Sea Limited, $24, March 2019

Category Score Conclusions Simplicity Average Operating three businesses with common business model characteristics in seven countries across one region. Finances Average $2bn of available capital on the balance sheet but capital allocation priorities to build scale are reflected in large operating cash losses. Competitive positioning Strong Market leadership in digital entertainment and ecommerce, growing barriers to entry via platform business dynamics. Track record Average Strong but short track record in growing users and user engagement. Some early evidence of monetisation. Growth opportunity Strong Addressable market expansion opportunity through higher levels of digital penetration across gaming, consumer retail and payments. Market consolidation and leadership maintenance and improvement potential via thoughtful long term and material capital commitments and management focus. Monetisation and sales and marketing leverage progress should improve gross and operating profitability of the ecommerce platform. Stewardship Strong The private ownership of the founder and strategic investor may facilitate a welcome focus for long term investors.

Simplicity - average

Three businesses united by common economic objectives: Sea operates three platform businesses in gaming, ecommerce and digital payments, primarily in seven Southeast Asian markets (Singapore, Vietnam, Philippines, Malaysia, Indonesia, Taiwan and Thailand). The customer proposition and monetisation mechanism for each business is discussed in more detail below. But broadly the core revenue driver for all the businesses is the size of the user base and the level of user engagement. In the gaming business, due to a freemium business model, the higher the number of active users, the larger the number of users likely to make in-game purchases. In the e-commerce business, the larger the number of sellers and buyers on the platform, the larger the value of transactions which will drive advertising and commission revenue. Finally, in digital financial services, the larger the number of paying users and the larger the number of merchants accepting SE’s digital payment solution, the greater the potential transaction volumes that drive commission revenue.

• Garena business model: o Garena was launched in 2009 and had expanded to all seven SE Asian markets by 2012. Primarily Garena distributes mobile and PC online games in its markets through (1) a desktop or mobile Garena app1, and (2) a network of cybercafes in its SE Asian markets2.

1 The application also provides a group voice chat function designed for multi-player games in which players form small teams and play against other teams. 2 Home PC and residential broadband penetration rates are low in many parts of Garena’s region; many game players rely on cybercafés to access online games. Garena markets its games through a network of cybercafé partners who have installed its

Sea Limited, $24, March 2019

Third party games are curated and adapted for local markets. Most games that Garena distributes are done so exclusively. Garena also recently had significant success with its first internally developed game, Free Fire, which was the fourth most downloaded game in the world in 2018 and was available outside of SE’s core SE Asian markets, including Europe, LatAm and Africa. Finally, Garena streams online gameplay, runs social features such as online user forums, and eSports3 events. Games are typically multiplayer and immersive4, such as battle royale games; multiplayer online battle arenas (MOBAs); massively multiplayer online action games (MMOAGs); massively multiplayer online role-playing games (MMORPGs); and sports games. o Game development: Garena identifies new game opportunities based on understanding gamer tastes, gained through data collection and market research. This is followed by concept development to testing and player engagement. For internally developed titles Garena coordinates programmers, game designers, graphic artists, and audio engineers, as well as its own marketing and analytics team. o Customer proposition: ▪ Gamers: Convenient access to high quality and locally tailored games through Apple App Store, Google Play Store and the Garena App, for mobile games, and for PC games through the Garena App and through its network of cybercafes. ▪ Developers: Access to a large and engaged gaming community, providing an avenue for games to become popular quickly. Services include game launch and hosting5, localisation6, marketing7, distribution, monetisation8, and integrated payment infrastructure. o Monetisation: Licensing contracts with game developers typically last three to seven years, under which Garena typically retains between 65% and 80% of gross billings. Billings are subject to a ‘freemium’ model in which users can download and play games for free, and revenue is generated through the in-game sale of digital representations of clothing, weapons or equipment designed to enhance the gaming experience. o Cost of doing business: The principal cost of generating sales are royalties paid to game developers whose games Garena is distributing and are paid as a percentage of gross billings, typically 20-35%. Other costs include servers and hosting, licence fees paid upfront for the right to exclusively distribute games and amortised over the life of the licence, and staff costs.

Gcafé management and billing system. The user interface of each computer in the cybercafé is customised to prominently display Garena’s games. 3 Organised, multiplayer video game competitions. 4 Users play online in a virtual environment existing on network game servers that connect many players simultaneously to interact with each other within the games. 5 Games are hosted on servers in leased data centres managed by third party data centre service providers. 6 Including navigation of local regulations and government approval processes. 7 Outdoor and print advertisements, television commercials as well as social media platforms and other online forums 8 Garena works with developers to set prices for in-game items to strike the right balance between revenue generation and user engagement.

