Share prices of many gaming, e-commerce and business communications stocks soared in 2020 and early 2021, then fell dramatically in late 2021. Tech stocks came under pressure intense as investors remain concerned about high and sticky inflation, labor shortages, and the resurgence of COVID-19 cases associated with the omicron variant.
However, there are a few stocks, such as Sea Limited (NYSE: SE) and Twilio (NYSE: TWLO), which have been excessively punished despite a healthy business model and solid financial results. Although the short-term trajectory is discouraging, there remains a strong possibility of a strong correction in these long-term stocks. Let’s see why Wall Street values these stocks at a significant premium to their current price.
1. Sea Limited: implied upside of 121%
As the US Federal Reserve forecasts interest rate hikes for 2022 (which will reduce the availability of cheap capital), investors are concerned about Sea’s high rate of cash burn for its e-commerce segment, Shopee , and the resulting lack of profitability. Investors are also concerned about the overreliance of the company’s only profitable business, the Garena digital entertainment segment, on the continued success of its Battle Royale mobile game, Free fire. While these challenges cannot be ignored, a share price decline of more than 50% from a high of $372.70 on October 19, 2021 appears to be an overreaction.
Sea primarily focuses on Southeast Asia’s booming internet economy, where gross market value (GMV) is expected to grow from $170 billion in 2021 to $360 billion in 2025. Shopee has already established itself as the largest online marketplace and accounts for nearly 57% of Southeast Asia’s e-commerce market transaction volume. Shopee has also become the leading mobile e-commerce application in Latin America, just two years after its launch. These statistics highlight the success of Shopee’s business strategy of prioritizing market share growth in terms of number of customers and sellers over profitability. Although it involves heavy expenditure on discounts and advertising in the first few years, it should create strong network effects for the company’s e-commerce business in the long run. As Shopee gets a better foothold in these markets, the company can cut expenses, paving the way for profitability.
Sea’s only profitable business, Garena, has managed to build strong customer loyalty for its Free fire Game. Thanks to this and the launch of the MAX free fire version, there is still a long way to go to grow the game’s quarterly paid user base (which was only 12.8% of the total paid user base in the third quarter ending September 31, 2021). The company is a distribution partner for Tencent Holdings‘ (OTC: TCEHY) famous games like League of Legends and Call of Duty.
Finally, Sea successfully leveraged its e-commerce and digital entertainment business to drive adoption of its mobile wallet services. Although it currently represents only a small part of the company’s business, the SeaMoney fintech segment is expected to become a major growth driver in the coming years.
Sea is a diversified company poised to benefit from several secular tailwinds in attractive target markets. So, although Sea shares have been in a downtrend since late 2021, the company’s average target price of $377.75 appears to be well within reach for 2022.
2. Twilio: 90% implicit advantage
Shares of leading cloud-based communications platform player Twilio are down about 53% from their high of $457.30 on Feb. 18, 2021. Despite the recent tech stock selloff, this drop seems exaggerated, especially since the company, which allows companies to communicate securely with their customers, has recorded solid revenue growth since 2014. Twilio offers application programming interfaces (APIs ), which are used by many leading companies to easily integrate messaging, voice, video, and email communication services into their applications.
In the third quarter (ending September 31, 2021), the company’s revenue climbed 65% year-over-year to $740.2 million. Third quarter year-over-year organic revenue growth of 38%, although a deceleration from previous quarters, remains a respectable number given the higher revenue base in 2020. rates for the next four years also seems quite achievable.
Over the past two years, Twilio has also maintained a dollar-based net expansion rate of over 130%. This means that each quarter, existing customers spend more than 30% more on the company’s services compared to the same quarter of the previous year. A healthy dollar-based net expansion rate (above 100%) is indicative of the company’s pricing power and successful cross-selling strategy.
Twilio served more than 250,000 customers across all industries by the end of the third quarter. The company boasts of a diverse customer base including big names such as Amazon, PayPal Creditsand Shopify. In the third quarter, international markets accounted for nearly 33% of the company’s total revenue, a significant jump from the 27% exposure of revenue in the same quarter a year earlier. Since 2019, the company has also managed to reduce revenue exposure to the top 10 customer accounts. A well-diversified customer base across customers, industries, and geographies has helped build the resilience of Twilio’s business model.
Twilio is not profitable yet. The company also generated negative free cash flow in the first nine months of 2021. However, this may soon change as the company has entrenched itself in the ecosystems of several major players. Against this backdrop, the company’s average target price of $408.59 does not seem out of reach in 2022.
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