Upside Surprises

Authored By Louis Stevens

This Brief will explore of a handful of potential instances of companies revising their forward guidance upward in their Q2'24 reports. As we all know well, when a company revises its guidance upward, it can send the stock soaring, as CAVA's across the board upward guidance revision in its Q1'24 report illustrated, and this is especially true if the stock is not priced as if it will experience upward revisions to its guidance.

Presently, I do not believe the market has factored any of these catalysts for upward revisions to guidance into the valuations of the companies listed below, and I will spend some time illustrating that via data.

As a BLUF summary, here's the three businesses and their catalysts we will examine today:

1. Sea Ltd. catalyst for guidance revision = SE Asia ecommerce and Mobile Gaming Markets return to elevated growth; Free Fire India Relaunches or data is set for relaunch
2. Hims & Hers Health catalyst for guidance revision = Growth acceleration persists from its sequential acceleration Q4'23->Q1'24; GLP-1s created surprise revenue and subscriber results
3. SentinelOne catalyst for guidance revision = Crowdstrike's recent internal process failure causing huge global IT system outages

In each section below, I will start by concisely re-stating each company's catalyst; then, I will provide interpretation and supporting data subsequently. Let's begin.

Sea Ltd.'s Catalysts

• Sea Ltd.'s (SE) guidance upside = SE Asia ecommerce and mobile gaming markets resume growth after flatlining 1-2 years + Free Fire India relaunch

As of today, Sea Ltd. trades at one of its lowest valuations in its company history, as can be seen below.

Sea's EV/Revenue And EV/FCF Metrics

Its valuation implies that the company won't sustain the 20%+ growth it just reported, but should the market think this way and price Sea as such?

Sea Revenue Growth Quarterly (Just Accelerated Materially, As LAS Anticipated It Would)

Let's now explore the aforementioned two catalysts.

I don't believe I've read analysis of Sea in which the author illustrated that the GMV growth of SE Asia's ecommerce market flatlined. In some cases, it wasn't just that GMV growth flatlined in SE Asia; instead, in some countries, ecommerce GMV actually declined from 2022 to 2023, creating a massive headwind for Sea's Shopee's GMV growth.

It's curious that analysts would not focus on this reality, detailed quantitatively below, for the SE Asia ecommerce market because it's essentially one of, if not the most, important elements of the Sea/Shopee thesis today.

As we know based on Sea's Q1'24 report, Shopee maintained its market share in 2023, and Sea stated that Shopee may have even gained market share. This data rejected the bear thesis, which emerged largely due to Shopee's growth struggles alongside the entrance of TikTok and Temu, that competition was eating into Shopee's market share in SE Asia.

So, if competition was not the cultprit for Shopee's flatlining GMV, what then was the culprit? As you've likely divined, it was simply the flatlining and, in some instances, declining of GMV in SE Asia, data illustrating which can be seen in the charts created by Google, Bain, and Temasek below.

Philippines Ecommerce Only Grew 5% 2022 to 2023, Creating A Huge Headwind For Shopee's Growth

‍Malaysia Ecommerce Declined By 4% From 2022 to 2023, Creating A Huge Headwind For Shopee's Growth

Singapore Ecommerce Only Grew 5% 2022 to 2023, Creating A Huge Headwind For Shopee's Growth

We can see that ecommerce growth slowed dramatically from 2022 to 2023 throughout SE Asia (I only included a few of the countries, but it was pervasively the case), and, in some cases, total ecommerce GMV declined, as in the case of Singapore and Malaysia.

This decline occurred because 1)SE Asia employed very draconian and severe covid lockdowns, which boosted Shopee's growth in 2020/2021 to unrealistic highs and 2) SE Asia opened very late, which reduced ecomerce demand in late 2022 and into 2023. Many portions of the rest of the world opened earlier, so they may not appreciate these specific dynamics for the region and Shopee.

The stalling growth/declines for SE Asia ecommerce in 2022 and 2023 can also be seen in Grab (GRAB) experiencing huge growth acceleration concurrently:

As SE Asia economies reopened, ecommerce slowed and ride hailing accelerated.

Grab hit its peak growth rate at the precise moments ecommerce growth slowed/declined in SE Asia, illustrating that there were the aforementioned macro-ecommerce forces at play, unrelated to Shopee's competitive positioning. Shopee has sustained at about 50% market share in SE Asia, and we know this because Bain/Google/Temasek confirmed total ecom GMV levels in the region at about $180B, and SE's annualized GMV is now at about $90-$100B.