Sea Limited, $24, March 2019

• Shopee business model: o Shopee is an ecommerce marketplace which has adopted a mobile-first approach since its inception in 20159. Shopee is a platform for connecting buyers and sellers of long tail10 products across fashion, health and beauty, home and living, and baby products. Shopee provides tools such as payment, logistics and fulfilment. To a lesser extent Shopee also purchases products from third party manufacturers and sells them on its platform. o Customer proposition: ▪ Sellers: Vendors are individuals, SMEs, large brands and retailers. Shopee provides sellers an online storefront on which they can list products, communicate with buyers and process transactions11. Shopee’s seller tools also allow sellers to review and analyse their sales histories to identify trends and buyer preferences. Shopee Mall allows brands to feature their logos on the Shopee platform. Shopee works with third party logistics firms to connect buyers and sellers. Unlike physical store setup, there are no upfront costs to establishing a presence on the Shopee platform. Shopee offers sellers training through “Shopee University” to empower them to use the tools in the Shopee Seller Centre, and provides training in customer communication, revenue improvement and marketing. ▪ Shoppers: Shopee offers buyers convenient 24-7 anyplace access to a wide product assortment12, and a discovery process aided by the ability to search and filter results and receive personalised recommendations13. Under a ‘Shopee Guarantee’ payment is made to sellers after acknowledgement of product receipt. Shopee also employs a seller rating system and has a live chat function which allows buyers to ask questions of sellers. These mechanisms are designed to overcome a security barrier to ecommerce adoption. Social media elements such as liking and following are distinguishing features of the platform, the purpose of which is to engender a sense of community. o Monetisation: Sellers are offered cost-per-click advertising services14 and are charged transaction fees and commissions as a fixed rate of gross merchandise value. o Cost of doing business: Shopee’s costs of operations comprise bank transaction fees, service fees paid to third party logistics providers, server/hosting costs, and staff.

9 The website was launched a year after the mobile app. 10 ‘Long tail’ was coined by Chris Anderson, editor of Wired, and refers to small/niche high categories which enjoy higher margins due to lighter price competition. 11 Using the ‘Shopee Seller Centre’, sellers can create and manage listings, interact with customers, complete transactions, and track and manage their revenue and orders in real time. 12 SKU variety is arguably a more material advantage vs. offline retail in these markets vs. regions with more developed traditional shopping infrastructure. 13 Think Amazon’s “Customers also bought…”; the value of this proposition improves through scaled use of customer data. 14 The paid ads service allows sellers to bid for keywords that match their product or service listing appearing in search or browser results on the Shopee marketplace. Their product or service listing will show higher in search rankings when users search for keywords they have bid on.

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• AirPay business model: o AirPay is a digital payments provider, launched in Vietnam and Thailand in 2014. Consumers can use the AirPay app as an e-wallet to pay from products and services. AirPay is integrated into the Garena and Shopee platforms. o Customer proposition: ▪ Consumers: AirPay allows customers, including those without bank accounts, to process payments on Garena, Shopee, and third-party merchants for products and services such as food, transport, telecoms and paying utility bills. Consumers do not need a credit card or a bank account as the AirPay App accepts account top-up payments in cash through physical AirPay counters located across the region (a ‘reverse ATM’). For consumers with a bank account, AirPay is connected to almost all major banks. ▪ Merchants: Professional payment solutions and money collection, and broader access to consumers15. o Monetisation: Commissions are charged to merchants for transactions settled using the AirPay platform, as a percentage of merchandise value. o Costs of doing business: AirPay’s costs of sales are bank transaction fees, commissions paid to counter operators, server/hosting costs, and staff.

15 For transactions completed using the AirPay App, AirPay receives the commission, less any banking or credit card fees. For transactions transacted over an AirPay counter, a portion of the commission is shared with the counter operator.

Sea Limited, $24, March 2019

Finances - average

SE IPO-ed in October 2017, raising $885mn16. The company issued convertible notes in 2017 ($625mn17) and 201818 ($575mn). In March 2019 SE issued 69mn shares at $22.5, raising $1.5bn. Subsequent to this the company has $2bn of cash on the balance sheet; last year cash from operations and investing activities was c. -$720mn. The business can fund this level of cash burn until the end of 2021 before requiring additional capital markets’ financing.

16 59mn shares at $15/share. 17 At 1 March 2019 $418mn had converted, $208mn was outstanding. 18 Mature 2023. $50mn sold to Tencent.

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Competitive positioning - strong

Network effects and multi-touchpoint flywheels: All three businesses are platform business models which take much investment to drive scale and barriers to entry but have winner-take-most potential economic outcomes.

