SEA: Tightening the Belt and Surviving is the Top Priority (3Q22 Minutes)

Below is the minutes of the 3Q22 conference call of Southeast Asian Tencent, please refer to "Game is in a mess, Shopee's PUBG, can SEA return to glory?" for a detailed review of the financial report.

Q: Shopee is expected to achieve balance of payments by the end of next year, but EBITDA is still in the red, how do you plan to achieve this goal? What is the biggest driver, revenue growth or cost reduction? What kind of revenue growth is expected? If competitors do not control costs, are you willing to sacrifice market share?

A: In terms of revenue growth, Shopee's monetization rate, especially in core markets, is significantly increasing. In terms of cost, we have tightened expenses related to sales and marketing. Especially logistics, not only reducing logistics subsidies, but also the overall cost reduction of the logistics system.

As for the driving force for future revenue growth, the improvement of monetization rate and cost reduction will maintain the current trend, and the results will continue to emerge in the next few quarters.

Regarding the impact on market share, from what we have observed, Shopee's leading position in the market is still stable, and the intensity of investment by the company's competitors is also being optimized.

Although there are short-term obstacles from macro development, given the positive demographic trend and low penetration rate in all markets, our view and confidence in the long-term growth potential of the market remain unchanged.

Q: Do you see any sign of stability in Free Fire? At the same time, we also saw the news of ending cooperation with Riot Games. What does this mean for your future publishing business? Does it have any impact on the priority purchase agreement with Tencent?

A: As far as Free Fire is concerned, the industry headwinds continue to affect user numbers, engagement, and monetization, which has been reflected in our performance in the third quarter and in our revised full-year guidance.

Due to the expiration of the agreement, we terminated our commercial relationship with Riot Games. We will continue to work with other top game developers around the world, which does not conflict with the priority purchase agreement between the company and Tencent.

Q: Given the challenging macro environment, do you expect any resistance to revenue in core markets? Will brands and merchants really cut advertising spending on Shopee?

A: So far, due to the increase in monetization rates for various services, sellers have adopted more projects and paid higher advertising fees. Currently, the response from sellers remains positive, and merchants are happy to continue investing on the Shopee platform.

Of course, potential macro headwinds may more deeply affect the entire market of the company. For example, declining purchasing power and disposable income may have a negative impact on the e-commerce industry in the region and the monetization rate of the Shopee platform.

Q: What is the EBITDA profit margin of Shoppee at a sustainable long-term level? Will you further reduce operations in other countries in Brazil and Latin America? Will you only focus on Brazil in the near future?

A: As far as Shopee's profit is concerned, our market revenue consists of two components: marketplace revenue (advertising and commission) and value-added services (logistics, etc.). In the long-term stable state, Shopee's marketplace revenue profit margin is expected to be comparable to other similar platforms in the market.

As for value-added services, they mainly include logistics services, which is mainly the last mile logistics provided by the company and first-party and third-party services provided on the platform.

As this revenue is primarily from logistics services, in the long run, profitability is expected to be at the level of similar logistics businesses. The focus going forward is to continue to improve the cost and efficiency of logistics services.

In the South American market, in addition to Brazil, the company will continue to invest in the market and strongly focus on return on investment and efficiency. The company will continue to operate in other Latin American markets from a cross-border perspective.

Q: GMV is actually growing at a rate of 21% year-on-year based on fixed exchange rates. How should we view the GMV outlook for the next few quarters or 2023?

A: Our focus on GMV growth is very clearly on improving monetization and achieving self-sufficiency. In the short term, macro environment, inflation, exchange rate fluctuations, and continued pandemic recovery trends could impact Shopee. In addition, the company's focus on efficiency, cost management, and improving platform monetization may also impact the scale growth of some operating metrics. The company can accept no growth or negative growth in the future.

Q: Should we expect more new games to be released in 2023?

A: In terms of game pipelines, we do have game pipelines for self-development and agency publishing. We don't discuss specific games that we haven't announced yet, but there are indeed projects in progress.

Q: Regarding Garena, can you share what factors led to the guidance change? What caused the significant slowdown in bookings from Q3 to Q4?

A: As far as the guidance we shared, inflation affected residents' disposable income and spending on games. Exchange rate fluctuations and overall consumption weakness have also impacted the gaming industry. We're giving more reasonable guidance according to the latest information we have while trying to improve user engagement and game quality. But there are many factors that we can't control.

Q: The net change in cash balance in Q3 was about 485 million. Can you tell us how much of that was used for capital expenditures? How much was due to changes in working capital? And how much was used for loan funds?

