GoPro is a recently IPO’d camcorder manufacturer that, while generating profit by selling its wonderful action cameras, is pumping itself to the market as a part-manufacturer part-social-media stock, which has conveniently led to it being valued much more like a social media stock, at nearly 10x current revenue. I expect the valuation to significantly compress as the social media sector loses steam and as GoPro experiences increased competition and a wearing off of the novelty effect around action cameras.

Description

GPRO was founded a decade ago by Nick Woodman who was surfing and realized it would be good to have a camera that shows the action from his own point of view (i.e. shows something as close as possible to what his eyes are seeing). He set out to build a company that manufactures a new type of camcorder called “action camera” and also the mounts/accessories that are used to place these camcorders in various strategic spots (e.g. on a person, on the front of a car..). The product was aimed at showing remarkable experiences and therefore was originally geared toward any person or object that does things physically that most people cannot directly do/experience. So for example, someone recently mounted a GoPro on a drone that was then sent above a volcano to capture footage from above. Another example is mounting the camera on numerous athletes’ heads as they engage is extreme sports. The other important feature in action cameras is that the casing is relatively resistant given what the camera must go through.

The company derives its revenue from selling these products, about 50/50 direct sales vs. distribution. Because camcorders have been decimated by smartphones prior to GPRO’s success, GPRO has 40% of the camcorder market, but that piece of the pie is shrinking.

Over the past few years, videos taken with GoPro cameras have impressed many a web surfer and have been in turn purchased by people that were impressed, including some celebrities. There has therefore been a growing discovery of the product which has led to a spiral of growth revenue popularity and eventually to last spring’s IPO. It seems there are two phenomena here: the discovery of a new technical product by people who know exactly how they want to use this product over the long-run; and, a novelty item that looks cool but will sit in basements. To figure out run-rate revenue investors must therefore discriminate between the former and the latter. GPRO management of course never discusses the latter and as I will detail later, they are additionally guilty of much more pumping. Not a surprise since this is an IPO situation.

I will begin with a discussion of the hype around GPRO and management more generally, and follow with some discussion of reality.

GPRO as a Social Media Company

The main hype around GPRO is that it is a social media stock. How is GPRO in the social media business? Because they said that they want to build and monetize a website/platform where owners of GPRO cameras will be able to upload their videos. Now, when it’s time to be official, management doesn’t promise anything. For example, in the Q2 call, Woodman said that any revenue from social media is far off in the future. Similarly, the S-1 says “We do not expect the revenue earned from these GoPro Channels to be material to us in 2014.” But in any context that is less official, it’s full speed ahead with the massive hype. This has successfully awarded GPRO equity a valuation that’s in line with social media stocks as opposed to electronics manufacturers.

GPRO constantly repeats its “4 pillars”. In their words: they help people "capture, manage, share, and enjoy meaningful life experiences." As a matter of fact, all their communication is filled with ‘hypy’ language. The “share and enjoy” pillars are the social media part. The following paragraph in the S-1 speaks for itself:

“GoPro is transforming the way consumers capture, manage, share and enjoy meaningful life experiences. We do this by enabling people to capture compelling, immersive photo and video content of themselves participating in their favorite activities. Our customers include some of the world’s most active and passionate people. The volume and quality of their shared GoPro content, coupled with their enthusiasm for our brand, are virally driving awareness and demand for our products. To date, we have generated substantially all of our revenue from the sale of our cameras and accessories and we believe that the growing adoption of our capture devices and the engaging content they enable, position GoPro to become an exciting new media company.”

Also, in the S-1, the company twice mentions something they refer to as the “GoPro Network” (capitalization theirs):

“We will continue to expand our distribution of GoPro programming and the reach of the GoPro Network to new platforms such as Xbox Live.”

“Leveraging media content.    We expect to increase our investment in the development of the GoPro Network and its related content. We believe we have significant opportunities to establish new revenue streams from these investments. However, we do not have significant experience deriving revenue from the distribution of GoPro content, and we cannot be assured that these investments will result in increased revenue or profitability. “

But nowhere in the document do they define the GoPro Network. A google search yields absolutely nothing.

The media plan is either a fraud or - at the very least - meaningless, for the following reasons:

-       GoPro cameras do not take amazing videos. Professional videographers do. And these videographers may or may not use a GoPro camera to do the filming. But it’s hard and it’s a lot of work. The amount of GoPro videos that can be termed ‘amazing’ is small. When you look online, you will notice that most of them are just videos taken by a camera randomly mounted on some guy. Filming and editing techniques take time to learn for each person who learns them. On top of that, replicating GPRO products – that’s actually easier and more scalable. Competitors are making impressive action cameras now, just as competitors knocked on iPhone’s door. So there isn’t much of a moat. Kind of like TiVO.