Garena:

• Platform dynamics lower customer acquisition costs: Garena is a platform business with network effects dynamics due to the social, multi-player nature of the games distributed. Each new gamer increases the value of the platform for existing users. This dynamic might suppress the cost of acquiring new users as the network grows in scale, as current users will tend to invite new users to the platform. • Strong and long-tenured developer relationships turn the flywheel: Garena’s success in distributing games for local game players facilitated relationships with international game developers such as Tencent, Riot Games, Electronic Arts and PUBG Corporation. This has allowed Garena to source high quality games from world class developers, many of whom work as exclusive partners in SE Asia19. Management is focused on the virtuous cycle dynamics of attracting more users with high quality games, which attracts more high-quality developers. The more users they have and the more games they distribute the better they become at localising games, increasing their appeal to gamer and developers. • An important voice in esports: Garena organises hundreds of eSports events annually and operates the largest professional league in the region. Garena World 2018, which was held in Thailand in April 2018, had an attendance of 240,000, attracted 11mn views online and more than 11k teams’ participation. Garena was also one of the organisers of the Arena of Valor World Cup held in LA in 2018. In Garena’s markets, the Arena of Valor World Cup competitions attracted over 33 mn views online. • Basis for competition: Garena competes on user base, user engagement, game portfolio, brand awareness/reputation, developer relationships and distribution/customer reach.

19 In November 2018, SE entered into a master license agreement with Tencent pursuant to which Tencent granted right of first refusal to publish its mobile and PC games in Indonesia, Taiwan, Thailand, the Philippines, Malaysia, and Singapore.

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Garena is dominant in Thailand, Vietnam and Philippines (2016 data):

Thailand: Singapore:

Malaysia: Vietnam:

Philipinnes: Indonesia:

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Shopee:

• Platform dynamics: As the number of buyers increases, Shopee attracts an increasing number of sellers, resulting in increases in SKU variety available on the platform, which increases the purchasing opportunities, and therefore monetisation potential, or value, for each of those buyers. • A market leader: Shopee was the largest ecommerce platform in SE’s region in 2018 by GMV and total orders20. According to App Annie, Shopee was the most downloaded app in the Shopping category in Southeast Asia and Taiwan in 2018. • Operating in niche product categories: The long tail products that are the focus of Shopee’s marketplace support margins due to lighter price competition vs. top-selling products. Ecommerce lends itself to long tail selling due to the capacity for predictive analytics and personalised recommendations to stimulate liquidity in niche markets. • Investment in seller services solves the chicken and egg platform problem: Sellers are supported through a network of payment providers and logistics partners, integrated into the platform, as well as local teams to help sellers make use of Shopee’s business management tools. Shopee provides a one stop shop allowing sellers to streamline store setup, inventory and revenue management, delivery and payment collection. • Basis for competition: Shopee competes with regional and local players on SKU variety and appeal, convenience and shopping experience, and availability of convenient payment and delivery services.

The essence of the gaming and ecommerce flywheel: The capacity for platform businesses to create substantial barriers to profitable participation may be quite broadly understood. As is the economic characteristic that additional users in a platform business model add more value for existing users. However, in addition, platform scale strengthens the ability of the platform to offer white labelled goods and original content. Netflix uses customer preference data collected over time to deliver not just a marketplace of products, but original content such as House of Cards. Like Netflix, Garena intends to develop more original content while distributing third party content. Based on customer intelligence, Amazon has c. 70 private label brands21, which were started in niche categories like batteries. Amazon’s marketplace dominance allows it to scrape the content of user reviews of third- party products and use that information to create superior products that are more valuable to consumers.

Concentrated economic value, which Shopee dominates: SE management stated on the 2Q18 conference call that Shopee’s estimated market share was 22-24% in its regions based on orders. However, a recent Temasek22/Google survey23 estimated the total SE Asia ecommerce GMV to be c. $23bn in 2018. Shopee’s 2018 GMV of c. $10bn implies a market share of >40% based on transaction

20 Frost & Sullivan 21 https://www.businessinsider.com/amazon-owns-these-brands-list-2018-7?r=US&IR=T 22 Singapore state owned investment holding company. 23 “e-Conomy SEA 2018, Southeast Asia’s internet economy hits an inflection point”

Sea Limited, $24, March 2019

dollars. As such the visitor traffic charts below likely underestimate the concentration of value in this market, and Shopee’s share of the economic pie.

