Why you shouldn’t worry about Sea Group’s growing net loss

Sea has just released its first quarter results for 2021. As always, its growing net loss, which has hit US$422 million (up from US$281 million a year earlier), will come under the microscope.

That said, we don’t think investors have cause for alarm.

Sea Group is actually profitable. In Q1 2021, it recorded a positive adjusted EBITDA (US$88.1 million) – something it has repeated for four straight quarters.

But what is adjusted EBITDA and how is it different from net loss?

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. Unlike net loss, EBITDA does not include the effect of accounting rules and financial decisions, which makes it in many instances a better reflection of the business performance of a company.

Here’s perhaps a more intuitive way to look at it: Under generally accepted accounting principles (GAAP), revenue collected for a product or service within a time period is spread out over its projected lifetime.

In other words, GAAP does not count all the money the company has collected as revenue immediately – hence the term “deferred revenue.” For Sea, deferred revenue mainly consists of “proceeds from [the] sales of in-game virtual items”. Other gaming companies like Activision-Blizzard and Electronic Arts also have to defer revenue.

Sea uses a measure called “bookings” to track both present and deferred revenue for its gaming business. Its bookings for Q1 was US$1.1 billion, or US$328 million more than its GAAP revenue for that business.

Taking all of the above into account, it’s looking like Sea Group’s business is both profitable on an EBITDA basis and is on an uptrend.

EBITDA is not without its critics, though.

For example, excluding depreciation and amortization overlooks the fact that a company’s assets suffer from wear and tear. At some point, they will need to be replaced, and this will require actual cash.

No cash is also required when compensating employees with shares. However, this will result in the company’s total share count going up and existing shareholders becoming diluted.

Sea’s cash flow trends are positive

Digital entertainment is profitable

Losses a reflection of a longer-term strategy