Sea Limited (SE) Q2 2018 Earnings Report, Transcript and Summary

Hello and welcome to the Sea Limited Second Quarter 2018 Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. Now I will turn the conference over to Alan Hellawell, Group Chief Strategy Officer. Please go ahead, sir.

Thank you, Keith. Good morning, and good evening, everyone, and welcome to Sea’s 2018 Second Quarter Earnings Conference Call. I’m Alan Hellawell, Sea’s Group Chief Strategy Officer. Before we continue, I’d like to remind you that we might be making forward-looking statements, which are inherently subject to risks and uncertainties and may not be realized in the future for various reasons as stated in our press release. Also, this call includes discussion of certain non-GAAP financial measures such as adjusted revenue, adjusted EBITDA and adjusted net loss. We believe these measures can enhance investors’ understanding of the actual cash flows of our major businesses when used as a complement to our GAAP disclosures. For a discussion of the use of non-GAAP financial measures and reconciliation with the closest GAAP measures, please refer to the section on non-GAAP financial measures in our press release. Let me begin by introducing the management team on the call. We have our Chairman and Group Chief Executive Officer, Forrest Li; and our Group Chief Financial Officer, Tony Hou. Forrest, Tony and myself will share strategy and business updates, operating highlights and financial performance for the quarter. This will be followed by a Q&A session in which we welcome any questions you have. With that, let’s begin with Forrest for our key strategic highlights.

Thank you, Alan. Good morning, and good evening, everyone. Thank you for joining today’s call. I’m very pleased that we are reporting a strong set of results for this quarter. Shopee continues to cement its position as our region’s most popular e-commerce platform, and Garena continues to deliver results from its strategy to capture new growth opportunities. Looking first at e-commerce. This was another very strong quarter for Shopee. Our strategy for Shopee is clear. We intend to continue building out our position as the regional leader by providing the most innovative and engaging e-commerce experience for buyers and sellers in our markets while driving ever greater efficiency improvements as we rapidly scale up. In the second quarter, we delivered on both fronts. E-commerce GMV reached $2.2 billion, almost triple that of the second quarter of 2017. Our ability to engage buyers with a huge range of products and the superior shopping experience increasingly makes Shopee the online shopping destination of choice for consumers across the region. A great example of how successful we have been in making Shopee the platform of choice is our peak Ramadan sale in Indonesia. This year’s sale, which ran through May and June, saw orders and GMV dramatically increase compared to last year’s sale. This is a peak shopping season in Indonesia, and our success in capturing consumers during this busy period really shows how important Shopee is for the online retail experience. We are also seeing very strong growth in marketplace revenue as more merchants made use of our value-added services to better engage with their consumers. Alongside this success in building engagement with buyers and sellers, we continue to drive the efficiencies across the business. Our ever-growing scale enables us to consistently drive down costs in areas such as shipping and the logistics. At the same time, as we continue to enhance the user experience and to build stronger loyalty with both buyers and sellers, we are able to achieve significantly greater efficiencies in our promotional programs. Sales and marketing as a percentage of GMV, for example, fell 40 basis points quarter-on-quarter from 6.6% in the fourth quarter to 6.2% in the second quarter. As Shopee goes from strength to strength, I’m pleased to say that Garena, too, is moving quickly to take advantage of growth opportunities in this, in our industry. Garena delivered an adjusted revenue of $139.1 million and adjusted EBITDA of $48.6 million in the second quarter, up 19% and 21%, respectively, year-on-year. In particular, as many of you well know, we have been focused on 3 key strategic areas for Garena one, moving from PC-only to mobile-first, two, moving from pure publishing to a mix of game publishing and development and three, moving from a regional footprint to a global presence. Across all 3 areas, we are making encouraging progress. In terms of mobile games, we are very pleased with how Garena has led the region in the development of the mobile space. And we are particularly encouraged by the strong performance of Arena of Valor and Free Fire, both of which are building huge and engaged mobile user base around the region. In the month of June, about 73% of our adjusted revenue for digital entertainment came from mobile games, which is a dramatic and a positive change in a short space of time. This speaks to our ability to understand the habits and the preferences of gamers in our region and adapt quickly and effectively to suit their needs. In terms of moving into game development, we view the successful launch of our first fully self-developed game, Free Fire, as the first step in our expansion into game development as a key growth strategy. We continue to leverage our traditional strength in publishing while exploring strategic opportunities upstream and the downstream. In the month of June, self-developed game revenue accounted for approximately 13% of our adjusted digital entertainment revenue. This is a record high, driven by the breakout success of Free Fire. The various monetization features we developed for Free Fire, such as the season pass concept, had led to encouraging monetizing results. Moreover, the game has most recently achieved a record high DAU count of more than 16 million. Looking upstream, we will continue to devote resources to enhance our in-house development capabilities. Having already established a development studio in China, we intend to grow that team while tapping into other talent pools in our region and the rest of the world. We also seek to expand partnerships with independent studios capable of developing promising titles. Strong game development capability will serve as a springboard for Garena to build up with global presence in the long run. In terms of the downstream value chain, we continue to explore new opportunities in eSports and game streaming in order to deepen user engagement. Our region continues to deliver one of the world’s fastest growth rates in terms of organized eSports and that there are still many opportunities for us as the first mover in our region. We will continue to build out our strength in esports, streaming and look forward to developing this aspect of the business further. Southeast Asia is a relatively underdeveloped market, and the history of growth in more maturing gaming markets suggested that there is a huge untapped opportunity here. Finally, I have already briefly mentioned our expanding global presence. We are hugely encouraged by Free Fire success. And if you walk down the street today in São Paulo or Mexico City, you are just as likely to see someone playing a Garena game as you would in Bangkok or Ho Chi Minh City. According to App Annie, in July 2018, Free Fire was ranked in the top 10 in terms of game downloads worldwide across both the App Store and Google Play Store. What we have seen from this global success is that many of the factors that drive a game’s success in our core market in Southeast Asia are the same as those in other parts of the world. I truly believe that Garena can play an important role in helping to build and develop gaming communities in many faster-developing markets globally, leveraging our success and experience in Southeast Asia. A brief example of this is Brazil, which is one of the fastest-growing mobile markets globally. According to Sensor Tower, Brazil ranked third behind U.S. and India in terms of the total number of downloads on the App Store and Google Play Store in the second quarter. Brazil is also one of the most exciting markets for Free Fire. According to App Annie, Free Fire has consistently been the top grossing Android app in Brazil across all categories since late June. This is an exciting and important period for Garena, and I will personally be playing an active role as we continue to push forward with these initiatives. I intend to work closely with our management team to ensure that even as we broaden our geographic footprint and grow our ambitions, we continue to deliver the same level of executional excellence that has driven our success to date. As we push forward with this initiative, we will periodically review our existing business to make sure we are allocating resources to where we can generate the best returns. This may mean some fluctuations from quarter-to-quarter as we continually optimize our game portfolio for future growth. As we move into the second half of 2018, we plan to launch new and highly anticipated titles across different genres in order to meet the evolving preferences of gamers in our region. In summary, I’m very proud of the growth that we have achieved in the second quarter of 2018, and I look forward to sustained growth for the second half of 2018. With that, let me hand the call back over to Alan.