Regional competition: Lazada is Shopee’s closest competitor and operates across all its markets. Lazada was founded in 2012 by Rocket Internet in Singapore with the intention of establishing the Amazon of Southeast Asia24. Lazada launched in 2012 in Indonesia, Malaysia, the Philippines, Thailand and Vietnam. In 2014, Lazada launched in Singapore. In 2014, Temasek Holdings led a funding round of $250 mn, bringing the total raised to $650 mn.

In 2016, Alibaba bought a controlling interest in Lazada by paying $500 mn for new shares and buying $500mn worth of shares from existing investors. In 2017, Alibaba increased its investment in Lazada by an additional $1 bn, raising its stake from 51% to 83%. Alibaba invested another $2 bn into Lazada in 2018. Lazada’s CEO has changed twice in the last year25, perhaps a sign of cultural/integration issues. Lazada’s traffic share has generally been modestly shrinking in its core markets, while Shopee’s has been rising.

24 Rocket is a German incubator that builds companies that copy the business models of successful US tech companies in emerging markets. 25 Lucy Peng was appointed by Alibaba and then replaced by Pierre Poignant.

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Ecommerce is becoming more concentrated: Shopee and Lazada, together with C2C player Tokopedia (Indonesia only), are growing significantly faster than the market:

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AirPay:

• Strengthening the network by growing the number of merchants: A wide variety of merchants are on the AirPay platform26. SE is focused on increasing the number or type of merchant to increase the number of users on the platform. One of the most obvious opportunities to do this is through the growth of the Garena and Shopee user base. • Basis for competition: AirPay competes with credit/debit cards and other e-wallets on processing speed, convenience, network size, reliability and price. • Fragmented market for payments: Many players, driven by the opportunity to provide a widely accepted digital payment solution, have built their own over the years, including ride hailing companies (GoPay, GrabPay), telcos (Telkomsel, GCASH, TrueMoney), banks (PayLah, Mandiri) and the global e-wallet players such as Apple Pay, google Pay and PayPal. It is not clear that any are developing any form of strong leadership in SE Asia. The incompatibility of these myriad solutions may be a barrier to widespread adoption.

Track record - average

SE’s total revenue has increased at a 55% CAGR 2016-2018 from $346mn to $827mn. Revenue growth accelerated in 2018 to 100%, primarily driven by ecommerce (3P) revenue growth of almost six-fold to $270mn, sale of goods growth (1P) of 60x to $100mn, and 27% yoy growth in the Garena business. Over 2016-2018 net losses have substantially widened from $225mn to $961mn.

26 E.g. Telcos, cinemas, amusement parks, utility service providers, food delivery providers, credit card issuers, banks, insurance companies.

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Revenues 2016 2017 2018 Digital entertainment 327,985 365,167 462,464 E-commerce and other services 17,675 47,444 270,049 Sales of goods 10 1,579 94,455 Total revenue 345,670 414,190 826,968

Costs of revenue 2016 2017 2018 Digital entertainment -185,314 -217,986 -267,359 E-commerce and other services -47,284 -107,260 -446,281 Sales of goods 0 -1,632 -98,570 Total cost of revenue -232,598 -326,878 -812,210

Gross profit 2016 2017 2018 Digital entertainment 142,671 147,181 195,105 E-commerce and other services -29,609 -59,816 -176,232 Sales of goods 10 -53 -4,115 Total gross profit 113,072 87,312 14,758

Gross margin 2016 2017 2018 Digital entertainment 43% 40% 42% E-commerce and other services -168% -126% -65% Sales of goods 100% -3% -4% Total gross profit 33% 21% 2%

Operating costs 2016 2017 2018 Sales and marketing expenses -187,372 -425,974 -705,015 General and administrative expenses -112,383 -137,868 -240,781 Research and development expenses -20,809 -29,323 -67,529 Operating income 2,103 3,497 9,799 Total operating costs -318,461 -589,668 -1,003,526

Operating losses -205,389 -502,356 -988,768 Operating margin -59% -121% -120% Garena has a short but strong track record in developing in house games. In December 2017, SE launched the first game developed entirely in-house, Free Fire, a Battle Royale mobile game.

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Shopee has grown orders and GMV strongly:

Growth opportunity - strong

The capital allocation priority is to build marketplace scale and liquidity, and increasingly on monetisation as GMV and market share continue to rise. It is this higher scale and liquidity that increases the rate at which the business can monetise its assets. In management’s words in the 2018 10K:

“We have made a strategic decision to invest in the growth of our Shopee marketplace by incurring sales and marketing expenses in advance of our monetisation efforts. We believe that taking a thoughtful approach to monetisation by building our user base and increasing engagement first will allow us to maximise our monetisation in the future.”

