Opera is a niche web browser in the midst of a strategic turnaround, trading at a FY22E EV/EBITDA under 4x. Overdone bearishness on ad-based business models, ADRs and a broad based market sell-off have dragged the share price lower, starkly contrasting with the improvement of its core business.
A rocky history and a “creative” VC-style capital allocation policy have also contributed to a depressed share price pre-2022, because it hid the gradual improvement of the core business since the IPO under a mayhem of exceptional gains & losses.
As Opera continues to cash out its VC bets, improve its operating business & buy back its own stock, financials will paint a clearer picture of the business & show dramatic undervaluation. I believe the stock could quickly rerate to a valuation of >15x FY 22E EBITDA, or north of $10 per ADR, implying 100% upside.
A niche browser for gamers and performance obsessed individuals reaching its full monetization potential
Opera launched one of the first web browsers in 1996. It has been a user-focused innovator, launching built-in products such as a VPN, an ad blocker and PC/mobile sync early on. A focus on privacy and performance has helped Opera carve a niche within the gaming community, shielding the small company against the competition of Microsoft, Apple & Google.
However, the company was not been effectively monetizing its user base, and was led by a team of Norwegian engineers. Since it was taken out by a PE firm in 2016 and the technology team wasn’t part of the deal, the focus has shifted towards monetization.
Opera has a strong brand value amongst the gaming community, and has the advantage of having a very homogenous user base. This means that they do not need cookie based advertising, or any privacy-invading data collection method, to offer competitive add slots to their advertising partners through their built-in ad marketplace.
Current management has decided to fully take advantage of this by focusing on retaining monetizable users, to the expense of decreasing its overall user base. By making the user-base even more homogenous, management intends to raise the competitiveness of its ads driving like-for-like ARPU gains.
Moreover, management has decided to target higher ARPU markets for MAU growth, away from its traditional developing markets user base. They are currently achieving this pretty successfully, as a few of their initiatives paid off:
Opera GX (2019), a gamer-only web browser which now boasts over 14 million MAUs, up 100% YoY in Q2 2022, and has 3x the ARPU of Opera’s other browsers.
Opera News (2017), which boasts >40m monthly readers and is available as a standalone.
Opera GameMaker Studio (2021), A gaming portal acquired through YoYo Games with half a million developers.
Overall, even though the loss of low value users outpaces the gain in developed markets users, implying an overall user decline, it is more than compensated by ARPU expansion from a revenue standpoint, as advertising revenue is up >2x over 2019-2022.
Messy financials that hide the structural business improvement
A necessary side effect of the long list of new strategic initiatives over the past 3 years is compressed margins. Moreover, as Opera did a lot of strategic acquisitions & joint ventures to spur off new initiatives, financials got a bit messy.
However, Opera is starting to reap the benefits of their strategy, and underlying margins are expected to expand. 2022 guidance imply a non-adjusted EBITDA margin of 15-17% (I don’t add back SBC).
Opera is actively divesting its investments to focus on the core business, so financials should start to paint a clearer picture of the business. Nonetheless, it’s important to discuss management capital allocation & to take a closer look at these investments as they now represent over 30% of the market value of the company.
“Creative Capital Allocation”
To understand what is going on with Opera’s non-operating assets, I think it’s important to understand the recent history of the company.
Opera was previously a holding company comprising the browser and a B2B ad business. A Chinese private equity company “Golden Brick” made a bid to buy everything in 2016. However, the US competition regulators rejected the bid, so the holding company sold off the browser business and renamed itself to '“Otello”. The browser was acquired for $600m, or 3x the current enterprise value.
Since then, the PE firm executive Yahui Zhou became co-CEO, and they invested in a bunch of new initiatives (some of which we discussed earlier). Opera IPOed on the NASDAQ in 2019 at $12 a share.
Instead of making an exit, the firm actually retained control of Opera and the two CEOs actually continue to lead the business. Yahui Zhou and other executives of the PE firm own close to 50% of Opera’s shares personally.
As we mentioned earlier, the two CEOs made a lot of “strategic” acquisitions. The way I see it, they look more like speculative VC type investments, which isn’t surprising given the CEOs backgrounds in PE. Also I think its important to note the speculation in tech stocks (both long & short) in 2021.
But, if we take a holistic view on those investments, they were far from leading to a disastrous outcome. In fact, I estimate that management made money for shareholders.
As the core business regained traction in late 2021, early 2022, they made a commitment to divest all their investments, probably seeing that it was a drag on the share price. Given that they own over 50% of it personally, I assume they care about it.
The current value of their book comes as a bonus to the browser business when investing in the stock. Here’s a quick summary of the material exits and assets held for sale:
Sold 19.35% of StarX for $83.5m in cash payed in 3 installments over 2022-2024.
Sold Nanobank for $127.1m divided in 8 equal installments over 2022-2026
They currently hold an interest in Opay, which was worth $84.6m as of their last funding round. It is also held for sale.
