Description

OPERA NO (Long):

Market Cap: $1B USD

Share Price: 57 NOK or ~$6.68 USD @ 8.53 NOK

Target Price: 80 NOK (including 15 NOK special dividend), with upside to 100 NOK in a takeout

Introduction:

Opera Software’s recently completed divestiture of their consumer business has left the resultant company undeservedly cheap, with ample catalysts over the next 6 months to drive material upside.  After the pending 15 NOK special dividend (with favorable return of capital tax treatment), we see 50-65% upside on the equity stub in our base case.  Assuming a 2x discount to peer multiples (recent peer AppLovin sold for 3x revenue / 14x EBITDA), Opera could be worth 75%- 100% more than the current trading levels. We estimate downside of 45 NOK, supported by the December special dividend (33% of that value), and a 7x multiple on downside case EBITDA.

Business Overview:

Pro forma for the sale of the consumer business, Opera Software operates 4 businesses, with two, Opera Mediaworks and Apps & Games, representing the bulk of the value.

Opera Mediaworks: 85% of PF 2016 revenue

Opera Mediaworks is a leading provider of mobile video advertising solutions through their proprietary AdColony SDK and Instant-Play HD mobile video technology (mobile video advertising is over 60% of revenue).  SDK, short for software development kit, is a piece of software incorporated into an app to allow Opera to track and serve ads to consumers – every time a game on your smartphone plays a video ad – that’s their SDK at work. The Opera/AdColony SDK  is the 2nd most installed SDK in mobile apps (after Google, but ahead of MoPub/Twitter, Facebook, AOL, and Apple), which provides a large network from which Opera can deliver ads.  Opera also has an in-house Brand business that works with major advertisers to develop mobile video campaigns to utilize this network.  During their 2015 analyst day they noted they work with 90 out of the top 100 Ad Age advertisers and recently cited working with 85% of the top grossing mobile publishers (Supercell, King, etc).  Revenue was up 30% y/y organically for the first 9 months of 2016 but margins have suffered as the company added costs in anticipation of even more revenue.  With a Q3 slowdown in app launches and its knock-on effect on Q4 revenue, Opera saw margins decline to 7% in Q3 and will see only modest improvement in Q4.  

Going forward into 2017 Opera is taking steps to right size its cost structure and we see the potential for elevated incremental margins going forward, driving margins again in the low teens, although we don’t underwrite this in our base case.

Apps & Games: 10% of PF 2016 revenue

The bulk of this revenue is from Bemobi, a subscription mobile game service operating primarily in Latin America (Brazil is by far the largest market), that Opera acquired in April 2015.  For a small weekly fee that is added to the cell phone bill (and is recurring), users in these markets can get access to a library of thousands of mobile games from AAA publishers (many of which don’t publish their games in emerging markets).  Subscribers text a code to download the app and are automatically enrolled (to give some context: in Brazil it’s ~$1 / week).  As of Q3, Opera Apps & Games had 13.6M subs in LatAm and 3.1M in RoW (25% qoq due to new launches), generated revenue of $13.7M (70% growth yoy) and EBITDA of $6.4M (47% margin).  

Q4 will see the launch of three new major markets: India, Russia and Ukraine, which should drive growth in to 2017.

Opera TV: 5% of PF 2016 revenue

A small contributor with lumpy EBITDA contribution due to timing of license deals.  Opera TV operates as a separate business and we think the ongoing sale process eventually completes and cleans up this segment.  

We think in a sale Opera TV could get $80M (7.5x 2016E EBITDA).

Performance and Privacy: 1% of PF 2016 revenue

This segment consists of 2 businesses: Surfeasy (a VPN business which is modestly profitable - $1-2M / year in EBITDA) and Skyfire, which is deeply unprofitable and the source of some of the recent volatility in the stock.  Opera got stuck with this business during a renegotiation of the consumer deal with the Chinese buyers, however this was not contemplated in the original $75 – 90M EBITDA guidance.  In short: Opera got stuffed with Skyfire, which is losing $9M a year, and this was the primary driver of the guidance cut in Q3.

Going forward, the company has expected to either right size the costs at Skyfire to make it profitable in 2017 or shut the business down, either way the unexpected drag on EBITDA will be eliminated in 2017.

The Set-Up from Here:

Before adjusting for the now-completed divestiture of the Consumer business (since it’s closed we won’t regale you with that tale, but it involves the Chinese, a 20x EBITDA multiple, CFIUS, multiple twists and turns and a healthy dose of waiting), Opera has an EV of $1.3B.  Adjusting for the $560M in cash received from the deal, that is a PF EV of $748M.  