And on the FY17 conference call:

“It's very clear in our mind, and it becomes clearer with every passing day, that almost all of our markets are consolidating very quickly and more quickly than we would have anticipated that even 6 or 9 months ago. Secondly, as a matter of principle, when given the choice to ease our spend and maintain our share or invest more heavily to expand our share, we've chosen the latter strategy. Reason being, we believe that investment is going to help us achieve dominance in the categories that are so important to us, female long-tail categories. That kind of dominance and the ability to be the go-to platform for these important and very profitable categories as we've talked about in the past should bring us to higher monetisation levels going forward. So really, just to conclude, at the end of the day, winning a merchant or a customer today in our mind is much better than having to

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spend more to win them in the future.” The emphasis is mine; it seems consistent with a capital allocation objective to maximise total long-term value for owners and reflects a capacity to suffer that is a desirable quality for such long term owners.

Capital expenditures amounted to $24mn, $80mn and $178mn in 2016, 2017 and 2018, relating to game licences and IP and, in 2018, investment in servers to support the growth of the ecommerce business.

Garena value drivers

User base growth and engagement are driven by the launch of new games, the expansion of existing games into new markets, and the improvement and launch of new content in existing games. Management expects Garena to generate adjusted revenue27 of $1.2-1.3bn in 2019 (82-97% growth).

Southeast Asia is the fastest growing games market in the world; the games market is expected to grow 22% to $4.6bn in 2019. Despite 63% internet penetration, the region has the most engaged mobile internet users in the world:

27 Adjusted revenues in Garena = reported revenues plus the change in deferred revenues (30% of adjusted revenues in 2018). It therefore reflects the cash spending of Garena customers in the period. The Garena cash EBITDA margins that SE reports (c. 45%) are lower than would typically be reported due to the higher denominator, which includes the change in deferred revenues.

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Esports is growing very strongly: In 2019, the global esports economy will grow to $900 mn, a yoy growth of 38%28. Three quarters of this will come from sponsorships and advertising. Media rights, tickets and merchandise make up the remainder. Global esports audiences, currently c. 380mn people, or 5% of the planet, have been growing in the mid-teens. 20% of the global population is now aware of esports. This growth has been driven by streaming platforms such as Amazon-owned Twitch, which attracts 15mn viewers per day each spending 100 mins per day watching live gaming.

28 This accelerated from the 33% growth recorded in 2017.

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Esports awareness:

There is evidence to support the assertion that esports is becoming increasingly mainstream:

• Personnel have been recruited from mainstream sports media. A few years ago, Activision announced that it was forming a dedicated esports division, and it hired Steve Bornstein, former CEO of ESPN and the NFL Network, to lead it. • Broadcasting rights deals are being struck with Twitch as well as mainstream broadcasters such as Disney and ESPN. • Sponsorship is becoming more mainstream. Esports teams have traditionally been able to pull in sponsors that are already closely associated with gaming e.g. from PC gaming companies like Razer, computer-makers HP and Intel, to Toyota and T-Mobile. • Employment conditions of players are formalising. Guaranteed contracts with minimum salaries are becoming more common, and teams are investing in state of the art training facilities, including coaches, chefs, dieticians, and sports psychologists. • Esports is big enough to fill an Olympic stadium. The finals of the League of Legends World Championship were held at the Beijing National Stadium:

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• Esports are increasingly included in the thoughts of Olympic Games organisers around the world. Esports were featured at the 2018 Asian Games as a demonstration sport29, and will be a medal event at the 2022 Asian Games. Paris 2024 Olympic organisers were "deep in talks" about including esports as a demonstration sport at the games.

Shopee value drivers

Shopee seeks to maximise the value of transactions taking place on its platform and minimise the costs of facilitating interactions between buyers and sellers, and of retaining and acquiring network participants. Management expects Shopee to generate adjusted revenues30 of $630-660mn in 2019 (117-127% growth).

Management expects Garena and Shopee to generate $1.8bn - $2bn of adjusted revenues in 2019.

Penetration and ARPU are low; engagement is high: Ecommerce penetration is materially below global averages in almost all Shopee’s markets (China c. 18%, US c. 10%).

29 Medals won in this sport would not be counted in the official overall medal tally 30 Adjusted revenues in Shopee = reported revenues plus revenues net off against sales incentives (7% of adjusted revenues in 2018).

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But ecommerce and m-commerce engagement in Indonesia, Shopee’s largest market representing almost half of GMV, is the highest in the world.

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The GMV of the internet economy is 2.8%31 of SE Asia’s GDP in 2018, up from 1.3% in 2015 — and is projected to exceed 8% by 2025. SE Asia is almost 10 years behind the U.S., in which the GMV of the internet economy was 6.5% in 2016.