The PV at 5% of the cash to be received and the valuation of Opay discounted by 50% to reflect the current environment add up to roughly $190m.
To that, we add the current value of their stock portfolio ($47m) and cash & cash equivalents of $139m to get total non-operating assets of $376m.
As the current market cap is $570m dollars, you get the Opera browser business for $200m, or a third of what management paid in 2016. This implies an enterprise valuation of 4x FY 22 EBITDA.
It should be no surprise that they are taking advantage of this to buy back stock, with $10m of their $50m buyback program used in H1 2022, repurchasing close to 2% of the market cap.
Hopefully, their capital allocation strategy has permanently changed from VC bets and market speculation to buybacks. That would go a long way to help the stock re-rate to fair value.
An attractive valuation, but a few material risks to consider
It really doesn’t take a long look to figure that Opera is significantly undervalued, even when applying ultra-conservative methods:
Assuming non-operating assets are worth 0 and just subtracting cash, you get an EV of $400m, a 33% discount to Opera’s 2016 EV of $600m. However, Opera is now profitable & has >3x the revenues it had in 2016..
For Opera to trade at 1x NTM Free Cashflow, the stock price would have to be $3 per share including non-operating assets. That’s how much downside you have even assuming its Opera’s last year in business. (-40%)
On the other hand, reasonable valuation methods imply a lot of upisde:
The previous M&A transaction valued opera at 6x sales. Assuming the business would trade at the same multiple, it would be worth $1.8b or $19 per share including its non-operating assets, implying 300% upside.
A comparable companies analysis of other ad-based business models and assuming Opera should trade at a 30-40% discount to the bigger more established companies would take you to a valuation of >10x FY 22 EBITDA, or $7.5 per share, in what is a really depressed environment.
A DCF with a 10% discount rate and assuming 10% growth/15% FCF margins between 2022 and 2027 and 3% terminal growth would give you a valuation of roughly $1.5b including non-operating assets, or $13 per share.
Taking all of this at face value, it seems that stock can hardly go lower, but can go much higher. I would agree, but I have to mention a few important risks that do turn me off a little:
There is credit risk attached to the sales of NanoBank and StarX. They were sold to PE firms connected to the current CEOs. The payment terms were already changed once for NanoBank, and that could happen again. They may not find an exit out of Opay.
Management could continue to speculate in non-related ventures, even though I don’t think that will happen as this has been a drag on the stock price, of which the majority is owned by management.
Opera owns 3% of the market, competing against the 4 most powerful companies in the world, literally. Though I do believe its niche, which has survived for two decades, is a powerful moat, you have to keep that in mind.
Why I think the reward outweigh the risks in the short term
The business momentum is very favorable as their strategy seems to be paying off. Opera has hit an inflection point in growth & profitability in the last two quarters. Under normal circumstances, it would be reasonable to expect positive price reactions to this type of performance.
However the macro is bearish, especially on advertising & small caps. I think this explains why the stock is down YTD even though Opera’s size & idiosyncratic outperformance makes this irrelevant.
We have been in an advertising bear market for close to a year now. Historically, bear markets don’t last much longer. Even though the economic conditions could stay depressed for a while due to the energy crisis, stocks will look forward towards the recovery when they see signs of an inflection point. More likely than not, the advertising bear market should be over sometime in 2023, perhaps before.
The guidance raise in late august implies that Opera’s business momentum will continue to be strong in 2022, and I don’t think it’s a stretch to assume that this will continue in 2023. If Opay is sold in that period and cash continues to go towards buybacks at an attractive valuation, Opera will look great when the market turns.
On the other hand, Opera only has to collect one payment for NanoBank this year, which makes the credit risk unlikely to materialize before 2023. Also, the competitive risks are not going to play out in a few months if they haven’t played in out in the last few years.
Overall, the good things are likely to happen before the bad things, which makes me confident that the stock will re-rate in the near term. I think a PT of $10 a share or 15x 22 EBITDA is in the cards, which implies a 100% IRR over that period. Perhaps one could even consider calls, such as the December 23 $10 strike calls when they come out.
This is a bit different from my other investments which tend to be longer term. I do not intend to hold Opera for years. Rather, I want to see the thesis play out in the short term and move on, unless I find reasons to believe that there is no credit risk, that management has changed its view on capital allocation & that competition from Apple, Google & Microsoft isn’t an issue.
If that happens, I’ll do an update.
Great article ! I think you are ultra conservative in the valuation given the 20%+ revenue growth and AEBITDA growth towards the 30% target. Couple of minor nit-picks 1)Song Lin has been with company for more than decade. Probably you meant Hongyi Zhou who owns around 20% of Opera, 2nd behind CEO Yahui Zhou 2)Financial terms of Nanobank changed recently not starX 3) Opay's 6.44% stake is worth $128M based on last $2B funding round.