A little over a year ago we published an article about a trip to the ASEAN region (ASEAN – A Force for Growth?). Sadly, it was a fairly unsatisfactory trip with a very short list of actionable ideas emerging from it. But there only needs to be one, and there was, and it was Sea Limited, which we bought following our first face to face meeting with management on that trip.
The thesis was simple and points to the heart of what we are constantly trying to look for at Aubrey. South East Asia, and in particular Indonesia, was entering the sweet spot of growth for e-commerce. Something we have witnessed and successfully participated in over the past decade in China, was finally coming to ASEAN. Our expectation of several consecutive years of 50%-plus growth in e-commerce revenues still looks comfortable.
Why now? A heady combination of rising disposable incomes, as GDP per capita reached levels which allow for a little more discretionary spending, the spread of smartphones and 4G internet connectivity, and the fact that bricks and mortar retail remains underdeveloped, all coincided with a “gold rush” of subsidised, market share grabbing, deep pocketed new entrants into the e-commerce sector.
It is all very well identifying the growth trend, but if there is no stock to buy, or not the right one, then it is clearly of little help to us. But here was Sea! What tipped the balance for Sea last March was twofold. Firstly, the aforementioned “gold rush” was coming to an end as even the deepest pockets emptied out, and so started the process of consolidation. Secondly, the realisation that Sea, or rather Shopee, their e-commerce marketplace, was going to be one of the winners in that consolidation process. These changes and the critical scale that Shopee had achieved allowed them to reduce consumer subsidies. In addition, the services that had been offered free to re-sellers could start to attract modest fees. The virtuous cycle towards profitability could begin.
Another helpful factor at the time came from Sea’s games division Garena, which was enjoying the runaway success of their first in-house developed game, FreeFire, across not just Asia, but much of the developing world. This not only helped to drive growth, but also provided the cash flow (another key facet of our process) to invest in the e-commerce side of the business.
So what did we pay for Sea a year ago and where are we today? The company was not yet profitable, which makes our PEG valuation methodology unhelpful in the short term. At the time we forecasted profitability in 2021, and as is usually the case in such situations, the initial growth is enormous, and the PEG, by definition extremely low and well within our target of 1x. Cross checking with other valuation metrics favoured by private funders of Shopee’s unlisted competitors, also showed Sea in a favourable light.
Roll on a year, and when we updated our numbers in April 2020, events had indeed rolled on considerably. We had grossly under estimated revenue growth for 2019, which came in at 163%. We had to increase growth expectations for 2020, although in the reality of Covid, Shopee has adjusted its sales mix which may result in “only” 50% revenue growth, despite faster than expected GMV (Gross Merchandise Value) growth, thanks to a change in product mix. Also, partly due to Covid, we have had to move profitability out another year to 2022, but again the PEG will still be very low when that profitability comes through.
The point of this analysis is to demonstrate the importance of identifying the correct growth trends in the countries in which we invest, which lies at the core of our process. All the conditions for dramatic growth in e-commerce were there in SE Asia, despite the broader economies offering relatively pedestrian rates of growth. Clearly, selecting the right stock is also vitally important, but had we been less confident in the trend of e-commerce growth in SE Asia, we might not have been looking here at all. We might also have baulked at buying a stock which had just jumped over 40% since reporting blow out Q4 2018 results, and was up over 100% since the start of the year. Instead, ignoring the short term excitement, and confident in our longer term view, we started buying at around $23.
Of course, it does not always work as well or as quickly as this one has done, with a fourfold rise in little more than a year. Talking to the Sea management again this month, it is clear that despite any short term issues, Covid has been hugely positive for the development of both core businesses, e-commerce and gaming, and we could not have foreseen that. Events like Covid are disruptive, but they usually just accelerate the kind of behavioural change we are already seeking to take advantage of. But that aside, this remains a good example of why the Aubrey process works, because we are already looking in the right areas for our growth.
*A popular Chinese expression back in the early 1990s used to describe someone who left the iron rice bowl of government or SOE employment and joined a private enterprise. As the decade went on the rewards of such a move increasingly proved to be worth the perceived risks.
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