31 Of this, 0.9% is ecommerce. The remainder is ride hailing, online media and travel.

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Ecommerce ARPUs in Shopee’s markets are amongst the lowest in the world:

More affordable mobile data is increasing the addressable market: mobile internet data affordability has also significantly improved. The cost of one GB of mobile internet has more than halved relative to the income of Southeast Asians over the last four years32.

Shopee monetisation progress and potential

The monetisation of Shopee’s customer is improving, driven by (1) higher take rates increasing the gross profitability of transactions on the platform, and (2) lowering of shipping subsidies and sales and marketing leverage.

(1) Revenue and monetisation

The take rate is suppressed…Shopee’s take rate (revenues/GMV) is currently suppressed by efforts to build scale and market leadership, entrenching the network effects’ barriers to entry of the business, and by the low but increasing mix of the branded B2C marketplace Shopee Mall, which commands higher commission rates33.

…but is increasing: The take rate has been increasing and management expects this to continue through a combination of three levers: (1) commissions, (2) advertising fees, and (3) value-added services. The region in which this monetisation effort seems to be most advanced is Taiwan, in which Shopee recently started charging commissions to both marketplace and Shopee Mall sellers. Management mentioned on the FY17 conference call that the Taiwan take rate at that time was 5%.

32 From > 2% of GNI/cap in 2014, to < 0.8% in 2018. 33 Currently c. 15% but management has commented that an ultimate 50/50 mix would not be unusual.

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Management expects Taiwan to be EBITDA positive (excluding head office cost allocation) in 1Q19. Chief Strategy Officer Alan Hellawell has commented that “we are very firmly committed to pushing up our take rate going forward”. It is also clear, however, that management’s timeline for introducing commissions in other markets will accommodate the goal to achieve a level of category dominance.

Competitors have higher take rates: Taking the example of one of Shopee’s most competitive markets, Singapore, peers are charging between 3% and 30% commissions, vs. zero for Shopee.

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Qoo10 charges 8-12% seller commissions in Singapore:

11street charges between 3% and 12% commissions rates to sellers in Thailand and Malaysia. In fashion, Shopee’s largest category, sellers are charged 12%.

Lazada charges on average 6.5% commissions plus a 2% payment fee in its markets. In fashion, Shopee’s largest category, sellers are charged 12% including the payment fee.

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Higher take rates improve gross profitability. Naturally the direct profitability of Shopee’s business is driven by the take rate that Shopee can command on the GMV passing through its platform. In 2017 Shopee’s take rate was practically zero and its gross margin was -125%. In 2018 the take rate was 2.8% and the gross margin was -65%. In 4Q18 Shopee’s take rate was 3.7% and its gross margin was -52%.

Even if we can expect diminishing marginal returns to higher take rates, the capacity to increase the take rate bodes well for the potential profitability of future transactions.

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(2) Sales and marketing leverage

S&M efficiency suppressed by efforts to build platform scale and liquidity: Shopee has heavily subsidised the cost of shipping for its sellers in order to build supply scale. The extent of these subsidies has been declining without any noticeable impact of GMV growth, resulting in sales and marketing expenses declining as a percentage of revenues. Shipping subsidies declined qoq in absolute dollar terms in 4Q18 as free shipping is now only available on baskets of a minimum size. This marketing efficiency improvement was achieved while GMV/orders grew 27%/31% quarter-on- quarter. Sales and marketing as a percentage of GMV for Indonesia, Shopee’s largest market, was lower than the ratio for Shopee as a whole, supporting the contention that scale drives operational leverage with respect to the cost of acquiring new customers. Management expects sales and marketing expenses to decline in absolute terms from here. This is a departure from previous intimations that sales and marketing costs should increase robustly.

Management articulated the lower customer acquisition costs in the following terms in SE’s FY18 conference call: “We are continuing to get outsized benefits from the flywheel effects where more and more buyers and sellers flock to the Shopee ecosystem. What this means essentially is that we get a lot in terms of organic user growth. So we don't actually need to continue to invest as much in sales and marketing in order to post a very robust growth rate”.

Shopee profit inflection

As the monetisation of Shopee’s customer improves through higher take rates and lower subsidies, and as sales and marketing efficiency lower customer acquisition and retention costs, management believes that the profit losses reported in the ecommerce business have bottomed:

“In terms of cadence of EBITDA losses, would it be fair to say fourth quarter EBITDA losses represents a watermark in terms of EBITDA losses? I think it's fair to characterise it that way”.

