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20 Oct

Uncertainty And Misconceptions Kill GoPro Stock

by

While the post-mortum discussions regarding the more than 70% drop in the share price of GPRO from this time last year (45% since July) continue to post on the Net, the consensus appears to point to GPRO as a stock that’s been knocked down too much from the souring opinions of a handful of analysts, which has now created a bargain at $30 per share.

Trading at nearly $100 per share in October of last year, GPRO’s financial metrics, arguably, did show signs of overvaluation at that time. But much can be said about many stained valuations traded on the Nasdaq since the spectacular run-up of more than a triple from the March 2009 lows, which only deepens the plot as to why this stock has reacted so violently to alleged changed conditions that haven’t been adequately demonstrated to a majority of analysts and journalists who follow this stock.

In any event, today’s much lower stock price and resulting Forward Price/Earning (P/E) Ratio of 14.5 places GPRO at a discount from Birinyi Associates’ (Yahoo Finance) forward P/E estimates for the Nasdaq 100 and S&P of 18.6 and 17.1, respectively. And for those who place more emphasis upon the stock’s price-earnings-to-growth (PEG) ratio of 0.50, instead, will certainly not feel like they’re ‘taking a flyer’ by holding a fad, momentum stock if shareholders will accept an earnings CAGR of 17.7% as a reasonable estimate for the newly-iconic brand of rugged and wearable HERO series action cameras.

Justifying a 70% drop to a stock price within a context of very healthy financial metrics and a growing marketplace for its products and future products planned in the virtual reality, drone, cloud, media and growing China markets may take some doing. We have not yet found any concrete information that would scare us away from this stock.

First, we ask ourselves: How many enterprises with nearly $2 billion of annual revenue, owe nothing to long-term creditors, and have $500 million in the bank? Additionally, with a gross margin range of 44% and 48%, operating margins of between 15% and 18%, and an adjusted EBITDA of approximately 20%, what is the problem with GoPro?

Apparently, enough traders have now come to believe the narrative that GoPro has seen its best days, and that excellent financial results won’t be easy to come by when meaningful competition moves in. Specifically, it’s been speculated that stiff competition from Garmin as well as camera makers Sony, Cannon, Nikon and others top the list of potential headwinds confronting GoPro. But from the looks of what’s selling best at Best Buys’ online store right now, GoPro’s line of HERO cameras rank no. 1, 2 and 3 for popularity in the “All Camcorders” category, and occupy six of the top 10 spots in this category. In Best Buys’ “Action Camcorders” category, HERO cameras hold the top six slots, ranked by popularity.

Could GoPro’s hegemony in the action camera business unravel? Of course it could, but investors should wait until they truly see the ‘whites of their eyes’ in the form of declining sales before pulling the trigger on a trade. And evidence of a crack developing in GoPro’s dominance in the action camera space—as suggested by Morgan Stanley analyst James Faucette—after GoPro announced a $100 cut in the suggested retail price of its recently-released (July) HERO4 Session is scant. According to GoPro CEO Nick Woodman, the cut in price for the Session was decided after company intelligence revealed that the Session was not selling as well as projected due to stiff competition from two other high-end competing camera, the HERO4 Silver and HERO4 Black, two of GoPro’s most popular products (representing more than 50% of revenue).

Faucette confirms the comments made by Woodman regarding the Session. “[O]ur most recent checks were decidedly more negative as customers prefer the Silver’s LCD screen and superior video quality over the Session’s smaller form factor,” stated Faucette in his research report released on Oct. 7. “Commentary by management at recent investor events confirm that Session has been a difficult sell at the same price point of its historically favorite HERO4 Silver model.”

So, is Morgan Stanley correct when it states that the disappointing sales volume from the Session is a “harbinger of future disappointments” elsewhere with the company’s product line, or is the Session another example of a product addition with too little differentiation from previously launched products, as Woodman claims?

The reason Morgan Stanley’s research report on GoPro and negative comments regarding the HERO4 Session are vital to the present narrative surrounding GPRO stems originally from comments made on Sept. 1 during the earnings call of GoPro’s supplier, Ambarella (AMBA), when Ambarella CFO George Laplante said during the call that he expected a decline in wearable camera revenue in the coming quarter. Investors interpreted Laplante’s comment to mean that GoPro’s revenue must therefore be slowing as well. But according to Dougherty & Company analyst Charles Anderson, Ambarella’s revenue derived from the wearable camera business was higher than expected in the quarter ending in July.