So this is the reality of what played out over the last 3 years for Sea Ltd. and its Shopee business.

Further very notable evidence that this has been the case can be seen in Sea's guidance for "high teens ecom GMV growth in 2024," which aligns with the above-illustrated reaccelerations of growth rates for each of the SE Asian countries.

"We are happy to have solidified Shopee’s market share in the region, and we intend to maintain our market share in 2024. We expect Shopee’s full year GMV growth to be in the high-teens range and its adjusted EBITDA to turn positive in the second half of this year." - Forrest Li, Q1'24 Sea Ltd. Earnings Call

Turning to Sea's Garena, i.e., mobile gaming business.

Here are the two catalysts that could create upward revisions to its current guidance:

1) India banned Garena's Free Fire in early 2022. India accounted for 40M Free Fire users, and Garena lost these users, which caused its Garena's sales to get cut in half, though SE has been working to relaunch this line of business in India (latest language from mgmt below). To reiterate why a relaunch would be an incredible catalyst for upward revisions to guidance and the stock in general:

"The battle royale game had over 40 million of its 75 million globally monthly active users in India in January of 2022, according to analytics firm App Annie. In fact, 'Garena’s Free Fire: Illuminate' was the most popular app to be banned in India in February 2022." -Times of India

2) Number of mobile gamers in SE Asia declined in 2022-2023 due to the aforementioned late re-openings of SE Asian economies, but this market has since returned to growth (chart below). I'm excited about Garena, arguably more than any other line of business for SE currently, because it generates $1.2B of cash flow per year presently, and this should start growing sustainably at 10-20% (much more if Free Fire India gets unbanned) in the years ahead as mobile gamer growth resumes in SE Asia, where digital product adoption still remains at just 50-60% of the population (so huge runway for growth ahead!).

Sea CEO Forrest Li On Free Fire's India Relaunch

SE Asia Mobile Game Users Declined In 2022, Putting Downward Pressure On Garena's Growth

"Finally, turning to our digital entertainment business. We are pleased to share that Garena is back to positive growth with bookings up 11% year-on-year. This was led by Free Fire’s strong performance across markets. In the first quarter, Free Fire’s average MAU increased 24% year-on-year. Our operational priorities for Free Fire will remain consistent in 2024, improving user acquisition, engagement, and retention. We continue to introduce play modes, redesign features, and launch new content all at a high frequency, allowing Free Fire to sustain high player engagement with this huge user base." - CEO Forrest Li, Q1'24 Earnings Call

Hims & Hers Health Catalysts

• HIMS guidance upside = Q2'24 GLP-1 sales contribution + full year guidance contribution greater than expected

I delineated the most important pieces of data for the Hims thesis in yesterday's Brief. I would strongly encourage you to read that Brief via the link below:

What Matters Most

In that Brief, I shared that Hims' GLP-1 business is likely booming based on my channel checks. Here's the language from said channel checks:

Now, in order to understand what has been priced into Hims' stock thus far, we need to do a little valuation math and make some assumptions. As ever, please remember that assuming makes an ass out of u and me. Assumptions are difficult and imperfect.

Risk = return, and all equities are risky, as Boeing and Crowdstrike have demonstrated profoundly.

That said, let's make some assumptions whereby we better understand what's being priced into Hims stock presently.

Below, we can see Hims' long term margin guidance. Let's review this data then continue the valuation discussion afterwards.

Hims' Long Term Margin Guidance

Using the midpoint of the above margin guidance, a 20% free cash flow margin would be more than achievable for Hims, again, based on this margin guidance, which is not guaranteed to be very, very sure.

That said, as we saw in yesterday's Brief, Hims' key metrics have been rapidly improving, which suggests that this margin guidance could very well be achievable over the long term.

So, granted this guidance is achieved, as of today, this is what Hims' valuation looks like:

• 220M shares outstanding * $19.50/share less net cash of $200M = $4.09B enterprise value
• Using assumed 20% long run free cash flow margin and TTM sales of (as of today) $1.1B, which equates to about $220M in pull thru free cash flow, Hims trades at 18.6x EV/fcf.

Considering the company just grew at 46%, while growing sequentially at 12.55% which represents 60% annualized growth, this is a staggeringly low valuation.