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AirPay value drivers

AirPay has thus far principally served to lower the costs of doing business for Shopee and Garena. By launching AirPay in 2014, SE reduced payment channel costs for Garena and Shopee and captured value that previously flowed to third-party payment services.

Unbanked, digitally savvy, addressable market: Credit card ownership in SE Asia is amongst the lowest in the world, but mobile banking penetration is amongst the highest:

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Low penetration of digital payments: One in two internet users in SE Asia has adopted digital payment services. Digital payment services account for an even smaller share of the overall transaction values, anecdotally in the low single digits. In China digital payment solutions like Alipay and WeChat Pay are ubiquitous among offline and online merchants.

Stewardship - strong

SE is substantially owned by insiders: Forrest Li, the founder CEO, owns 31% of the business34 and Tencent owns 33%35. All directors as a group own 44% of the company. Management has shown a preference to direct efforts and capital to projects that they believe will create long term value.

Risks

Fragility of customer trust: Negative experiences spread quickly online, and SE’s business success is driven by customers’ trust in the platform. Customers must believe they will be protected in order to transact safely online. As the number of connections and transactions grows exponentially there is a risk that this additional complexity renders SE’s risk control measures inadequate. This might lead to negative network effects as one or both sides of the platform are driven away by unpleasant experiences. Shopee verifies sellers, screens listings and has teams dedicated to dispute resolution. Shopee also offers a ‘Shopee Guarantee’ under which buyer payment is held by Shopee until delivery of the goods, reducing settlement risks and encouraging buyers to purchase online.

The huge increases in active user engagement across a variety of online services suggests consumer comfort with transacting online is increasing.

34 44% of the voting rights due to his ownership of B shares, carrying three votes each. 35 29% of the votes.

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Ecommerce competition and a barrier to user monetisation: Shopee may not be able to adequately monetise the transactions taking place on its platform. So far KPIs relating to the company’s monetisation progress are moving in the right direction. Take rates are increasing and subsidies are reducing without harming the company’s asset growth.

Gaming tastes changing: Garena has three- to seven-year agreements in place with multiple developers. It can use its experience as a distributor of games developed by others to improves the prospects for success in its own internal development ambitions. Free Fire is a short, but encouraging, piece of evidence that they may be able to do this successfully.

Valuation

Applying Garena’s run rate adjusted EBITDA margin of 45% to FY adjusted revenue guidance of $1.25bn implies $0.5-0.6bn of EBITDA, 100% growth yoy, and an 86% three-year CAGR.

Sea Limited, $24, March 2019

Assuming, for now, that AirPay is worth nothing, what is the implied valuation of Shopee for a range of sustainable growth hypotheses applied to Garena’s profits?

If we assume that Garena can never grow it’s EBITDA, an investor with a 10% opportunity cost of investing might be willing to pay 10x EBITDA, or c. $5.5bn to earn this opportunity cost. This would imply a valuation of Shoppe of $3.3bn, one third of SE’s current enterprise value of $8.8bn and 5x Shopee’s expected sales this year.

If we value Garena at 16x EBITDA, or less than 4% sustainable EBITDA growth36, both Shopee and AirPay are priced by the market as worthless. The implied value of less than $9bn for Garena would seem conservative given the business’s demonstrated profit growth and potential.

$mn Garena 2019 EBITDA 550 Garena sustainable growth 4% Multiple of EBITDA 16x Garena value 8,871

SE market cap 10,800 SE net debt -2,000 SE EV 8,800 Garena % of SE EV 101%

Implied Shopee EV -71 Shopee revenue 2019E 645 Shopee EV/sales -0.1x

36 Electronic Arts and Activision Blizzard trade on 15-18x EBITDA, which is growing LSD-MSD, EBITDA margins of c.35% are lower than Garena’s.

Sea Limited, $24, March 2019

Downside scenarios.

If Shopee and AirPay burn through SE’s $2bn cash pile but fail to make progress in demonstrating the ultimate path to sustainable profitability, we might be willing to pay $9bn to own SE’s equity, c. 18% downside from today’s market cap of $10.8bn.

Downside scenario 1: Garena grows sub-4%, AirPay and Shopee burn through cash pile and cease operations

$mn Garena 2019 EBITDA 550 Garena sustainable growth 3.8% Multiple of EBITDA 16.1x Garena value 8,871

AirPay and Shopee value -2,000 Net cash 2,000

SE equity value 8,871 SE market cap 10,800 Downside -18%

What assumptions does an owner of this business need to make to render his interest worthless? We could assume that Free Fire is a one hit wonder, and therefore Garena’s profitability shrinks by some 30%37, and never grows again. We might also need to assume that the company’s cash balance of $2bn is used to fund investment in AirPay and Shopee which earns zero return, and that in addition SE continues to burn cash at the current rate of $750mn per year for the next five years (undiscounted). There is evidence to suggest that this is not an appropriate set of assumptions:

• Shopee’s take rates are improving. • Shopee’s sales and marketing leverage is improving. • Shopee’s user, order and transaction growth remains strong.