Thank you, Forrest. With regards to e-commerce, the markets in our region continue to grow at a healthy rate. Frost & Sullivan recently released its quarterly e-commerce report, which estimated that 2Q 2018 GMV for the markets we operate in grew by 45% year-on-year to US$10.7 billion. Based on their analysis, Shopee is still the largest e-commerce platform in the region by orders with an estimated regional market share by orders of between 22% to 24%. E-commerce monetization, meanwhile, continues to rise encouragingly. Our take rate, excluding product revenue, rose to 1.7% in the second quarter from 1.1% in the first quarter. Marketplace revenue surged 69% quarter-on-quarter as all major components: advertising, commission, fulfillment and logistics, grew nicely quarter-on-quarter, and all grew markedly faster than GMV. The second quarter improvement across all service lines of our e-commerce platform is indicative of our ability to steadily improve our value proposition to our user base. We are confident that we can continue to drive the take rate upward as we share a steady stream of innovation and efficiency improvements with buyers and sellers. Turning to Garena. In the second quarter, quarterly active users, or QAUs, grew 150% year-on-year and 27% quarter-on-quarter to 160.6 million. We deepened market penetration as new games continue to grow while existing key franchises continue to deliver solid results. Quarterly paying users, or QPUs, in the quarter declined to 6.6 million from 7.2 million for the first quarter of 2018. The quarter-on-quarter drop was primarily attributable to the decrease in the number of paying users in Vietnam due to measures launched in April by Vietnam’s leading mobile operators to restrict the use of prepaid telco cards for online game top-ups. We are now actively strengthening alternative top-up channels to assist our paying users in this market. It is still too early to predict how quickly the market will recover as we develop these new sales channels. However, we believe that fundamental demand for our games remained strong. In fact, across our titles, QAUs in Vietnam continued to grow to record highs in the second quarter. We are also encouraged to see growth in the number of paying users again in the past few weeks as users adapt to the new environment. And finally, with regards to our digital financial services business, I’m pleased to tell you that earlier this month, we obtained the e-money license in Indonesia. We are still in the early stages of planning for the types of services that AirPay will provide with the license.Though, obviously, we see this as a significant opportunity to further strengthen our digital financial services infrastructure to support both Shopee and Garena in Indonesia. We are indeed excited about the future of online financial services in Southeast Asia. During this period of rapid evolution and the value proposition of AirPay, we’ve realized that there is a need to update the legacy metrics that we have been sharing with you. This will, in fact, be the last quarter that we disclose GTV in its current form. We aim to return in the future with disclosure that better captures the rapid adoption of e-money and other online financial services across our markets after we have further implemented our services in connection with the recent developments. With that, I will pass on to Tony to talk more about the financials.

