The folks at Cabot are so often enthusiastic about great growth companies, often picking them and re-picking them as they soar higher, that they sometimes remind me of David Gardner and his Motley Fool Rule Breakers… and given their yen for growth, I imagine both probably are coming off of exceptional years with the explosion in cloud, SaaS and “pandemic” tech stocks.
The latest Cabot pitch is for that Cabot Stock of the Week service ($997/yr), which is kind of a “greatest hits” newsletter — publisher Timothy Lutts picks his favorite idea from among Cabot’s stock advisory services each week, so they’re presumably mostly “growth” ideas, given Cabot’s quantitative bent, but they do also have a few dividend and value-focused newsletters… so there ought be some variety.
This time, though, it’s all growth on the docket — they say that this “blue ocean growth stock” is already up 708% and has “plenty of room to grow” and “looks like Tesla when we recommended it in 2011.” So what is it? Can we get you an answer for something a bit more free-ish than $997?
Here are our clues from the email about “This hidden company… headquartered in “the Switzerland of Asia”:
“One secret to this New-York-Stock-Exchange-listed company’s stunning success in becoming the most valuable company listed in high-quality Singapore is the background of its three founders.
“They are all now billionaires.
“Two of the three founders came to Singapore for an elite education, and two also hold degrees from prestigious American universities.
“These young entrepreneurs were also lucky to focus on and then dominate three key high growth markets in Southeast Asia – a market with 650 million people.
“The company’s stock is up 395% in 2020, after surging 255% in 2019.”
OK, so that rings a big ol’ bell — I think this is a pitch we’ve covered before. And, of course, if it’s had growth like that most investors will probably at least have heard of it, no? What other clues do we get? More from the pitch…
“There are three powerful engines propelling this company and stock.
“One market is gaming, another is digital payments, and the third is an E-commerce platform that is growing revenue much faster than Amazon with orders of more than 2 million a day.
“Revenue is growing at a rate of more than 100% because it is targeting some of the fastest-growing markets in the world. It’s ecommerce sales have grown exponentially from $47 million in sales in 2017 to $823 million last year.”
Ah, so now that’s starting to sound a bit more familiar. You might be ready with some guesses now, too, I imagine… but let’s check one or two other clues just to be sure:
“A leading conglomerate owns 30% of and has a strategic partnership with this company.”
Mmm hmmm, that tracks too. More?
“It has $2.6 billion is cash and only $1.3 billion of long-term debt.
“The company is expanding into India, which has a population of 1.3 billion people but only 10% of this company’s customers are from India.”
OK, fine, we can’t put off our answer any longer — this is indeed still Sea Ltd. (SE), the wild growth story that’s trying to become the MercadoLibre/Tencent/Shopify/Paypal of Southeast Asia.
And, of course, most growth or technology investors will probably have heard of this one by now, it has emerged from almost nowhere to become a $120 billion company (it was $20 billion a year ago… and came public at about $5 billion in 2017), riding the same gaming and e-commerce waves that propelled so many tech stocks during the coronavirus shutdowns last year… but with a little rocket fuel added in because they’re also a leader in one of the fastest growing parts of the world. And yes, thanks to that surging stock price, Sea is now the largest company in Singapore by market capitalization… though it doesn’t have a listing on the Singapore Stock Exchange (it only trades in NY).
I didn’t start buying this stock until after the coronavirus hit, in May of 2020, and even then, at $60 a share, the valuation felt challenging — but sometimes you just have to hold on tight when great companies get an investor tailwind, and count on position sizing and perhaps a stop loss order to protect yourself if that enthusiasm turns into a bubble that ends up popping. Sea is a real company, with huge scale and amazing growth, and it’s still cheaper than Shopify and a few other competitors if you look at metrics like price/sales… though it’s also unprofitable (unlike Shopify) and very dependent on Free Fire, and analysts are all over the map with their forecasts (none expect profitability over the next couple years, and in fact the company has routinely lost more than predicted thanks to their massive spending on growth, but the revenue predictions vary widely — for 2021, the high forecast is $10 billion and the low is $7 billion… obviously either represents rapid growth from 2020’s $4.4 billion, but the difference is abnormally huge).