37 In 4Q18 Free Fire was 45% of Garena adj. revenues.

Sea Limited, $24, March 2019

Downside scenario 2: Free Fire is a one hit wonder, Garena does not grow, AirPay and Shopee burn through cash pile and another five years at $750mn per year (undiscounted)

$mn Garena 2020 EBITDA 400 Garena sustainable growth 0.0% Multiple of EBITDA 10.0x Garena value 4,000

AirPay and Shopee value -5,750 Net cash 2,000

SE equity value 250 SE market cap 10,800 Downside -98%

Upside scenarios.

If Garena can sustainably grow nominal EBITDA in line with real GDP growth in the region of c. 5%, AirPay is worth nothing and Shopee is valued at 5x 2019 revenues (making no adjustments to revenue to reflect the potentially supressed take rate)38, SE’s equity is worth c. $16bn, 50% higher than the current quoted market cap.

38 This implies a value of Shopee’s enterprise of 0.2x EV/GMV (2019 est.).

Sea Limited, $24, March 2019

Upside scenario 1: Garena grows 5% sustainably, AirPay = 0, Shopee valued at 5x 2019 adj revenues

$mn Garena 2019 EBITDA 550 Garena sustainable growth 5.0% Multiple of EBITDA 20.0x Garena value 11,000

AirPay value 0 Net cash 2,000

Shopee 2019 revenues 650 Shopee value 3,250

SE equity value 16,250 SE market cap 10,800 Downside 50%

If Garena can sustainably grow nominal EBITDA modestly in excess of real GDP growth in the region of c. 5%, AirPay is worth nothing and Shopee is valued at 10x normal revenues, adjusting the estimated take rate from 4% to 10% in line with competitors in the region39, SE’s equity is worth c. $37bn, 240% higher than the current quoted market cap. This would provide an upside : downside ratio of >13x vs. downside scenario 1.

39 This implies a value of Shopee’s enterprise of 1.1x EV/GMV (2019 est.).

Sea Limited, $24, March 2019

Upside scenario 2: Garena grows 7% sustainably, AirPay = 0, Shopee valued at 10x 2019 adj revenues (10% take rate)

$mn Garena 2019 EBITDA 550 Garena sustainable growth 7.0% Multiple of EBITDA 33.3x Garena value 18,333

AirPay value 0 Net cash 2,000

Shopee 2019 revenues 650 Shopee value 16,250 Implied EV/GMV (2019 est.) 1.1x

SE equity value 36,583 SE market cap 10,800 Downside 239%

Ratio of upside to downside 13.4x

Shopee valuation: private market peers

Private market transactions suggest Shopee could be materially undervalued:

• Tokopedia, a C2C business, like Taobao or eBay, but operating only in Indonesia, raised capital in 2018 which valued the enterprise at $7bn, c 1.5x the estimated GMV. • Flipkart, the dominant40 Indian ecommerce business, was acquired by Walmart at a $21bn valuation41 in 2018, implying an EV/GMV of 2.8x42.

If we apply a 4%43 take rate to management’s adjusted revenue guidance of $630-660mn, Shopee could be processing c. $16bn of GMV this year. At 0.5x EV/GMV Shoppe is worth the entire EV of Sea Limited.

40 FlipKart and Amazon India both have c. 30% market share 41 $16 billion investment for a 77% share of the company, https://techcrunch.com/2018/08/20/walmart-flipkart-deal-done/ , $7.5bn 2018 GMV: https://tech.economictimes.indiatimes.com/news/internet/amazon-overtakes-flipkart-with-7-5-billion-gmv- report/66834077 42 $7.5bn of GMV. 43 2018 take rate 2.8%, 4Q18 take rate 3.7%.

Sea Limited, $24, March 2019

Shopee EV for different normal take rate and GMV multiples, $mn Shopee normalised take rate 16,000 2% 4% 6% 8% 10% 0.1x 3,200 1,600 1,067 800 640 0.2x 6,400 3,200 2,133 1,600 1,280 0.5x 16,000 8,000 5,333 4,000 3,200

GMV 1.0x 32,000 16,000 10,667 8,000 6,400

2.0x 64,000 32,000 21,333 16,000 12,800 Multiple of 3.0x 96,000 48,000 32,000 24,000 19,200

Sea Limited, $24, March 2019

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