Thank you, Alan, and thanks to everyone for joining the call. Same as the previous quarters, we have included detailed quarterly financial schedules together with the corresponding management analysis in today’s press release.So I will focus my comments on the key financial metrics. For Sea overall, our second quarter total adjusted revenue was our highest at $219.6 million, an increase of 71% year-on-year and 11% quarter-on-quarter. This was mainly driven by our continuous monetization efforts in our e-commerce business in the past quarters and the growth of our digital entertainment business year-on-year. Digital entertainment adjusted revenue was $139.1 million, an increase of 19% year-on-year and a decrease of 5% quarter-on-quarter. The year-on-year growth was primarily due to the improvement in monetization of our existing games and the launch of new games. For the sequential decline in revenue and QPUs, Alan has already discussed the telco cards top-up restrictions in Vietnam as the main reason. Digital entertainment adjusted EBITDA was $48.6 million, an increase of 21% year-on-year and a decrease of 12% quarter-on-quarter. E-commerce adjusted revenue was $58.8 million, up 74% quarter-on-quarter from the first quarter of 2018. Of this $58.8 million in adjusted revenue, marketplace revenue was $37.3 million, while product revenue was $21.5 million. Adjusted EBITDA loss widened slightly to $188.3 million despite the increase in marketing efficiency compared to the first quarter of 2018 as we continue our investment to fully capture the market opportunity in the region. We will stick to our strategy to grow our Shopee platform and strengthen our market leadership position, especially in our focus categories. We expect our investment in sales and marketing to continue throughout 2018 as both our GMV and gross orders continue to grow. Digital financial services adjusted revenue was $3.4 million, a decrease of 36% year-on-year from $5.3 million in the second quarter of 2017 as we focused our efforts on strengthening the infrastructure to support our existing platforms. Digital financial services adjusted EBITDA loss was $6.8 million in the second quarter of 2018 compared to a loss of $11 million in the same period of 2017. Returning to our consolidated numbers, we recognize a net non-operating loss of $30.8 million in the second quarter of 2018. This was primarily due to the fair value loss of $37.2 million arising from the fair value accounting of the convertible bonds we raised before our IPO. We had a net income tax benefit of $0.2 million in the second quarter of 2018, which was primarily due to the deferred tax assets we recognized in our digital entertainment segment. Finally, our adjusted net loss, which is net loss adjusted to exclude share-based compensation expenses and the fair value change for the pre-IPO convertible debt, was $198.7 million in the second quarter of 2018 as compared to $86.9 million for the same period of 2017.

Thank you, Tony. We shall now open the call for questions. Steve?

We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Miang Chuen Koh of Goldman Sachs.

For the games business, can you perhaps elaborate a bit more on how you’re strengthening the alternative top-up channels in Vietnam? And you also mentioned some improvement in paying users that you’ve seen in July. Can you talk about how large that improvement was? And on the games side as well, as you’re talking about, as you talk about going more global and more self-development, can you also talk about whether or not there’d be any impact on your relationship with Tencent? Thank you.

Sure. This is Alan, let me take that first question about strengthening alternative top-up channels. We’re doing a number of things from further pushing our own branded top-up cards in the existing channels that we’ve worked with historically. I’m not sure, I didn’t see if you’ve noticed over the past few days, but it’s extremely encouraging to see that the acting minister for information and communications indicating that the ministry intends to introduce processes that should enable companies to recommence offering telco top-up cards for digital services in the coming weeks. I think the reality is this is an extremely valuable channel for the telcos. It’s obviously a popular means the gamers to play our games. And in sum, there are a lot of constituents who want to see the restoration of that channel. But we are confident that growth will return. As Forrest has pointed out, there’s been very strong growth in our key titles. And so we would think, with time, things will come back to normal.

