One of the strongest and most beautiful sources of growth for Sea Limited (NYSE:SE) stock has been its Digital Entertainment (DE) segment.
Source: Postmodern Studio / Shutterstock.com
The company’s global hit and breakthrough game, Free Fire, had been a magic wand. It enabled Sea to recruit loyal and enchanted players in their millions globally. But Indian authorities have put out SE stock’s beacon of light.
Developed in its Garena subsidiary, Sea Limited optimized its first self-developed, addictive, and all-inclusive Free Fire game to run smoothly even on most low-end mobile phones. The game, among other licensed titles, powered Sea’s DE segment to exponential growth in the past 11 quarters from 216 million active users by the fourth quarter of 2018 to over 729 million by September 2021.
Sadly in a surprise development, India announced a ban on 54 applications citing national security concerns, and Sea’s Free Fire is one of them, alongside Tencent’s (OTCMKTS:TCEHY) Xriver. India is by far the largest market globally by app installs, and potentially contributed the majority of Free Fire’s paying user base.
Resultantly, SE stock plummeted by nearly 19% during the Monday trading session.
How Significant is an India Ban?
Sea Limited has three operating segments, Digital Entertainment, E-commerce (anchored by Shopee), and a small Digital Financial Services segment.
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Sea’s DE segment, where Free Fire is single-handedly the highest-grossing app, contributes significant revenue to the group. It generated 52% of group sales during the fourth quarter of 2019, before being eclipsed by a faster-growing e-commerce segment in 2020. Recent revenue contribution was down to 41% of the group’s total GAAP revenue by September 2021.
Free Fire undoubtedly powers Sea Limited’s only profitable segment. Free Fire’s segment converted an average of 56% of segment revenue into operating profits during the first nine months of 2021, up from just 12% of sales in Q4 2018.
The DE segment’s revenue contribution got eclipsed by a Shopee-led e-commerce business line since mid-year 2020. However, the e-commerce segment contributes exponentially increasing operating losses to the group.
Free Fire’s segment has been producing the cash flows to sustain the business as it nurses the other two loss-making segments that are draining the company’s cash flows.
Most noteworthy, given that India probably contributes the majority of Free Fire users, Sea Limited’s operations might just have been dealt with a huge blow due to the India ban. Alternative markets may take time to grow the user counts back to all-time highs.
Sea Limited Had a Digital Entertainment Problem
Although Free Fire’s total user growth seemed like it had stalled as the world emerges from the Covid-19 pandemic, the company added 3.8 million more active users and a million paying users to its tally during the September 2021 quarter.
Ignoring customer churn, the data implies about 26.3% of the new active users converted to become paying customers. The company has adopted market deepening tactics to convert existing free gamers into paying users. Better conversion neutralized stalling user growth as the component of gamers that became paid users increased from 5.3% in 2018 to 12.8% by September last year.
Source: Source: Author compilations from Sea Limited’s quarterly earnings presentations
However, the company still needed to work its user base to entice it into spending some cash on the app so it can sustain its cash flow bleeding segments.
Unfortunately, an India ban could mean significant problems ahead for SE stock.
Actually, the latest ban amplifies an already emerging challenge.
SE Stock: Evidence of Plateauing User Growth Emerges
Free Fire’s plateauing user growth probably accelerated during the past quarter.
According to an active gamer tracking website activeplayer.io, Free Fire’s active user numbers have been going down since October last year. The site estimates that the game’s average monthly active players declined sequentially from 339 million in September 2021 to 325.9 million for January 2022.
More concerning is the website’s estimate that average active users declined by a staggering 10 million during the past 30 days.
Sadly, Sea Limited may be compelled to scale back on its aggressive rollouts of payments solutions and Shopee’s expansion plans to contain cash burn after Free Fire’s ban in India.
A loss of a key market could just have made Sea Limited’s problems worse than they already were, and SE stock could stumble further once the predicted user declines get confirmed in the company’s upcoming earnings report in March.
On the date of publication, Brian Paradza did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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