Like Sea Limited? Here are 2 risks to be aware of before making a purchase

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Sea Limited (NYSE: SE) was a hot stock – and for good reason.

On the one hand, the technology company has proven itself. In just five years, it has grown from a pure gaming start-up to a rising force in e-commerce, grocery delivery and fintech. Additionally, Sea has often exceeded expectations due to its strong execution and an ever-growing, addressable market.

The result: the share has gained almost 2,000% since September 2016. Shares of Amazon, in perspective, increased by around 240% in the same period. However, in order to maintain its momentum, Sea must overcome a number of risks that could affect its growth trajectory.

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Sea Limited is overly dependent on Garena

Many technology investors are familiar with Shopee, Sea’s fast-growing online shopping platform. But ask her about Garena – his gaming business – and you might get questioning glances.

But make no mistake: it was Garena’s success that paved the way for Sea to expand into what it is today. The game developer and distributor is the company’s main profit engine, generating billions in profits each year that it can use to expand its other businesses such as Shopee and Sea Money. That momentum was evident in the last quarter when Garena posted adjusted EBITDA of $ 741 million, while the remaining businesses reported an EBITDA loss of $ 765 million.

Garena is one of the world’s largest game distributors with rights to distribute top titles such as call of Duty and League of Legends in Southeast Asia. But the core driver of its performance is Free fire, a mobile game developed in-house. Sea doesn’t report user numbers for individual titles, but it’s likely that the majority of Garena’s quarterly active users – 725 million as of Q2 – are on the platform to play Free fire. This means that the majority of Sea’s winnings can likely be attributed to that single game.

On the one hand, that is an impressive achievement. Garena started out as a little-known game distributor in 2009. It was just published Free fire 2017, when nobody could have guessed that the title would be so successful. A video game, on the other hand, serves as the foundation of his digital entertainment business – that’s a concentration risk that just can’t be ignored.

Until now, Free fire fired on all cylinders. The user base continues to grow, not only in Southeast Asia, but also in the United States and around the world. This drives Garena’s steadily rising profits, but investors are counting the days up Free fire begins to lose relevance. In the gaming world, that’s only a matter of time.

The big question is: can Garena bring out another smash hit? The company seems to be working hard to create one. In January 2020, it was acquired by Phoenix Labs, the manufacturer of Fearless – a highly rated, cross-platform game. Sea recently announced the addition of new offices in Montreal and Los Angeles to the Phoenix Labs team. But game development is notoriously difficult and expensive. When Garena fails to create a title that can be replicated Free fire ‘s success, future performance (and the ability to sustain the rest of the company) will be called into question.

Stretching Too Thin?

While Garena is Sea’s top profit driver, investors are most excited about Shopee.

Building on its success in Southeast Asia and Taiwan, Shopee is now entering other equally promising markets. For example, it is growing rapidly in Latin America, where it is already one of the most popular shopping apps in Brazil. Earlier this month, Reuters reported that Shopee plans to launch in India and Europe as well.

But while Shopee has performed well in Southeast Asia, there is no guarantee it can turn that experience into profit in these new regions. For one, being successful in retail requires a deep understanding of local markets, which can vary widely from country to country.

But even if Shopee overcomes this challenge, it may lack the resources to drive its expansion. On the one hand, it has to compete with e-commerce giants like Amazon in the race for talent. And on the other hand, there is still the need for Garena to take over the bills, which is not sustainable in the long run.

Remember, Sea is expanding beyond e-commerce into adjacent markets such as grocery delivery and logistics. These initiatives have the potential to become significant sources of income. For example, the company’s ambitions appear to be to convert Sea Money – its fintech arm – into the Ant Group of Southeast Asia. But this business, like the others, will require heavy investments to turn it into a profitable operation.

So far, the market has cheered Seas for never-ending expansion, but there is a real risk that the company will try to do too much and too quickly. This risk is likely to be low at the moment, as Sea still has around 6 billion euros in the second quarter.

The sea is not a cheap share

Many investors believe that Sea Limited could one day be the next Amazon or Tencent. And given its impressive track record to date, it has a real chance of reaching that level of success in Southeast Asia and beyond.

However, the magnitude of the opportunity also explains why the stock trades 25 times its volume with a nosebleed. That’s an incredibly high bar to meet, and investors should carefully weigh the risks the company faces before rushing into this growth stock.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Sea Limited, and Tencent Holdings. The Motley Fool recommends the following options: long January 2022 $ 1,920 calls on Amazon and short January 2022 $ 1,940 calls on Amazon. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.

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