Yes. I’m happy to answer the second question. Yes, so I think like, we have a lot of discussion with the Tencent games leadership team. Our interest is fully aligned. I think that both companies have the strong interest and intention to explore international global opportunities, and there is a lot of areas we can collaborate and we can lend best practice and compare notes together. Especially I think for certain areas because our, this is related to our increasing like capability in terms of the game development, and we work together to like explore some co-development opportunities for the global market. I think an early example of that is the co-development of Arena of Valor, and we expect to do more with Tencent on that front in the future as well.

Great. If I may ask one additional question, just curious, post a recent fundraising exercise. Could you sort of talk about whether or not you are not fully comfortable with your financial position now as you expand more in the e-commerce space?

Yes. This is Alan, I’ll take that question. We’re generally very comfortable with our cash balance. I think you referenced the $575 million we raised through a previous CD. And as we've discussed on previous earnings calls, we moreover have multiple alternatives to raise money should we so desire. And we indeed remain very open minded about which option, if any, to proceed with. Clearly and invariably, maximizing shareholder value is our most important consideration, so we're still evaluating indications of interest from potential strategic partners and members of the financial community. I would also add that we're very pleased with the valuations we're seeing amongst smaller e-commerce players of recent in the region, and so we're very comfortable both with our position cash-wise right now and the options we have going forward.

And the next question comes from Michael Olson with Piper Jaffray.

Two questions. First, regarding the go-forward outlook, if there is one, maybe I missed it in the press release or elsewhere, but are you providing a go-forward outlook? Is it a reiteration of the existing full year guidance that you’ve given? And then I have one follow-up as well, please.

Yeah. Hey, Mike. So we would definitely maintain our full year 2018 revenue and GMV guidance. We’re comfortable with that. We -- as of the second quarter, if the question is whether we have rolled out 2019 guidance, we have not done that yet. We’ll do it at one of these upcoming quarters.

Okay, thanks. And then are there any more details that you can provide on the new internally developed titles that will be coming to Garena in the second half of the year? I guess, specifically, are these games in a similar genre to Free Fire? Or are they in other genres? And how many titles could we expect? Thank you.

Sure. At this moment, yeah, we are still very focused on the future development of Free Fire. And we believe this is just the beginning of the battle royale genre, and there’s -- the genre itself is still rapidly evolving and there’s -- that will present a lot of like opportunities down the road. And even like for Free Fire itself, the user base is growing quickly. And also like we still see a very promising monetization opportunity for that game. So that is -- at this moment, we have like about half of our studio employees working on Free Fire. We have another half there is a pretty much focused on exploring the prototype of some new games. This is across a quite active range of genres, including MMORPG, including SLG and including the card game. So -- but I think all of them is still at very early stage, and we are not like have a clear plan for what is going to be the launch plan for our next game from the studio, but we are actively working on that. So we will let you know as soon as we have more concrete update on that part.

Thank you. And the next question comes from John Blackledge with Cowen.

Great. Thank you. A couple of questions on Shopee. So the GMV was better than expected in the second quarter. I’m just wondering if you could talk about the drivers, any key verticals driving that growth. And then on the monetization side, if you could discuss the value-added services in some more detail, kind of the key drivers of the value-added services monetization in 2Q, which markets you’re seeing the most penetration. And then lastly, on the monetization side, any color on the marketplace revenue, the split between the commissions and advertising and the value-added services.

Sure. This is Alan. So with regard to your first question about GMV, I'll state probably something that's very obvious, we saw generally strong sequential growth across all 7 markets. In terms of the actual drivers, generally speaking, we continue to draw the majority of our growth from new customers. Most of the other inputs to the equation are relatively stable: average basket size, frequency, et cetera. And so yes, it's characteristic of a market growing from 2% to 3% to 4%. It's really user growth that's driving that. With regard to your second question, Shopee monetization, I'd just -- as I mentioned in my prepared remarks, the very nice thing is that every flavor of monetization, if we think about it as a take rate, actually increased quarter-on-quarter. So adoption of advertising continues to grow. We’re seeing a very healthy growth in the actual number of sellers using advertising. Some of the other aspects, the VAS, such as logistics, we saw very appreciable growth in the number of sellers who adopted our SLS and other solutions. And so penetration is generally spreading. And this is, at least across advertising and VAS, across almost all of our markets. As you know, commissions are still significantly a Taiwan-based game. In terms of marketplace revenues, again, advertising and commission, both nicely outgrowing GMV. But VAS, in turn, given that it’s a relatively new service, is growing faster than those 2. I can try to give you some more color offline, but generally, again, very encouraging uptake of all of our marketplace-based services.

And the next question comes from Alicia Yap with Citigroup.

