for e-commerce logistics are a factor. I want to know if this is mainly due to global freight rate increases, particularly with our larger cross-border activities due to geographic expansion, or if it's more related to the value-added services being integrated, which also affects the take rate. Thank you.

Yanjun Wang, Group Chief Corporate Officer

Okay. Thank you. In terms of global expansion questions, we may from time to time test waters, but I think the focus is to concentrate on markets where we have a strong presence, and there's not much to report on at this point. If we open a new market, I'm sure people will hear about it in those markets otherwise. Now, regarding the marketing campaigns, we haven't really focused on widespread national campaigns. If you look at our other markets, we believe we're well followed on social media in Southeast Asia and Latin markets. For newer markets, again, I would not read too much into the current operations and numbers because it's still in a very nascent stage. In terms of our logistics and cost structure, we usually partner with third-party logistics providers to serve our sellers and vast communities. Most of our sellers are primarily local, so we focus on connecting with local third-party logistics providers to streamline the process and ensure timely and reliable delivery for our users. The cost can, over time, decrease due to efficiency and improvements in operations. We continue to view our logistics strategy as holistic, looking at how the overall experience has been for our sellers and buyers. Whether we will need to ramp up more of our own Shopee Express delivery or we can rely more on third-party logistics providers, we remain open-minded and take a pragmatic approach to this.

Operator, Operator

Our next question will come from Ranjan Sharma of JPMorgan. Please go ahead.

Ranjan Sharma, Analyst

Hi. Good evening. And thank you for the call. Two questions from my side. Firstly, on the gaming side, you have not changed your guidance. Based on your nine-month results, it's indicating that the gaming portfolio is going to decline in the fourth quarter despite the launch of Free Fire MAX. Is there any chance that you might guide this way, or could there be some upside risk to the guidance? The second question is on the e-commerce basket size; it seems to be trending down. If you could help us understand what's driving that and if that could turn around as well. Thank you.

Yanjun Wang, Group Chief Corporate Officer

Yes. Thank you, Ranjan. Regarding the gaming side, as I mentioned, we are continuing to build out our franchise. Free Fire MAX is primarily a user engagement tool to deepen engagement with user communities by offering more features and possibilities for users with higher-spec phones that allow for higher resolution maps and features. This isn't a revenue driver for us at this stage; we believe our game guidance, given the end of the year, has a strong guidance in terms of monetization, given the comparison versus last year and our overall size of the game portfolio that we have scaled up rapidly over the past few years. It is crucial for us to solidify our user base, as well as our game content and pipeline capabilities to focus on long-term growth and maximizing the potential of the Free Fire platform and IP, as well as diversifying our genres across a stronger spectrum. In terms of e-commerce average order value, I believe it has trended slightly downwards partly due to new market entrants where the basket size tends to be smaller. Overall, our average order value has been relatively stable within a high single-digit to low double-digit range. Sometimes it can fluctuate based on shopping seasons or category mixes. Thus, overall, I think the average order value trend is fairly stable, and we don't have a KPI to drive it upward. The average order value as the right mix depends on the markets we are in and our understanding of what our users in those markets need, what categories we serve them best, and how it might evolve over time as we focus on user growth. Therefore, singularly focusing on average order value could negatively impact the health and long-term profitability of the e-commerce platform.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Min Ju Song for any closing remarks.

Min Ju Song, Group Chief Corporate Officer

Thank you. And thank you all for joining today's call. We look forward to speaking to all of you again next quarter. Thank you.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.