Friday, 20 May 2022

Sea Group: Growth Story No Longer Present

The latest results shows that the growth story has disintegrated. Profits earned from Garena is declining, losses from Shopee grew and GMV has slowed. In a sentence, Sea Group's share prices looks set to go down further.

Sea Money is unlikely to be the Winner in South East Asia Space

No doubt, South East Asia has a large population of unbanked individuals where Sea could tap on. However, it has two major competitors in Grab and Go-to.

Furthermore, it seems Grab has keeping itself toe to toe with Sea despite the latter having a larger warchest. Grab's latest financial results shows it has slowed its cash burning rate and is able to survive 10 more quarters on its current cash balance. This means shopee has to balance burning 8 billion in cash over the next 10 quarters to keep its battle with Grab.

The emergence of Go-To with a large war chest post IPO signifies that that digital payment battle is far from over and I do not think we are going to have a clear winner. This means a continuous battle in South East Asia. Hence, I am ascribing a 0% chance we will have a clear winner among the 3 which would have been a winner with a US$65 billion valuation like DBS.

Based on my previous post in determining the value of Sea Group, I have since modified it that Sea has a zero chance of domination in the digital space. A truce is more likely with Sea being the largest of the 3 in South East Asia (excluding Indonesia). Sea should be worth US$15 billion. This is much lower than my initial valuation of US$40.5 billion where I thought Sea Group had a good chance of winning.

On a sum of parts valuation, Sea Group is worth US$40 billion in market capitalization (US$72 share price).

Potential Dilution of Shares

Sea Group has about US$2 billion in convertible bonds due in 2025-2026 where bondholders can convert shares at US$90-300+ per piece or get back in cash. Given that it is unlikely Sea Group share prices will return to its hey days, existing shareholders face a medium term equity exercise raising by Sea Group to repay its debts.

In addition, the group has about 54 million in share options granted to employees and majority shareholders that have not been exercised. This means a potential dilution of 9.6% based on unvested options.

One can reasonably expect an enlarged share base of 15% from now to 2026 factoring more share based compensation to be given; maintaining a US$40 billion valuation, the future share price in 2026 is US$62. Expecting a 60% total return for owning a stake for 4 years. A worthwhile price to enter Sea Group is US$38

Only if Grab or Go-To declares bankruptcy, will a positive re-rating happen for Sea.

Tuesday, 3 May 2022

Alibaba's Value is now clearer as Regulations has Eased

Last week, the Chinese Government has again affirmed that the many rounds of regulation on the likes of Alibaba, Tencent etc. is nearing its end via a speech that the future economic growth of China will be supported with the rise of its own Internet platforms. 

While it is merely verbal affirmation with no real policy shown yet, the continuous regulations has resulted in Chinese economy slowing and China Internet companies have been firing their own locals in order to cut cost. 

What's Next for Alibaba?

Just by a single speech, Alibaba moved up 10%. However, to me what is important is that are we now able to value the worth of Alibaba as a sum of parts. To me, it might now be safe to evaluate Alibaba's value as the waves of regulations has cleared.

Base Case Scenario

Based on Alibaba's latest quarter (page 8), its e commerce business margins have dropped, international e commerce's competition has intensified and local consumer services has not been doing well. At the end state, it is likely the first 3 sectors will be making RMB$40 billion per quarter, while the Cloud division and Cainiao will only break even, earning RMB$1 billion each. Personally, it is difficult for Alibaba Cloud to be a successful as Amazon's Web Services which generates as much profit as its e commerce. This is because Alibaba Cloud's main market is China and the Chinese Government is still wary of Alibaba Cloud and has been asking government entities to shift to Huawei Cloud which is technologically inferior to both Tencent's and Alibaba's cloud offering. 

Excluding the RMB $28 billion impairment which is one time, I expect Alibaba, as a group, to be reporting profits of RMB $37 billion per quarter (USD$5.6 billion per quarter). Extrapolating to a full year, Alibaba might be a US$22 billion profit generating machine. Applying a 20 times P/E (which is 50% of Amazon's valuation), we are looking at a US$440 billion market cap, implying a 58% upside.

Bull Case Scenario

To me, the bull case is that its cloud services becomes as profitable as its e commerce division as China allows it to prosper- something that Amazon Web Services has achieved for Amazon. This means the doubling of profits and will put Alibaba at US$880 billion market cap at 20 times P/E. This is a 215% upside.

My evaluation

To me, the bull case is a little hard to believe because i don't forsee China ever allowing Alibaba and Tencent Cloud to rule over China's Internet and Payment Services like what Amazon, Microsoft, Alphabet have done to the Western World. 

The offerings and Technological innovation by these 2 China Tech giant are definitely as good as the latter 3 US companies. But because the Chinese Communist Government is wary of them in growing to be larger than the communist party itself. I personally don't think either of the 2 will become trillion market cap giants.

Hence my view is that Alibaba can grow to be a US$420-US$500 billion market cap. Alibaba's business offering is more diverse than Amazon's (on an apple to apple comparison) because it has a 'Google Maps" division, a payment service, a digital banking arm and a youtube equivalent in China. This means Alibaba is in fact an Amazon + part of Alphabet. However to even grow to even Amazon's value of US$1.2 trillion is never going to happen.

My estimate is at a price of US$186 (share price) or US$500 billion market cap, it is the upper limit of Alibaba's fair value.