I have some follow-up on the situations in Vietnam. So what is the current status now? I understand we’re trying to smooth it out gradually. And if we can get some color, for example, what was the percentage of revenue coming from this mobile operator? And is this just 1 operator or multi-operators? And, or why have they suddenly decided to do that? And would there be any reset also happening to other countries in the region? And then just quickly, a follow-up on the Shopee business. I understand one part of the main driver for the revenue uptake could be related to the logistics and fulfillment. Any other value-added service that you plan to roll out into the second half? Thank you.

Great. This is Alan. With regard to your first question on Vietnam, we don’t actually break out our gross billings by channel. But suffice it to say, telephone, mobile, telco top-ups were, have historically been a pretty sizable channel. And the impact of this, I can say, if this has not happened, we would have seen a sequential growth in our mobile gross bookings, so that gives you a sense as to what it, how it impacted our Vietnam business and also overall. You asked about the reasons behind this decision. The telcos, I think, wanted to ensure that this form, this application of top-up was being used for all the right reasons. And obviously, gaming is one of those right reasons and legit applications. I think there were probably some other more untoward uses, and they found it best to kind of summarily discontinue that. But as I mentioned earlier, many actually do look to top-ups and the top-ups for entertainment for a lot of revenues and profits. And I think this is probably one of the reasons the government has now made such committal remarks in the press. I wouldn’t want to handicap when exactly things will be brought back on stream, but you can find it in the media that there is reference to likely a number of weeks before it comes back on stream. So we’re cautiously optimistic there. Your third question was whether the Vietnam situation could happen in other regions. We have absolutely no reason to believe that there is, this would happen in any other market, not even a whisper, I think it is very isolated and one-off. And then your final question, Shopee monetization, any other value-added services that we intend to roll out. The answer is yes. That said, we’re generally pretty conservative about signaling to the market what tools we have planned, but it will be part of our drive to continue to drive up take rate, and we’ll do our very best to profile any new tools that we announce as soon as they are released.

Thank you. And the next question comes from Conrad Werner of Macquarie.

Hey there. Thank you so much for taking the call. First, just a couple of questions on the e-commerce business. You mentioned the successful Ramadan sale, which really helped boost the GMV through June. Is there any risk that as we head into the third and fourth quarters, that that creates a sort of a more tricky sequential comp? Or are we still growing at a healthy rate where we still can expect sequential growth kind of through the remaining 2 quarters of the year? The second question, just on the e-commerce. I tend to look at the sales incentives, net of item as a sort of a proxy, for commissions. I’m not sure if that’s still correct or not because that was kind of down sequentially from $6.4 million in the first quarter to $4.16 million in the second quarter. And I know there are some accounting quirks that go with that, but are commissions growing sequentially? Your comments seem to suggest that they still were. Then maybe just on the games, talking about maybe some of the third-party games. Can you tease any titles into the second half? Can we expect any new titles in the second half to kind of boost the games portfolio? And then just lastly, on the balance sheet. The shareholders’ equity right now stands at just above US$200 million. And given that we’re still in investment mode and kind of losses are in and around that kind of ballpark, is there a risk of the company kind of tipping into a negative shareholders’ equity position anytime this year? Is that something we should be concerned about? Are there solutions to that? Those are my 3 areas of questions. Thank you.

Sure thanks. So with regard to your first question, you made reference to the Ramadan sale and the strength that we saw and the impact on the third and fourth quarters. We envision no negative impact. We saw very appreciable sequential growth in the second quarter. Obviously, we speak now, as of August 22, we’re generally very pleased with the third quarter. So I don’t think you would see what has happened in some other markets, in which events become so all-consuming that they conceivably stuff GMV from prior and subsequent quarters. We’re generally seeing good sequential growth.

So with your second question, on sales incentive, net of under GAAP is decreasing compared to Q1. So actually, we net off on a per order basis. And that’s another angle to look at it as we are continuously driving down the per order subsidies over the quarters. And for the fourth question about the balance sheet, well, so the main reason is that we had 2 rounds of convertibles raised pre-IPO and recently. So if you’re looking at the pre-IPO convertibles, the conversion price is around $13 to $14. We’re pretty much in the money at this moment, so not really worried on that point. And for the CVs we raised recently, the conversion price is $19.8. And we’re quite confident that with the time being, down the road, that our share price would be higher than that, and we’re not quite concerned at this moment.

Okay. And then regarding the second half 2018, the game pipeline. And in general, we are conservative to mention any game titles, which are not like 100% in the launch pipeline yet. But like what we have launched in early August, this Contra Return, which is a mobile game developed by Tencent with a very famous Japanese IP Contra. And it’s still -- like it’s only happening like almost 3 weeks. It’s still too early to judge the potential of the monetization of this game. But in generally -- in general, we are pretty happy with the result we have seen for the first 3 weeks. And we just launched a game in Taiwan, so in August, and we plan to launch in the rest of our market in September. So for the other games, like we probably -- we’re going to have another 2 games will be launched on the regional level, so across almost all of our markets in second half of this year. So we’ll let you know as we have more concrete launch plan of those games in the future.

