Key Points
Sea Limited CEO Forrest Li just wrote a memo to employees on the ninth anniversary of the company's IPO.
In it, Li said Sea was looking to IPO part of its fintech business, while also starting an AI cloud business.
Investors sold the news, but savvy long-term investors should buy.
Sometimes, the market reacts to news in confusing ways.
Case in point: Southeast Asian super-app Sea Limited (NYSE: SE) plunged after announcing what could be exciting news. The stock is now down 20% over the last two weeks, over 40% on the year, and a whopping 78.5% from its 2021 highs.
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The most recent sell-off appears to have been caused by a memo Sea CEO Forrest Li sent to employees, which was leaked to the Wall Street Journal. In that memo, Li lays out two big strategic moves Sea may soon undertake.
Yet the successful execution of Li's new plan could create massive value, making the decline a tremendous buying opportunity for patient investors.
Li's next steps for Sea
Li wrote a memo to employees this week, marking the ninth anniversary of Sea's IPO. In it, Li made two announcements. First, Sea may list part of its fintech arm, Monee, on public markets to raise capital for that business. Second, Li said that Sea intends to become an AI-oriented cloud computing company.
The memo was met by a crescendo of selling pressure, despite Sea's having already declined significantly this year.
Why the sell-off? Possibly, for a few reasons. By listing Monee as a separate company, Sea would arguably be selling off part of its best business. Monee grew revenue a whopping 58.9% last quarter, making it Sea's fastest-growing segment. The division was also solidly profitable, with adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $288 million. While that EBITDA figure was up only 12.8%, it's because Sea reinvested a large portion of its profits into sales and marketing, aiming to capitalize on the significant growth opportunity it sees ahead.
Investors may also be concerned about Sea's entry into the AI cloud business. This is a crowded field with a lot of competition, and some are concerned that AI may be in bubble territory. In the U.S., pure-play "neoclouds" like CoreWeave (NASDAQ: CRWV) have seen their stocks plunge amid rising interest rates and concerns over whether their customers will be able to meet obligations under multi-year spending contracts. The cloud business is also capital-intensive, increasing risks.
Why these concerns are likely overdone
While investors may view these strategic steps negatively, these two moves could create tremendous value.
First, Sea already appeared quite cheap based on the sum of the likely valuations of its business segments if each operated independently. This is a phenomenon known as a "conglomerate discount." Therefore, if Sea were to list Monee independently, it could garner a higher valuation than it would when grouped with Sea's e-commerce and gaming businesses.
Second, raising capital at a higher valuation could help accelerate Monee's growth. Much of that business revolves around loans made to customers and businesses across Southeast Asia and Brazil. To protect itself from a financial downturn, Sea would need an equity "cushion" to support that growth. While Sea has just over $10 billion in cash on its balance sheet, raising more capital for Monee at a higher valuation would free up its balance sheet for investment in new ventures, such as an AI cloud business or returns to shareholders.
The cloud business: why not?
Third, while venturing into the AI cloud business may seem like a risky move for a late entrant, Sea isn't starting from scratch. According to Li in the memo, Sea has already built an AI cloud internally for its own three businesses, "at a level of cost and reliability we could not have bought from anyone else."
The experience of running its own infrastructure for years de-risks the initiative. Additionally, if Sea builds capacity and customers don't sign up, it will likely be able to eventually "grow into" this cloud infrastructure with its own businesses.
While these points de-risk the venture, the upside could be enormous. Right now, advanced AI computing power is in high demand, with rental prices rising sharply. On Space Exploration Technologies (NASDAQ: SPCX) earnings this week, CEO Elon Musk noted on the conference call with analysts that SpaceX is generating massive returns on its AI cloud spending:
What we're seeing in the market is extraordinary. At current pricing, new compute deployments are generating a payback of less than a year. Pricing is currently tracking slightly above the high end of the $30 to $50 per watt range we were discussing just last quarter, which further supports the attractiveness of these terrestrial SI [superintelligence] compute investments.
Sea may also be at an advantage over Chinese cloud companies in Southeast Asia, as its cloud would likely have access to the latest Nvidia (NASDAQ: NVDA) chips, which are currently denied to Chinese competitors.
What's wrong with profitable growth?
Listing Monee could help accelerate that business unit's growth, as Li noted in the memo. Meanwhile, a new cloud business could create a highly profitable growth business unit atop its existing e-commerce, fintech, and gaming franchises.
So, if the market's concerns here are overblown, this week's sell-off could make for a huge buying opportunity for long-term-oriented Foolish investors.
Billy Duberstein and/or his clients have positions in Sea Limited. The Motley Fool has positions in and recommends Nvidia and Sea Limited. The Motley Fool has a disclosure policy.