Opera: The Street Is Wary

Source: Author

Opera’s (OPRA) fintech bets are promising but risky. Recent macro instability has sent valuation nosediving. Calling a bottom is futile as there is already a stampede at the exit. Investors are encouraged to keep the faith and see beyond the bear market.

Demand (Rating: Neutral)

Source: Author (using data from Seeking Alpha)

Opera reported solid results last quarter. Opera’s revenue and cash flow are being driven by the expansion of its fintech bets in EMEA. While the strong momentum and revenue growth guide is promising, the risk inherent in the bets will continue to lead valuation, given the level of fintech competition in its operating countries. Also, the potential ripple effect of a weak EU market will impact its EMEA forays. While business activities are going on smoothly in Africa, the market is already pricing in possible macro instability, which could manifest in the form of FX volatility and slow economic activities as African businesses whose supply-side depend on Europe and China might be impacted from the current market turbulence.

Business/Financials (Rating: Neutral)

Source: Author (using data from Earnings Slide)

Opera is now largely a fintech bet on the growing middle class in emerging markets. The loan loss rate trend suggests a huge risk premium has to be priced into these bets. Though the trend is expected to improve due to a mix shift towards more returning customers with better credit scores. The guide for the new fintech bet in Europe was positive, though the contribution to revenue won’t be significant until 2021. This means the ad business has to do the bulk of the heavy lifting for margins and cash flow to improve.

Source: Author (using data from Seeking Alpha)

Management has decided to respond to the recent short report by focusing on growing its business in addition to the recent share buyback announcement. Here are my takes on the key talking points:

The browser business

Source: Statcounter

Opera has chosen to set up shop in West African countries like Nigeria, where it has a strong browser dominance, though the market share trend is not favorable in the long term.

Source: Statcounter

In Kenya, the scenario is the same. Opera strategically set up its operations in these countries to leverage its browser ad inventory to drive marketing for its fintech bets at little to no cost, given that it still has a double-digit market share in both countries.

Google Play

The image below is an excerpt from the personal loan policy page.

Source: Google

Users should note the line, which states: “apps for personal loans must disclose the following information.” This implies that personal loan apps will remain in the play store. If Google intends to ban personal loan apps, that line won’t be there. However, it also states in the excerpt that we do not allow apps that promote personal loans which require repayment in full in 60 days or less… The correct interpretation of this line is that you shouldn’t promote sub-61 days loans. This mostly applies to ad promotion. Google has ML (machine learning) algorithms that crawl ads for banned keywords. Promoting keywords, phrases, or content that have been banned by Google can lead to a suspension of your app or landing page. This means Opera’s loan apps can continue to run on Google Play if they avoid the promotion of sensitive keywords on their landing page. Any knowledgeable ad manager knows this, and most ads aren’t approved if they have the potential of implicating the landing page or app.

Loan rate/default

These are quick loans aimed at buying cheap items and goods. No fintech algorithm will recommend that you repay $100 for 365 days. I don’t think any data scientist will keep his job building such a ludicrous algorithm. Therefore, I don’t see a problem with the loan rate.

Macro/Competitors (Rating: Bearish)

Kenya’s Credit Reference Bureau has blacklisted 2.7m people for being unable to repay loans as little as $2. This suggests that financial inclusion has some downsides, if the products themselves are mercenary and unregulated.

There is little Opera can do to the EMEA risk inherent in its loan business in Africa. Government regulations and competition from established commercial banks can impact loss rate and user base growth. For example, there are 49 digital lenders in Kenya. In Nigeria, the number of fintech companies providing quick loans keeps growing daily. As a result, I consider the timely move towards the European fintech space via the recent acquisition of Pocosys a brilliant decision.

COVID-19

The whole of Europe has now been on lockdown since the World Health Organization officially declared COVID-19 a pandemic. New cases remain concentrated in Europe as China falls off the chart of the top countries with more than a hundred new daily cases.

Source: Bloomberg

Italy is set to flatten its transmission curve, just like South Korea and China did. As it stands, it will take at least a week for the global transmission curve to flatten as most countries only recently instilled a travel ban. Therefore, I expect investors to continue to price in the ripple effect of low economic activities across publicly traded assets. Central banks are already preparing massive stimulus packages, which are akin to preparing for a worst-case scenario.

Source: Goldman Sachs

While Opera derives the bulk of its revenue from Africa, no continent will be spared from the ensuing ripple effect as economic activities across the globe slow. Therefore, investors have to wait for the next earnings call to gauge the full impact of COVID-19 on Opera’s business. If Africa remains spared, I expect Opera to report good numbers next quarter, though my biggest worry right now remains the possibility of a currency devaluation in Nigeria. This will have a big impact on Opera’s ad and fintech revenue from the country.

Investors/Valuation (Rating: Bullish)

Source: Author (using data from Seeking Alpha)

The most important part of Opera’s business is the sentiment of investors towards the stock. I don’t know how management intends to rewrite the narrative; however, the table above summarizes all that investors need to know. The first line highlights the FY’20 analysts’ FWD revenue guidance. The Street is highly conservative due to a mix of negative catalysts weighing down its growth narrative. Management is guiding for more decline in the retail, technology, and licensing (at 4% of revenue, expected to phase out) segments, and single-digit revenue growth in the search business. On a positive note, advertising and fintech bets are expected to power growth. While the advertising business can be scaled efficiently, given Opera’s enviable MAU, it has to contribute towards growing the fintech business. This will reduce its monetizable inventory. Also, the fintech business is risky, and growth is expected to moderate going forward.

The suppressed P/S (TTM) ratio is a function of the negative sentiment that was triggered by the recent short report. This was further catalyzed by key macro headwinds, including COVID-19, and asset inflation worries as central banks continue to search for new tools to control volatility in top economies.

The EV/EBITDA ratio is a function of a mix of strong EBITDA guidance, which bakes in the huge capital requirement of its loan business, which is expected to impact margins.

The suppressed P/E ratio is a function of the unwillingness of the Street to buy into the profitability narrative given that net income is partly a function of contributions from the third-party assessment of the fair value of OPay and StarMaker. These businesses both came under attack in the recent short report.

Risks

While the bulk of its risk factors remain priced in, Opera’s growth will continue to be plotted along the risk curve of the volatile indicators of economic soundness in EMs like Nigeria and Kenya. I can’t predict the future when it comes to running a business in Africa; however, I can confirm that you should always have your plan B ready.

Conclusion (Overall Rating: Hold)

Source: Author (using data from Seeking Alpha)

The recent fintech bet in Europe is promising as it will provide some cushion for Opera’s risky EMEA exposure. COVID-19 has set the tone for the level of volatility to expect in the coming quarters. In the midst of all the noise, investors should bear the following in mind:

  1. The global transmission curve has to flatten before volatility subsides.
  2. We are entering the first inning of a bear market; key valuation metrics will swing towards value factors (profitability, debt/equity ratio, cash flow strength).
  3. Companies with huge exposure to EMEA will be the most volatile as Europe remains under lockdown. This means their road to recovery might take more time than anticipated.
  4. Now is the time to reassess your portfolio and stay defensive.

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Disclosure: I am/we are long JMIA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.