Here’s a little snippet from a longer Annual Review piece on Sea that I posted about a month ago:
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Sea Ltd. (SE) posted very strong earnings again, and ludicrous guidance. They have some interesting potential growth engines in financial services, and a new investment arm, but the business is really dominated by two things: the Garena video game business (mostly their Free Fire mobile game), which generates a lot of cash flow, and the Shopee e-commerce platform (similar to Shopify or MercadoLibre), whose growth is being subsidized by Garena.
The numbers are jarring — 111% growth in bookings for their gaming business, Garena, to $1 billion in the quarter, and with $664 billion in EBITDA from that as Free Fire continued to be the most popular mobile game in the world (for the second year)… but let me focus on the annual revenues, because I think that provides a better idea of the huge numbers we’re dealing with. Garena had $3.2 billion in bookings in 2020, and the adjusted EBITDA from that hit $2 billion. Engagement grew consistently through the year, and their user base grew 72% and the paying user base 120%. Garena is still the economic engine of the company, and it’s still very much reliant on Free Fire, but they are also investing in their game studios to develop new content both for Free Fire and for new games that should be able to capitalize on the huge installed base (which was more than 600 million active users last quarter, 8% of the global population — yes, 80%+ of those are free accounts, probably with many players having multiple accounts, but still…).
And in the Shopee e-commerce business, which is primarily focused on Southeast Asia (with number one position in some big countries, like Indonesia and Taiwan), the growth was similarly wild — Gross Merchandise Volume (the money flowing through Shopee stores, not money Shopee actually makes) hit $35.4 billion in 2020, and Shopee’s own revenue grew 150% to hit $2.2 billion. they guided investors to expect revenue at their Shopee division to grow to $4.6 billion in 2021, more than doubling again from $2.2 billion last year….
The bad? Well, they’re not profitable. That intense focus on growing e-commerce at a crazy clip means that they’re chewing up all the money that Free Fire makes plus a lot more, so the total operating loss for 2020 was about $1.3 billion. This is, they make very clear, a choice — much like Shopify a few years ago or Amazon for decades before that, Sea believes that they have the potential right now to scale back on growth and break even on their e-commerce business… but they are investing in growth, by choice, and therefore can be somewhat elastic about pulling back if they ever need to.
So why did the stock come off of its highs? Well, obviously some of that’s just “growth stocks are going down” because there’s been a reset in the market, caused mostly by shifting sentiment about interest rates, since higher rates have the general tendency to make future revenue look less valuable than current revenue. We can’t do anything about that shift, nor can we predict when it ends — that’s just mass psychology in motion, and it could easily overcorrect on the way down just as much, or more, than it overflew rational valuations on the way up for all of these kinds of stocks.
But we can look at the company itself, with its vision about continuing to bring the digital world to the emerging world, and see how they’re doing and what we think that should be worth. I think the Sea-specific news that was taken a little bit badly by the market was a combination of much lower forecasts for Garena revenue growth, and the passing note that the buzz about their Shopee business expanding to Brazil is probably overdone. They are building that business in Brazil, mostly to support existing cross-border relationships between Latin American and Southeast Asia, but they made clear to note that it was very early days and they hadn’t decided to move aggressively into Latin America and don’t necessarily understand those markets well yet. Latin America and India are the two hugest markets for Free Fire, so investors are prone to speculate that this might mean they can expand Shopee to those markets, and see incredible new avenues of growth, and it struck me that there was a little bit of cold water splashed on that idea in the conference call. They don’t need to expand Shopee beyond Southeast Asia at this point to find new growth avenues, they’re still growing very fast in a region of the world where economic growth should also be very fast, but hope springs eternal for more global domination….
I think that patient investors can pay 10X forward sales for Sea and have a very good chance of it working out well over the long run — with guidance for bookings and revenue coming in at roughly $9 billion for 2021, even with what some folks are considering to be lowball guidance on the gaming side (“only” 38% growth), that would be a market cap of roughly $90 billion. That would be $175 per share.
If you want to be a little more optimistic, paying up to 12X sales (P/S for SE before 2020 generally fluctuated between 7-12), that would be about $210. If you want to go higher than that, you have to probably start to make some assumptions about 2022 revenues — with the expectation that 2022 revenues will be around $11 billion (the analyst forecast range is $9.2-14.3b), those numbers might roll up to $210 (10X 2022 sales) and $250 (12X 2022 sales).
