Is Tencent SEA going to be dragged down by another poorly-made game?

On the evening of May 16th, before the US stock market opened, SEA Donghai Group released its Q1 2023 financial report, with the following highlights:

1. Profit Release "One Season Tour"? Overall, SEA achieved revenue of USD 3.04 billion this quarter, a year-on-year increase of 5%, which is completely in line with market expectations, without surprise or joy. However, the overall operating profit of 130 million achieved this quarter is significantly lower than the market's expected 270 million. The operating profit margin also slid from last quarter's 9.9% to 4.1%. Dolphin Analyst believes that after the "miracle" of just turning losses into profits last quarter, the re-sliding of the profit margin in just one quarter will make the market worry about the sustainability of SEA's profits, which is probably the main reason for the sharp drop in the stock price after the market closed.

2. The biggest problem, Garena is still collapsing: Looking closely at the performance of each segment, the biggest drag on this performance is still the gaming segment. In terms of revenue, this quarter confirmed a revenue of 540 million, which is close to halving both year-on-year and quarter-on-quarter, and far lower than the expected 650 million. In fact, since 3Q last year, the decline in Garena's gaming revenue has been close to halving. The decline in revenue in the previous few quarters was only 10%-30%, which was made up by overdrawing hundreds of millions of deferred revenue each quarter. However, with the "grain reserves" approaching depletion, the confirmed deferred revenue this quarter was only 60 million, which caused the revenue scale to collapse rapidly.

Due to the significant shrinkage of revenue, the operating profit of the Garena segment this quarter was only 280 million, significantly lower than the expected 320 million.

In terms of operating data, the confirmed revenue this quarter was 460 million, a year-on-year decrease of 42%. The number of paying users also decreased by 6 million compared to the previous quarter. The only good news is that the number of active users increased by 6 million compared to the previous quarter. The total number of players began to return, but most of them are "free riders", and the core paying players are still decreasing. From the current trend, Garena's collapse is unlikely to end in the short term.

3. After crazy cashing out, has Shopee's GMV growth disappeared? The biggest change in the Shopee segment this quarter is that the company did not disclose data such as GMV and order volume, leaving only revenue and profit as the two financial indicators. Specifically, the Shopee e-commerce segment achieved revenue of 2.07 billion, which is completely in line with market expectations. The year-on-year growth rate is 36%, which is slightly faster than the previous quarters, and the revenue growth performance is good.

Combined with the company's recent announcement of a general increase in monetization rates in the Southeast Asian market, revenue growth is likely to be driven entirely by the increase in monetization rates. The growth of GMV is probably not good, so the company simply did not disclose it.

In terms of profit, Shopee achieved an operating profit of 120 million, exceeding the expected 83 million. Against the background of the continuous increase in monetization rates, the profit margin of the segment is also logically increasing. However, the problem is still what Dolphin Analyst previously emphasized. A higher monetization rate will inevitably be unfavorable to the growth of e-commerce platforms, and how to balance growth and profit in the future is still a problem. 4. SeaMoney Financial Maintains High Growth: SeaMoney achieved a revenue of RMB 410 million this quarter, with a revenue growth rate of 75%, which is significantly higher than the expected RMB 370 million. SeaMoney is still in a high-growth phase. In terms of risk management, the proportion of loans overdue for more than 90 days remains at 2%, the same as last quarter. The bad debt provision for this quarter was RMB 170 million, which is also the same as last quarter. At present, the risk of SeaMoney's business is still under control.

5. Decline in Gross Profit, Also Blamed on Garena: In terms of gross profit, the company's overall gross profit was RMB 142 million, which is lower than the market's expected RMB 144 million. The gross profit margin also dropped from the high point of 49% in the previous quarter to 46.6%. Looking at the different business segments, the gaming segment is still the main drag, with a gross profit margin dropping significantly from 74% in the previous quarter to 68%. The gross profit of SeaMoney's financial segment also slightly decreased from 15.5% to 13%. However, due to the increase in realization rate, the gross profit margin of the e-commerce segment increased from 43% to 45%.

6. Expenses Are Increasing Again: Among the regular operating expenses, only marketing expenses are still shrinking, accounting for a decreasing proportion of revenue, down to 13.2% on a quarter-on-quarter basis. The marketing expense ratios of the gaming and financial segments are only in the low single digits, basically maintaining the minimum level of promotion, while the e-commerce segment still has more than 15% of its revenue used for marketing.

Management expenses and research and development expense ratios have begun to increase on a quarter-on-quarter basis, with the former increasing by 1.5 percentage points and the latter increasing by 3.4 percentage points. Although the company announced a 5% salary increase for the entire group, implying that the company's cost control efforts will be eased, it was unexpected that it would be reflected in the first quarter financial report, earlier than Dolphin Analyst expected.