The Ambarella CFO also noted that he doesn’t expect any new launchings from customers in the wearable camera business, which was interpreted by investors as there will be no surprise launches from GoPro prior to the holiday season. And after Morgan Stanley reported Session’s lackluster sales, investors looking for that big launch into the holiday season will have to wait until the first half of the year for a new product launch. The HERO4 Session is it for 2015, and don’t expect any surprise revenue additions from a hot product during the holiday season.

Aside from the issue surrounding the reason for the $100 reduction to the Session as we move into the holiday season, Morgan Stanley is by far the least impressed with GoPro’s future. The analysts there also don’t care for the company’s editing software, stating, “Without compelling differences in software, GoPro devices will remain a niche alternative to smartphone video capture,” slowing its growth substantially to a rate that “fall[s] in-line with the broader digital camera market.”

With $1.7 billion of revenue booked last year, a slower rate of growth is expected from a larger base. While the Nasdaq moved up smartly from the Sept. 29 low, initially GPRO followed but continued to fall following the Morgan Stanley report. Besides Piper Jaffrey analyst Errin Murphy’s suggestion that a survey among teens (though not GoPro’s prime demographics, see page 13) revealed tepid enthusiasm for GoPro action cameras, Morgan Stanley’s report was the only significant news to warrant the selling pressure earlier in the month. We have to apply the principle of Occam’s Razor and suggest that Morgan Stanley’s report was most likely responsible for GPRO’s underperformance against the Nasdaq during the October rally.

With 20 analysts covering GoPro, we’ve presented in this article the worst of the latest opinions from well-respected research firms—that of Morgan Stanley’s. So, we ask the important question prior to earnings, scheduled for Oct. 28: Does GPRO really deserve a nearly 45% cut (at one point on Oct. 14) to its price following the Ambarella disclosure? Our guess is, that investors have overreacted and already discounted a worst case scenario, which include disappointing future earnings, starting with the earnings release (quarter ended Sept. 30) scheduled on Oct. 28. In our opinion, GPRO is priced today to reflect future disasters to revenue, margins and earnings. But, is there enough evidence to suggest that? We say, no!

On the bullish side of the stock’s future prospects for continued growth to achieve the estimated 17.7% five-year, CAGR to earnings, investors should consider that GoPro intends to launch HERO5 and a drone product, named quadcopter,during the first half of calendar year 2016. Piper Jaffray analyst, Erinn Murphy, stated the drone business could initially add at least 20 cent to per share earnings in 2016. The market for drones is still in its infancy and is expected to grow into a multi-billion dollar marketplace rather rapidly, according to Piper Jaffrey.

“She [Errin Murphy of Piper Jaffrey] estimates that the total drone market to be in the range of $1 billion to $2 billion in sales for 2015,” writes the Wall Street Journal. “By 2016, it could swing to $2 billion, and if GoPro could capture 10% to 20% of the overall sales, it could add between 20 cents and 40 cents to its annual earnings per share.”

Then there is the virtual reality (VR) business that Cowen & Company has said is an “underappreciated driver” of GoPro’s future revenue. The size of this market will become more clear as we approach the launch of GoPro’s first product.

And China. With 1.3 billion people and a huge middle class of consumers, revenue from China might overtake all other countries except the United States by the year 2020. As with any product sold in China, there’s enormous potential there.

“[A] quick update on China, where we are very pleased with our progress: China has become a top 10 revenue generating country for GoPro, and our store track count grew 31% sequentially,” stated GoPro CEO Nicholas Woodman. “Later this quarter, we will launch a simplified Chinese user interface for our HERO4 line of cameras and a simplified Chinese version of our mobile app.”

Conclusion

With so many markets for industry leader GoPro’s technologies and products yet to be serviced across the globe, the notion that such a consistently profitable company’s stock, GPRO, should be priced at a discount of approximately 20% to the Nasdaq 100 makes little sense at this time. Considering the reaction by traders to sell GPRO down to such a steep discount based upon the opinion of one analyst and original misconception from comments made by the CFO of a supplier may be giving investors a gift at GPRO at $30. Considering, too, the enormous short interest of more than 36% of the stock’s float held short, any positive news will most likely set off a rather sizable short squeeze. Thirty-six percent of the entire float held short is very dangerous situation to those holding GPRO short. All of these shares must be bought back at some future time, and any reason to rally the stock following the release of the company’s earnings scheduled for Oct. 28 may create a panic buying scenario. We believe the risks to the upside are rather steep when compared with the downside potential of a company that’s already taken quite a beating from so many shares sold short.

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