A: As far as the improvement of the cash flow is concerned, it is mainly driven by the improvement of EBITDA in our e-commerce and digital financial services businesses. As a result of better monetization and cost efficiency improvement.

Capital expenditures and working capital fluctuations are volatile. Both may fluctuate in each quarter for many reasons, such as in capital expenditures. Many of these are related to office buildings, server and logistics-related equipment, and machine equipment, among others. We are continuing to optimize our staffing levels, as well as reducing the need for office leasing, decoration, and computer hardware equipment. Additionally, the company is tightening its budget for servers and attempting to predict expenses more closely based on our business needs. Previously, we did indeed tighten server expenditures and kept them in line with our predictions for future business growth. Capital expenditures and operating capital are both long-term concerns that we pay close attention to. However, quarterly analysis may not have significant implications.

In terms of the loan business, as we have shared, we have a loan balance of approximately 2.4 billion US dollars and over 200 million US dollars in credit losses. This accounts for just over 10% of the total outstanding loan balance. Loans that are 90 days overdue account for about 4%, and the tenure of our outstanding loan book is about four months.

Q: Regarding the EBITDA loss in the third quarter, you mentioned one-time severance and lease termination costs. Can you quantify the impact on the third quarter, and how should we think about the current situation in the fourth quarter?

A: As far as severance and lease termination costs are concerned, the scale is roughly 77 million US dollars, most of which is related to e-commerce.

Q: How does staffing levels at the end of the third quarter compare to those at the end of the second and first quarters? How much of the cost has yet to be reflected in the overall numbers?

A: We do not handle staff numbers in a top-down or percentage-based approach. We take more of an item-by-item, function-by-function, unit-by-unit, and project-by-project approach to evaluate key areas and items that can be prioritized and rolled out first. There may continue to be some severance-related costs in the fourth quarter.

Q: Will the digital bank's promotion plan in Singapore lead to any short-term cost increases? And regarding Shopee Express, how does cost focus lead to strategic change, as this also requires considerable investment?

A: As for investment in the digital bank, it is still in a very early stage. Meanwhile, our Merrybank in Singapore has begun some pilot projects and opened limited functions to employees. We do not expect related costs to increase sharply immediately.

Shopee Express is a last-mile delivery service. Therefore, most of the spending in this area is mainly related to employee and vehicle leasing and network input. Thus, this area is mainly an operating expense, which can increase or decrease relatively quickly based on business volume, rather than a long-term, significant expenditure. At the same time, the company will continue to work closely with other third-party service providers to reduce costs and improve delivery quality and efficiency.

Q: Regarding financial services, with losses down nearly 60% year-on-year, should we also consider balancing the EBITDA income and expenditure for financial services next year?

A: In terms of the DFS business, the reduction in losses mainly comes from tightening spending on the mobile wallet plan. Given that the current losses are under control, we believe in the long-term prospects for this business as we continue to improve cost efficiency and monetization. However, our colleagues in the company are also concerned about quality, not just rapid growth and quick monetization. Therefore, we hope to ensure that our business model is resilient, including the prudential quality, user experience, and operating efficiency of our credit business. Therefore, we do not expect significant fluctuations in our loan business and do not consider it a growth-focused business for our company.

Q: The EBITDA loss from other services adjustments grew by 140%. Could you please share the reasons behind it? And should we expect it to decrease in the coming quarters?

A: The quarter-on-quarter comparison is actually much smaller. Many of these costs are related to the severance payments we initiated with our food delivery business in the third quarter. We expect to see more savings in the next few quarters.

Q: The gaming business saw a stabilization in the number of users in the second quarter, but a further 8% decline in the third quarter. What caused this? And what factors in this business led to the lowered guidance for the company?

A: We continue to see the macro headwinds affecting user engagement and the user base. In addition, the full resumption of school in the third quarter had a significant impact on some of our user groups and user engagement. This led to our lowered guidance.

As far as "Free Fire" is concerned, it remains to be seen what level of core user group it will reach.

Q: When can investors expect the company to restore its 2023 guidance?

A: Given the macro uncertainty, we do not plan to provide guidance at this time. Therefore, if our views on the macro and operational environment change, we will provide the latest information to the market.

Q: Could you provide more details on the content of the DFS loans? What kinds of loans are they? What have you done to change your write-off policy, considering the macro uncertainty?

A: In terms of digital financial services, we have various loan-related products in different markets. Therefore, we will continue to improve our underwriting quality through data reviews and consider various factors, including cycle information and backlog information, as well as past tracking records of user behavior to predict potential shifts in user and user patterns and adjust our underwriting policies accordingly.