Looking at the profit of each business segment, the relatively increased research and development expenses this quarter were mainly used in the gaming segment, but a lot of investment was made in the development of new games, and it is unclear when it will be effective.

Overall, the total expense ratio increased significantly from 36% in the previous quarter to 40.5% after combining the three expenses. Coupled with the decline in gross profit margin by nearly 3 percentage points, the company's overall operating profit margin dropped from 10% to 4%, significantly lower than expected.

Dolphin Analyst's View:

Overall, the only downside of SEA's financial report this quarter is still the Garena gaming segment. After the "residual income" is exhausted, the revenue scale quickly declines, leading to a significant decline in the profit of the gaming segment, which is also lower than expected. Although the revenue growth of the e-commerce segment is still strong (although at the cost of an increase in realization rate and a probable shrinkage of GMV), and the segment's profit is still continuing to increase, it still leads to the overall profit of the group being lower than expected. And in a market where confidence in SEA was already low and the prospects were unclear, a financial report with flaws but no highlights still led to an overzealous pursuit of safety in the market, with the first to run being the most respectful.

Therefore, the focus of the company has returned to when the Garena sector can launch successful new games, reactivating the heat and revenue growth of the gaming industry.

According to Dolphin Analyst's preliminary estimates, the pre-market valuation of the company is in the neutral range, and the sharp drop in the market during the trading day has basically wiped out all valuations of the gaming sector. It is close to the conservative range of pricing only for e-commerce and net cash.

The following is a detailed interpretation of the financial report:

1. Shopee e-commerce abandons scale and only looks at revenue and profit

This quarter, the company did not disclose GMV and order volume data for the Shopee e-commerce sector , so we can only look at financial performance. Specifically, revenue was $2.07 billion, in line with expectations of $2.06 billion. The year-on-year growth rate reached 36%, actually accelerating.

Among them, the core platform revenue was $183 million, a year-on-year increase of as much as 46%. Although the company stopped reporting GMV, it is still in a period of significant improvement in monetization rates according to Shopee's announcements in various markets.

Therefore, the growth of revenue in the e-commerce sector this quarter should be mainly driven by the improvement of monetization rates, and the company's non-disclosure of GMV data is probably a choice made under unfavorable data conditions.

Although how to balance profit and scale in the future is still a decision for management, the current results show that Shopee's performance is good.

2. The collapse of the Garena gaming sector continues

The Garena gaming sector is still sliding into the abyss, with revenue collapsing and no fundamental improvement in other operating data.

This quarter, the confirmed revenue of the gaming sector was $540 million, a year-on-year decrease of 52%. Even the month-on-month decrease was more than 40%, and it can be described as a complete collapse.

In fact, the "corruption" of the gaming sector has already begun, and the actual revenue received each quarter has been close to halved since 3Q last year. The reason why the decline in revenue in the previous few quarters was relatively small was entirely due to the overdraft of deferred revenue of several hundred million yuan each quarter.

This quarter, deferred revenue only made up less than $60 million in revenue, and Dolphin estimates that the remaining deferred revenue should have been almost exhausted, and the speed of revenue decline has begun to match the inflow.

On the user data front, a good news is that the number of active users has increased by nearly 6 million compared to the previous quarter, indicating that the popularity of Garena games is beginning to recover and players are returning. However, the number of paying players who actually contribute revenue has decreased by 6 million compared to the previous quarter. It can be seen that most of the returning users are low-value "free riders", and the revenue from high-value paying users has not stopped.

Therefore, from the trend of the number of users, it is feared that the turning point for the recovery of revenue and revenue of the Garena segment will not come in the short term. When the company can launch a popular new game to activate user and revenue growth is the key to everything.

3. SeaMoney digital finance continues to soar, but risks are controllable

Continuing the trend of the company's focus on the lending business after shifting its financial business focus to the lending business, SeaMoney's digital financial business achieved revenue of RMB 410 million this quarter, with a year-on-year growth rate of 75%, which is also higher than the market's expected RMB 370 million, indicating that the growth momentum is still sufficient.

On the risk control data: 1) As of the end of the first quarter, the company's outstanding loan balance was US$2 billion, a slight decrease of US$100 million compared to the previous quarter. 2) The bad debt rate overdue for 90 days remained stable at 2% compared to the previous quarter. 3) The bad debt loss provision for this quarter was also about RMB 170 million, which is basically the same as the previous quarter.

While continuing to grow in scale, risks are still controlled at the previous level.