Sea shares have been in that neighborhood recently, the shares dipped briefly below $200 in the past couple weeks before bouncing back higher again, but it’s certainly not easy to catch a perfect moment for volatile growth stocks like this.
I wouldn’t talk you out of nibbling in this area, sometimes for a great growth story — and that’s what Sea is — owning just a share or two even at a crazy price is a good way to get a little handle on them. If you own a share or two it gets your full attention, you monitor the progress, and if it drops 10% or 20% the next time things get a little ugly, and you feel better about the valuation, you can begin to fill out a position.
I do still have a call option position on SE in addition to my equity stake, so I’m not adding currently… but I’ll be tempted if the shares drop to my buy range, and it’s very likely that I will eventually exercise those call options to increase my holdings (assuming, of course, that SE remains well above $100 — my options are at $90 and expire in January). Sea is a big company already, with its high valuation multiple and $120 billion market cap, but it’s not very often that you see companies with “next Amazon, next Tencent” ambitions.
It’s hard to find comparable stocks to Sea, and it really only looks reasonably valued if you compare it to some other wild high-octane stocks, like Shopify (SHOP) or MercadoLibre (MELI)… so there is ample reason for caution, but I do need to reiterate that the growth is just plain phenomenal. Sea has now grown revenues by at least 100%, year over year, in almost every quarter for three years (nine quarters of at least 100% year-over-year growth, once even hitting almost 200%, and three laggard quarters of 98%, 82% and 77%). That’s considerably better than Shopify, which has not yet quite hit 100% growth (they’ve been damn close, in the 90s for the past three quarters), and it’s worth noting that this wasn’t a one-time acceleration because of the pandemic — the pandemic was clearly a tailwind for a lot of their businesses, but still, growth for Sea was slower in 2020 than it was in 2019.
Shopify is a better business, it’s got sustainable profitability now and serious operating leverage because of their focus on software sales, while Sea has significantly higher operating expenses and isn’t profitable because they’re investing their gaming profits back into e-commerce growth, but Sea is a bigger business despite the fact that they’re growing faster — they had $4.4 billion in sales last year, to $2 billion for SHOP (on the e-commerce side, SHOP is still far larger, with Gross Merchandise Volume of $120 billion for 2020, versus just $35 billion for Shopee).
The risks? They are in very competitive markets pretty much everywhere when it comes to digital payments and e-commerce, and they are very reliant on the continued success of their hit Free Fire video game to generate some positive cash flow, which is mostly being used to build the e-commerce platform.
If you invert those risks, of course, that’s like saying the biggest risk is that they’re in high-potential countries and have a huge and sustained hit on their hands. Tencent was a big risk years ago because they were dependent on WeChat and competing with other well-capitalized companies like Baidu and Alibaba. Tencent at a similar stage, when it was a $100 billion company, was trading at only about 12X sales, not 20X or 25X like Sea, but that’s more a function of the market we’re in than a definitive statement about which is a better company at those points in time (OK, fine, Tencent was also profitable back then, trading at about 40X earnings when it was a $100 billion company in 2013… though it was also growing revenues at “only” 40%). Tencent built a massive and powerful platform on a fast-growing economy that was going rapidly digital, and Sea is trying to do that as well… I don’t know if it will work or not, but Tencent is also backing Sea (they’re a 30% owner), and I like their chances. I also like Sea Ltd’s metaphorical step-up to becoming a “grown up” regional technology company, with investments recently in Artificial Intelligence R&D and a new billion-dollar venture fund that they will use to seed new ideas.
I think the valuation probably shot too high as it approached $300 last month, since Sea has a long road of growth ahead before they can think about becoming sustainably profitable, and they’re not likely to ever approach the 70-80% margins of some of the high-growth software companies that help to support (at least for now) those valuations of 30X-40X revenues… but I also didn’t sell when we hit those prices. I think the growth is probably still under-appreciated at this point, as is the fact that they are winning in both gaming and e-commerce in some of the most important and yet most-overlooked emerging markets in the world (like Indonesia).
That’s just my thinking, though, and what I’m doing with my money — with your money, it’s your decision that matters. Think Sea has potential? Think the growth is too pricey here? Do you like Free Fire and Shopee, or think they’re facing too much competition? Let us know with a comment below.
Disclosure: Of the stocks mentioned above, I own shares of Sea Ltd, Shopify and Amazon, and call options on Sea Litd.