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Last week, Sea’s founder and CEO, Forrest Li, announced that the company’s top management would stop receiving compensation until the business became profitable and self-sufficient. .
I’ve noticed that whenever I report on Shopee’s incredible growth in the past (like here, just last month), many readers like to point out that it doesn’t mean much. because part of the business is flowing money, resulting in the entire Deep Sea into red territory. Certainly, they say, a company that loses too much cannot be considered well-managed.
So the question today is – why didn’t Sea focus on profits earlier, in better times? Shouldn’t it be more frugal in previous years?
The answer is no, and now is the perfect opportunity to explain why.
Profit is a dirty word, sometimes
A common belief about business is that companies exist to make a profit. After all, isn’t that the purpose? Invest your own money and time in the business to sell a high-value product or service that gives you a positive profit?
Actually, no, it’s not.
Companies don’t exist to make a profit – they exist to maximize shareholder (owner) value.
Now, in many cases, maximizing value for the owner is actually the profit from the business. Most small businesses operate this way, as the people who run them have to cash out monthly rewards to pay their bills. Otherwise, they can go bankrupt very quickly.
However, this is the source of a widespread misconception about business – most people only interact with smaller companies and, therefore, assume that profit is important to all of them. Meanwhile, the definition of value varies with the size of the business.
While hawkers, grocery stores, or hairdressers regularly make money, larger companies – especially those that are listed on the stock exchange or want to be – offer the greatest rewards. their owners/shareholders through the value they gain in the process.
To better understand this, let’s look at Amazon, one of the most valuable corporations in the world. As you can see in the chart below, while the company’s quarterly revenue has increased over the years, its profit has remained roughly flat.
The company itself has returned very little cash over 20 years.
If the company doesn’t make money, how can it be considered a good business? And why on Earth would anyone invest their own cash there if they can’t participate in the profits?
The answer is found in the second chart below:
A single share of Amazon in 1997 (adjusted for a breakdown over the years) was worth just $0.09 the day after the company began trading on Wall Street. Today, even after falling from last year’s historic high, that very stake in the company is still trading at more than $120 – more than 1350 times profit.
$1,000 put into Amazon in 1997 would be worth more than $1 million today and a million dollars would make you a billionaire (after 20 years of doing nothing, just letting Jeff Bezos run the business) business).
This is the “shareholder value” that large companies are pursuing. And it’s also how they attract investors eager to pour millions, if not billions, of dollars into their development.
That is also why Sea Ltd., similarly, does not mind making profits, but instead accelerates its growth using funds raised in the open market. to promote it.
Paradoxically, if it is profitable, it means the company is doing badly because it is not spending enough to capture market share fast enough to keep its shareholders (investors) happy. They really don’t care if the financial results show a net profit, because they don’t expect a payback – they expect their money to multiply in value.
Why is it suddenly important?
You might be a little confused right now. I just spent a lot of time explaining why profits don’t matter, right after Forrest Li vowed to make Sea profitable. It makes no sense at all!
Please bear with me a little longer.
You see, pursuing growth and losing money requires money to cover. If the company’s coffers are empty, it goes bankrupt – the party is over, everyone can go home, and the people who run it can often end up in a less hospitable place with lots of metal and concrete.
To keep burning cash in pursuit of growth, a business must increase it. Sea did just that last year, raising $6.3 billion from stock and bond sales in September 2021, followed by $2.6 billion raised in December. 2020.
As a result, combined with previous holdings, Sea had about $11 billion in cash in June 2022, $4 billion more than last year.
That sounds like a lot, but at the same time, it reported a net loss of nearly $1 billion in the same quarter. At this rate, it could burn US$3 billion to US$4 billion per year, meaning its war stock could be destroyed in as little as three years (and game over if that’s not enough). happen).
And, unlike last year, it can’t really go back to the stock market for any more gains, for three reasons:
- First of all, as all stocks fell in value, so did Sea, losing 84% from its peak. Raising US$6 billion last September would be just 4% of the company’s stake. To raise as much as it is today would require breaking up with more than 20% of the business.
- Second, the stock market outlook is not very positive, so there is no interest in large transactions between individual and institutional investors. While last fall, financial analysts suggested that Sea could trade above $400 per share, the concern today is that it could fall below $50. This has little to do with the company itself – which has continued to grow over the past 12 months – but unpredictable market conditions (with high inflation prompting central banks to raise interest rates and a a possible global recession around the corner).
- Ultimately, no one knows how long these problems may persist. Global uncertainty is at an all-time high with the war in Ukraine likely to go on for years and protracted supply chain problems (made worse by strict pandemic restrictions) of China) – both of which have increased the cost of international trade due to high energy prices and high transportation costs. While they remain high, consumers’ willingness to spend will decline. That’s not good news for the e-commerce that Sea has been investing in, especially a platform like Shopee that relies on selling mostly cheap goods with razor-thin profit margins.
In other words, Sea is entering a storm with no idea how long it might last and it has no choice but to lean on, as it cannot raise any more funding until conditions calm. come back.
Simply put, it is not profit the company suddenly pursues, but self-preservation (which is essential to the company’s shareholders).
The situation was not resolved by the ban on hit mobile game Free Fire in India – one of its biggest markets – earlier this year, pushing even the digital gaming arm in favor. Garena’s profits into trouble.
That’s why they have now chosen to fire some of their Latin American businesses, lay off employees and forgo paying large sums to their top management in pursuit of saving the most money possible. while making the most of the markets in which they are strong.
Under such circumstances, the most valuable activity to a company’s shareholders is no longer expansion – which is increasingly difficult with global conditions – but survival.
However, its odds would be significantly worse without the $11 billion cash pile, which it wouldn’t have amassed, had it pursued profits over growth in better times. .
Featured image credit: Michael Petraeus