4. Overall revenue is unremarkable, but the game segment drags down gross profit

Although the revenue of the game segment is significantly lower than expected, it is basically compensated by the financial segment that exceeded expectations, and the revenue of the largest e-commerce segment is also in line with expectations. Therefore, the company's confirmed revenue of RMB 3.04 billion is basically the same as the market's expectations. The year-on-year growth rate has further slowed to 5%, which is a reasonable consequence of the company's choice of profit first.

However, as the segment with the highest gross profit margin at present, the drag on gross profit level by the game segment is difficult to be filled by other segments. The gross profit margin of the game segment this quarter has dropped from 74% to 68%, hitting the lowest level in 21 years. Although the e-commerce sector continued to increase its monetization rate, and the gross profit margin continued to rise from 43% to 45%, it still failed to reverse the overall gross profit margin decline from 49% to 47%. This led to the company's overall gross profit of 1.42 billion, which was lower than the market's expected 1.44 billion.

5. Are expenses returning to investment pace?

From the perspective of expenses, the most flexible marketing expenses are still shrinking. The expense rates of the gaming and finance sectors have both fallen to less than 5%, which can be said to have retained only the minimum marketing promotion.

Only 16% of the revenue from the e-commerce sector is still used for marketing, but it has also decreased by 2pct compared to the previous period. Overall, the marketing expense ratio still decreased by 0.5pct compared to the previous period.

However, administrative expenses and research and development expenses have begun to expand on a month-on-month basis this quarter. Among them, the management expense ratio, which includes bad debt losses, increased by 1.5pct month-on-month, while research and development expenses increased by 3.4pct month-on-month, showing a significant expansion. Dolphin Analyst believes that the company should increase its investment in new games.

However, while the gaming sector dragged down the company's gross profit margin by 2pct, the company's cost control efforts also relaxed, and the total expense ratio increased significantly from 36% in the previous quarter to 40.5%. This ultimately led to the company's overall operating profit margin dropping from 10% to 4%, and the final profit of 130 million was significantly lower than the expected 270 million.

6. Actual profitability is not bad, all due to the drag of the gaming sector

However, looking at each sector separately, we can see that the operating profit margins of the three major businesses themselves have increased month-on-month, and even the absolute profit values of the e-commerce and finance sectors have grown month-on-month. It is only the gaming sector that has caused a significant drop in profits due to the sharp decline in revenue, which has dragged down the overall performance of the group.

In the meantime, the company recognized a goodwill impairment of approximately RMB 120 million this quarter, which increased the undistributed operating loss from approximately RMB 200 million in the previous quarter to RMB 320 million this quarter. In addition to the gaming sector, this impairment is also the main reason for the lower-than-expected profit.

However, since the goodwill impairment does not actually affect the company's cash, SEA's operating cash inflow this quarter was RMB 610 million, a significant increase compared to RMB 320 million in the previous quarter. At the same time, the company's cash and cash equivalents as of the first quarter reached USD 7.2 billion, further increasing from USD 6.9 billion last year. Therefore, the company's cash flow is not a problem, and the "bankruptcy risk" is unlikely to reappear.

Previous Research on SEA:

March 8, 2023 Telephone Conference Call "SEA: No More Fuss, Profit Remains the Priority in 23 Years"

March 8, 2023 Financial Report Review "Everything for Survival! Small TENCENT SEA Fights for Survival with One Arm"

November 16, 2022 Telephone Conference Call "SEA: Tightening the Belt, Survival is the Top Priority (3Q22 Minutes)"

November 16, 2022 Financial Report Review "Terrible Games, Shopee's Last Stand, Can SEA Make a Comeback?"

August 17, 2022 Telephone Conference Call "SEA: Efficiency is the Top Priority, Regardless of Scale (Minutes of Telephone Conference)"

August 17, 2022 Financial Report Review "No More Growth, Still Huge Losses, How Can Sea Save Its Valuation?" On May 17, 2022, Telephone Conference "Game Business Needs Diversity, E-commerce Business Needs Profitability (SEA Telephone Conference Summary)".

On May 17, 2022, Financial Report Review "SEA: Games are "Aging", E-commerce is Holding Up Alone".

On March 2, 2022, 4Q21 Telephone Conference "SEA Telephone Conference Summary: Strategic Reversal, Game Entertainment Diversification, E-commerce Needs to Increase Efficiency".

On March 2, 2022, 4Q21 Financial Report Review "SEA Wants to "Segment": E-commerce and Games are Two Different Worlds".

On January 5, 2022, "Little TENCENT" was Scared Away by TENCENT's Little Brother? The Significance of This Matter for SEA is Different.

Risk Disclosure and Statement of This Article: Dolphin Analyst Disclaimer and General Disclosure