Thanks so much. And maybe just the last follow-up.Sorry to take up all this time, but there was some news out of China talking about delays in game licenses and Tencent and other game publishers, developers being impacted by this. Does that trickle down to yourselves? Has that delayed any of the launches that you had planned for the second half in collaboration with developers or not?

Like -- number one, there’s I think like a quite isolated Chinese -- China industry issue. It’s a market-wise, and this has nothing to do with our market. And actually, so if you ask me to make an estimation, it’s may be a slightly positive trend for us. Because like things like the China market, it’s a little bit like a slowdown for whatever reasons. And there are some more and more developers start to put their eyes on the international market. And we have seen increasing interest like from the Chinese developers to try to work with us to launch their games out of China.

Thank you. And the next question comes from Varun Ahuja with Credit Suisse.

Yeah, hi. Good morning everyone. I’ve got a few questions. First, on the gaming side, can you tell us how the FIFA launch has been for you? And how is it ramping up over the last few months since you have launched? That’s number one. Number two, you mentioned that your self-developed games are increasingly taking higher contribution of your adjusted revenue. But if you look at your gross profit margin for this quarter, it was around 51%, down from 52% previous quarter. So just wanted to understand, is there any other cost elements because my belief is that increasing contribution from self-developed games should at least help you in your margin side? So that’s number two. Number three, on the, you mentioned that Brazil and Mexico has seen a recent take-up of Free Fire. Is there any chance, given you’ve seen that these markets are exciting, that you may also consider a similar arrangement with Tencent or other developers to push your games in these 2 markets? Are you looking at Brazil and Mexico as another extension of your Southeast Asian market, which have similar kind of attributes? So that’s number three. And lastly, on e-commerce side, this product revenue, can you just provide more clarity in which markets are these primarily? Are they largely in Indonesia and Taiwan? That will be helpful.

Okay, thank you. And I think like regarding like FIFA Online 4, and we launched the game right before the World Cup. And the, I think like, at this moment, we consider this game as still in the transition period from the previous like version of FIFA Online 3. And we see a pretty good pickup like from the new launch for FIFA Online 4, both in terms of the user base and the revenue side. But we’re still seeing a lot of, a lot of gamers are still continually playing FIFA Online 3 at this moment. And we recently, so we recent, I think this is kind of like it’s another, it’s a plan because we really want gamers to have a transition, migration period of time and to let them slowly migrate to the new version. We believe it’s a much better version of online, FIFA Online 4. But we don’t want to force gamers to do that. That’s why we plan a pretty like a decent transition period. And I think that is the best for, from the gamer’s perspective. And of course, this may, at this moment, it may limit the monetization capability and the growth capability of, for FIFA Online 4. And then recently, we made the official announcement to the gamer community. So soon, we are going to close FIFA Online 3. And in a way, this is a push to gamers to migrate to the new version as quickly as possible. I think like when we finish this migration process, and that is the time like we probably have a better sense of the user base and the monetization potential of FIFA online 4. Yes, so I think, at this moment, because of the migration situation, it’s still a bit early to tell. And regarding your question about the South America, yes, definitely, I think we are very excited to see the potential in those markets. And as I mentioned just now, so we do see a lot of common success factors between South America market and the Southeast Asia, which we are very familiar with. At this moment, we are really, really focused on, to make sure like Free Fire continually being a very successful game in those markets. And we travel there frequently, and we engage with the local communities. We are going to join a big game show in Brazil in October. And I think like through all those efforts and like where we get a chance to continually building up our local operation and the publishing capability. I think like when we have those capabilities build up, and that may be the chance for us to talk to some third-party game developers to launch their games in South America, which is very similar to what we have done with game developers in Southeast Asia. But interestingly, we do already have some incoming like request for us, if we are interested in launching like their games from like third-party game developers in South America. So this could be a potential growth opportunity for us down the road. And, but at this moment, we still really, really focus on to continually make Free Fire a very, very successful game in South America.

So I’ll take your question on gross profit margin for the games side. So basically, under GAAP, we only defer the revenue and channel cost but not the rest of the cost. Say, for the revenue share part, it has to be on the cash basis. So that naturally creates a disparity sometimes over the quarter that cause the GTV margin to fluctuate. But if you only look at the cash revenue, it’s pretty stable.