Even a 35x EV/FCF alongside this growth might be considered undervalued, much less an 18.6x EV/fcf.

When we factor in the booming GLP-1s business which was not a part of that phenomenal sequential growth rate, this valuation is doubly staggeringly low. In short, neither Hims normal sustained growth rate, nor its margin expansion, nor its GLP-1 business are factored into the current pricing of the business.

Should its growth sustain at more than 30% in the years ahead, its margins expand, and its GLP-1 business boom, the stock should generate 30%+ annualized returns from these levels and should re-rate with each confirmation of these elements of the thesis.

Turning to guidance, Hims shared that it would grow 41.5% at the midpoint. It has historically been very conservative in its guidances, and note that this did not include GLP-1s, so, with conservatism and GLP-1s in mind, this could certainly come in over 50%, and, as the valuation exercise above illustrated, the company is priced as if 1) no margin expansion will ever occur, 2) growth will fall off a cliff in rather short order, and GLP-1s will contribute nothing to the business.

Hims' Guidance For Q2'24

But the data-based reality is that Q1'24 represented a period of accelerating growth without the impacts of GLP-1s.

Q1'24 represented a period of increasing strength, so Q2'24 is likely to reflect the same without the impacts of GLP-1s.

And as these realities, along with the actual impacts of GLP-1s are revealed, upward revisions to revenue and free cash flow guidance should come and the stock should correspondingly appreciate.

To close, the market has not baked even Hims' regular strength into the stock price, much less its very likely booming GLP-1 business, so this could certainly be an upside surprise when Hims reports its Q1'24.

(To close here 2x, I did not include the below market share chart in the previous Hims Brief, but this bears noting. Hims has its highest market share ever, which aligns with the business' incredible strength detailed in yesterday's Brief.)

SentinelOne Catalysts

• S1 guidance upside = business flips from CRWD as uncertainty of CRWD's future reaches apex; vendor diversification returns as a trend instead of going all in on platformization; SMBs turn to S1 for greater attention while CRWD focuses on remediation, customer retention, and brand management; cloud business grows faster than expected

As of today, S1 trades at nearly its lowest valuation in its corporate history. There was one or two days in 2023 when the stock traded at just below its current valuation based on TTM sales (as of today) of ~$725M.

S1 Trades At 7.8x EV/Sales Using TTM Sales Of $725M, 310M Shares Outstanding, Net Cash Of $1.1B, And A Share Price Of $21.80/Share

This suggests that the market expects that S1's growth will continue to fall off a cliff.

But will that be the case following Crowdstrike's internal process lapse that has ultimately cost banks, airlines, hospitals, and other institutions billions of dollars?

We can't be sure. There's no way to no for sure today what will come of the next few quarters for either of the businesses. That said, the Crowdstrike situation will likely divert dollars to S1's revenue and free cash flow growth, which is presently not being priced into the stock in any respect whatsoever. The stock's pricing still suggests a business, like Elastic, bludgeoned by an endless assault by a better executed and larger scale competitor.

But will this persist as S1 sustains elevated growth, generates free cash flow, holds $1.1B of cash and no debt, and reaches $1B in ARR scale as Crowdstrike finds itself at least temporarily down for the count?

CISOs will likely look to diversify vendors so as to avoid catastrophic scenarios such as the one we just witnessed. Moreover, MSP (managed security providers), such as Pax8, will likely receive many more requests for S1's software in light of the Crowdstrike incident.

It's worth noting that S1 historically dominated the MSP space, but, in recent years, starting around the time Crowdstrike poached S1's CMO and CPO (which is an event that's worth noting!), Crowdstrike got more aggressive in the space, and I do think this slowed S1's growth a bit.

With Crowdstrike losing its luster and with it focusing its resources on customer retention, remediation, and image management, S1 has an opportunity to bring the devotion of MSPs back to its platform.

Presently, the market thinks S1 will grow at 20% in the year ahead. If it can demonstrate that it will grow ~30% atop free cash flow, as Monday has, there's likely about 100% upside from these levels.

Monday & SentinelOne Compared

In closing, these are a few potential upside surprises to monitor in Q2'24 earnings season.

I have a few more I'd like to share with you so be on the look out for a part two.

Disclosures:

L.A. Stevens has rated Sea Ltd., SentinelOne, Monday.com, and Hims & Hers Health a "buy."

L.A. Stevens has not rated Crowdstrike.