Opera has already announced their intentions for that $560M:

1. Repay $185M in debt

2. Pay a $275M (15 NOK) special dividend in December

1. This is classified as a return of capital and won’t incur withholding tax

3. Repurchase “up to” 10% of the float between now and the 2017 AGM (March 2017)

On November 28th Opera announced the details and commencement of the buyback of 14.7M shares – they can buy a maximum of 25% of the average daily volume for that day.  For the sake of discussion if they were buy the maximum amount based on the trailing 3 month volume, they would be buying ~97,000 shares per day and it would take them 151 business days (roughly 5 months without holidays) to complete the buyback.  So even running full speed from now until the AGM they will likely still have money left on the authorization and we believe they will do a second special dividend at that point with anything left – in short: investors are getting that money and the PF balance sheet will be clear with no net debt and modest earn-outs from prior acquisitions (of which only $20M is cash).

Capital Structure and Valuation:

Bridging to 2017 and 2018 EBITDA:

A few notes before addressing the bridge below:

1. Per the Q3 call Skyfire will be restructured in late 2016 to eliminate the $8-9M in losses. Those won’t recur in 2017.  

2. Mediaworks is rolling out a new Apollo ad platform which will consolidate a number of legacy systems, resulting in “single digit millions” of savings in 2017.  Opera had been supporting a number of old platforms from its acquisition spree to build what it is today and unfortunately for investors (but maybe fortunately for us) they have now completed the new platform and can shut down the spending on those other systems once clients are migrated.

3. We assume moderating growth in both Apps & Games and Mobile Advertising.  Modeling both is a maddening exercise, since for Apps & Games it depends on the timing of market launches (which we only see a quarter in advance) and Mobile Advertising depends on the launch of high grossing mobile games which have the Opera SDK installed – the success and timing of which are hard to guess although Operas significant SDK share ensures that if we see the next Clash of Clans or Candy Crush that Opera will be there).

4. We conservatively model Mediaworks incrementals @ 10% (they are more likely to be in the mid-teens to 20%, but given recent margin performance we use the lower end) and Apps & Games @ 60%.  We model Opera TV EBITDA flat given the unpredictable nature of licensing.  

5. For reference: consensus is $96M in EBITDA for 2017 and $115M in 2018.

Valuation:

We think the business is worth 80 NOK, or 65 NOK after the dividend, which equates to 9.6x our 2018E EBITDA. This is roughly a 10x EBITDA multiple for Mediaworks and Games and 7x for Opera TV.  We view these multiples as reasonable for a business growing at 20%+ organically and with a 7% (target) FCF.

There is a case for it to be worth a lot more.

AppLovin, a smaller but faster growing mobile ad serving technology firm sold a majority stake to the Chinese firm Orient Hontai Capital for $1.4B in September.  Our upside valuation equates to a ~$1B EV.  TubeMogul, which is roughly analogous to half of Opera Mediaworks (the Performance side, not the Brand business), was acquired by Adobe in early November for 2x 2016 sales (by comparison Opera is valued at 1.2x today and is growing faster).  If Mediaworks and Bemobi were valued at 12.0x in a transaction or ~2.0x 2017 sales, the stock would be worth 100 NOK (an adjusted 85 after special dividend vs. an adjusted 42 today).  

As for our downside, we think that if Opera only shuts down Skyfire and grows at a modest 5%, it would still be worth 45 NOK or 7.0x 2017E EBITDA.  Putting this downside in context, we think there are multiple ways to think about backstopping Opera at 45 or higher: this implies an EV of $500M EBITDA or less than 1.0x revenue. Bemobi was acquired for $110M and has over 2x as many subscribers and has seen accelerating growth due to Opera’s relationships with emerging market carriers (cemented from high share of the legacy Opera mobile browser), we think worst case Bemobi is worth $250M today (7.0x EBITDA, too cheap in our view). That leaves $250M of EV for Opera Mediaworks (with $600M+ in 2017 sales) and Opera TV (which we think is worth $80M) – which we view ample asset coverage for our downside.

Conclusion:

Opera is cheap and should be catalyzed by an aggressive near-term stock repurchase program, simple cost-cutting, continued organic revenue growth and the prospective sale of the TV business.  We don’t think Opera remains independent in the long run as programmatic mobile video advertising is a scale game and having the 2nd largest SDK footprint has significant value for the players trying to establish long term positions in the space.  We are confident owning it today at this price and think the standalone value is substantially higher than here.  

Catalyst

- Near-term share repurchase for 10% of float

- Special dividend on December 22nd

- Opera TV sale

- March 2017 Investor Day

- Full company takeout (not near-term)