Maybe I’ll take your last question on e-commerce product revenue. We don’t disclose by market, but I can say just more maybe qualitatively, we’ve seen very encouraging uptake in markets such as Taiwan and Indonesia. And we are obviously continuously rolling out these capabilities across all of our markets. But yes, I would say the most encouraging results happen to be our 2 largest markets.

Thanks everyone. Just 2 follow-ups. On Free Fire, how do you see the impact of Fortnite being launched on Android platform in these markets? So that’s number one. And secondly, PUBG is, I don’t think the intent there is a really focus on monetizing PUBG in the market. So how do you see it increasing Tencent looking international games, will that impact Free Fire’s monetization potential? So increasingly, more battle royale genre games coming in, especially Fortnite on mobile. How do you see that may impact Free Fire monetization in the next 12 months or so? That’s number one. And number two, the gross profit margin that I was talking about was on cash basis only, so it’s 51% compared to 51.6%, so 52% in the previous 2 quarters. So, but adjusted the accounting thing. Thank you.

Sure. And for the question for Free Fire, looking at the monetization trend and what we have done, what’s in our plans. So I’m very optimistic about the monetization capability of Free Fire. I think like, but the others there is some similar type of game in the market. As you mentioned, Fortnite and the PUBG Mobile, I think like that those games already existed there so for quite some time. So it’s like definitely, there is, this is like, even just from the competition perspective, this is just another new competition. And respectively for Fortnite, and as you mentioned, we remain to see what is the potential of this game on Android. And I think there is some factors like we are looking at, and I think like we don’t think this is a big threat or a concern for us, number one. So in general, I think like Fortnite is much more popular in Western markets than in some emerging market, and especially like Southeast Asia or even South America. And the second is like, recently we heard the game is not being distributed through Google Play. And we do know. So we’ve been cautious to see what the impact in terms of the accessibility of Android version of Fortnite. And the third is like even just considering across the globe, the market, and I think that the game itself is probably more popular on the console than on the smartphone. But if you look at Free Fire, so our focus is very, very clear. So number one, it is to optimize for the smartphone users and, specifically, like optimize for like Android users and with the relatively lower-spec phones, right? And the second is we are really focused on some emerging market, like all of the market where like Free Fire is doing very well at the emerging market. And the third one is, at this moment, we already a decent, very large user base, 16 million daily active users. And we continually enlarge the user base at the same time. So over the years, we have accumulated a lot of great experience through our publishing capability, how to retain users, how to build communities among the user base and how to run all the top-ups like game events, including eSports events, for those users to make sure they stay with that game. And actually, that is our strength like traditionally. So in a way, we are very confident about the prospect of Free Fire. But interestingly, on top on that, I think like we closely monitor, so we learn from the best practice of some game in the genre that we like in terms of monetization from Fortnite, from PUBG Mobile, for some best practice we may implement them into Free Fire, which offer Free Fire a higher, better prospect in terms of the monetization.

So for your follow-up question on GP. I guess, you add up the change in deferred revenue and the deferred channel cost, and derived the percentage. So that’s similar in terms of cash term. So the main reason is we have some fixed cost like depreciation, like human resource cost. Naturally, compared quarter-to-quarter, the revenue or the gross billing drops a bit, so that part contributes to the margin drop slightly.

Thank you. And the next question comes from Andrew Orchard with Nomura.

Hi, guys. Thanks for taking my question. Firstly, on the e-commerce advertising. Obviously, that’s quite a big jump in the quarter. Just trying to understand where, and specific to advertising, growth is coming from? Are you putting in more ad loads? Or is your per ad price going up? And then also on Free Fire, just trying to understand what’s the relative size of the game in your entire gaming portfolio right now? And can you also give us a sense of how monetization is trending relative to what you’ve seen in your previous games in the past? Thanks.

Yeah. So with regard to sources of advertising growth. I think I mentioned in the past seeing a growth in overall number of advertisers. And I think that that’s one of the biggest, if not the largest, basic driver. We generally don’t disclose ad rates, but generally, they've been rising gradually. We obviously want to ensure at this important stage that sellers identify very persuasive ROI. And so you, obviously, as you well know, you expand inventory to, among other things, relieve pressure on pricing. And so we’re kind of in that mode. But I think the most important thing and the one, the thing that we do, we work toward, is to educate advertisers and grow that number. And I think we’ve been very successful in that regard.

Yes. And regarding your question, the relative size of like Free Fire in our game portfolio. I think as we reported, and if you look at our like June revenue, right, and actually June is the first full month when we start to focus on monetization of Free Fire. And if you remember like our last earnings call, so in mid-May, we mentioned that, okay, we were going to have like an update, a patch in late May. And that is the kind of the first patch we start to focus on monetization effort. And so June is the first full month of that effort. And so if you look at the June number, Free Fire has already accounted for 13% of our entire game revenue. And so this is very promising. And you can expect for the next couple of months, that percentage number will increase. And that gives you a sense of the size of the, in terms of the revenue contribution of Free Fire in our entire game portfolio. I think in terms of the monetization, like sense of monetization relatively to other games, and I think it’s relatively early to judge. And because this is a new genre, right, it’s very different from the, some like MMORPG or like even mobile or FPS game, which is a very mature genre, and even the monetization, too, is pretty, like, in a way, it’s pretty standard. But like for Free Fire, for battle royale as the new genre, so every quarter, every month, there is some new idea in terms of the monetization. And definitely this reflect there is a good potential. And I think if you just look at our number now and based on existing monetization tools, I think we’re quite happy with the, in general, about this genre in terms of the monetization capability. It may not be as good as some mobile game like Arena of Valor but, definitely, it’s better than a lot of other games in our portfolio, yes.

And the next question comes from Mark Goodridge with Morgan Stanley.

I just had a couple of questions on the e-commerce business. Firstly, just on the competitor environment with Lazada. We’ve seen them introduce free commissions for the merchants in Malaysia, Thailand and Singapore since July. But I just wanted to see, has there been any impact on your business, any slowdown in any form whatsoever? And then secondly, last week, in Indonesia, we did see that the Indonesian government introduced some import taxes. So I just wanted to see, would there be any effect on your business in Indonesia on that?

Sure. This is Alan, I’ll take those questions. So with regard to Lazada having introduced the 0% commission, we simply have not seen any impact on Shopee, and we don’t expect to see any material impact. We’ve historically not seen such measures as having, really have any relevance on our growth trajectory. I mean, may be stating the obvious here and as you know, we went from a 1.1% to 1.7% take rate. Our general working assumption is that as the market consolidates and matures, we should be rolling out more and more monetization tools. And so that’s the direction we’re headed into, and we would be very firmly committed to pushing up our take rate going forward.

I’ll take your second question on Indonesia import tax or duties. So the impact will be minimal because, at this moment, the cross-border transactions are not substantial for Indonesia market. And we are, meanwhile, we are closely monitoring the progress and the details on how the government may operate such rules or tax laws. And we’ll see, and we’ll actively seek for the consultants’ opinions on how to cope with it to make sure we are fully compliant of the new regulation.

Would you, would your expectation on that Indonesian change to be more affecting people in the market or your competitors in the market who have a higher proportion of 3 Cs being sold through their product mix?

Well, my opinion recently, expect it, yes, because pretty much naturally, you’re going to pay more as a local consumer. So that will be expected, yes.

Thanks guys.

Thank you. And the next question is a follow-up from Miang Chuen Koh with Goldman Sachs.

Yes, hi. Just additional follow-up on the e-commerce business. Just wondering what is the percentage of GMV now that is from B2C and also from cross-border. And also just wondering when in Taiwan, Shopee Mall has already started charging commissions to create for some time. Just wondering whether other regions are in the works of seeing the same change or the same monetization? Or there will still be something down the road? Thank you.

Yes, this is Alan. With regard to your first question, percentage of GMV coming from B2C and cross-border, I’m sorry, when you say B2C, are you talking about direct sales?

So it includes obviously merchants’ existing products, the different merchants’ existing products in your marketplace as well.

Right, right. Okay. Well, so if it’s Shopee Mall, that continues to grow as a percentage of GMV. I don’t have a material update for you right now. I think we have mentioned in the past that the percentage across most of our markets begins in the very high single-digits and moves into the mid to high teens. And cross-border, I believe, would be still in the mid to slightly high-ish single-digits but no major change there. And then you had another question about introducing mall commissions to other regions and the time line. I think notionally speaking, to the extent that Shopee Mall commissions are, by and large, being paid by multinationals and large domestic brands, basically 2 constituents that are, have a tradition of paying commissions, whether it’s in China or Latin America or Japan, we structurally don’t see ourselves as any different. With regard to time line, unfortunately, we can’t really give you much detail there for competitive signaling reasons and other reasons. But we have shared with you in the past, MC, that one of the big triggers in our mind is achieving a level of category dominance. And with this last quarter, we feel like across all of our markets, we’ve moved closer to that. So I would continue to focus that as a potential catalyst.

Got it. Thank you.

And I think -- sorry, we’re going to need to wrap up right now. I just wanted to thank all of you for joining today. And for all of us around the table, I think I speak for the entire management team, we very much look forward to seeing you at many of the upcoming corporate access events over the next few weeks, and we remain totally committed to fielding any other questions you might have subsequent to this call. But I trust you all have a good day, evening and morning. Thank you very much.

Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.