-       The professionals who make the quality content work hard, so they would not want the company to monetize their videos that easily, especially since they have nothing to gain by posting their video on a GPRO website. Also, the degree to which a professional will be aware of how much their content is worth will be directly proportional to their work’s quality. So any GPRO media platform is likely to *not* have the very best user videos.

-       Horizontal disaggregation: GPRO is either pretending or convinced that they can succeed in keeping GoPro-created content on GoPro media channels even though there are other action camera manufacturers and other websites who specialize in video sharing (and that actually exist already!), not to mention the fact that these websites (YouTube, Facebook) are protected by network effects. There must be a reason why no other camera manufacturer has a famous website for people to share content created with their hardware.

-       Even if this plan were to happen, by the company’s own admission, it is far into the future and because its potential is limited, the present value is meaningless.

Final note: the company pumps certain deals like those with Virgin America and Xbox Live but they do not contribute revenue.

Management

I will point out 2 more tidbits about management. Firstly, while we are still in the lock-up period, the following announcement was made earlier this month: (I’m pasting the exact quote from the release to convey the fullness of the message…)

SAN MATEO, Calif., Oct 1, 2014 /PRNewswire/ -- GoPro, Inc. (NASDAQ: GPRO), enabler of some of today's most immersive and engaging content, today announced that GoPro's husband and wife founders, Nicholas and Jill Woodman, have provided a personal gift towards establishing a new charitable organization, The Jill + Nicholas Woodman Foundation.   

So… the company just went public, the growth rates are enormous, holiday season is coming up, a few quarters ago they had an inventory snafu and yet somehow they decided now was the time to start a new foundation.

Secondly, this from the S-1, for what it’s worth:

“In connection with the preparation of our financial statements for the years ended December 31, 2011 and 2012, we, in conjunction with our independent registered public accounting firm, identified a material weakness in the design and operating effectiveness of our internal control over financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness primarily comprised deficiencies related to a lack of technical accounting skills, monitoring activities and a lack of adequate review processes and controls within our accounting and finance organization. During 2013, we took certain actions that remediated the material weakness, which included hiring management level personnel with technical accounting expertise, designing adequate review and monitoring procedures in our accounting and finance organization, and identifying and implementing improved processes and controls. “

The Actual Business

So now that we know what GPRO isn’t, let’s focus on what it is: a maker of what is broadly known as “Action cameras”.

First, the category as a whole: I have mentioned GPRO to a few people and the average reaction is “oh ya.. isn’t that for sports”. And indeed, camera quality is *not* the niche here. The niche is the way in which the camera is handled and handles itself, i.e. the camera vs. its environment. Now, the people interested in this niche are divided in two, the serious people who want this ‘forever’ and those attracted to the novelty aspect. Among those who are attracted to the novelty and will end up with the product sitting in their basement, some actually engage in activities where a GoPro is useful while others do not even do *that*. Obviously sales based on novelty and x-mas gift popularity are not sustainable. Another important aspect for future sales is the pace of upgrade. Right now this is so new that few people who have an earlier version will feel a need to upgrade. The current product is very special and different as is. Although..some of the real fans have more than one action camera, so it’s a fluid situation. Anyhow, here is a notable comment from an online discussion:

“Working at a camera store I think this is a pretty accurate assessment. People are beginning to realize that the GoPro doesn't magically create amazing footage, they're also realizing that most of the time their GoPro is collecting dust in the closet.

As camera geeks we drool over the next 4k 240FPS WiFi gizmo, but the average consumer doesn't understand what any of that means. The market is getting close to saturation for GoPro and many people won't understand or even need to upgrade.”

It does in fact seem there’s a lot of useless GoPro content out there just because it is possible. It reminds me of the Michael Jackson music videos 30 years ago where they would put multiple Michael Jacksons in one screen just because it was a newly invented gimmick.

So while volumes to customers who are true fanatics is likely to grow in the U.S. and oversees, the bubbly novelty portion will go to zero.

Competition

On top of all that, we also need to account for competition. GPRO’s market share will surely shrink from last year’s 45%. Better companies have not only watched but already started competing and the results are good for them. Sony, iON, Panasonic and JVC are all in the market and GPRO’s gross margin has declined from the 50s to the 30s. Competitors have waterproof, HD and Wi-Fi enabled cameras. And the quality is there! Just look at the reviews:

http://www.amazon.com/Sony-HDR-AS100VR-Action-Camera-Remote/product-reviews/B00HNJWTDW/ref=dpx_acr_txt?showViewpoints=1

Firstly, I'm a heavy user of action cams. I've used them for everything from B-roll footage, timelapses, drones/quadcopters, helmet cams, weather balloons, high speed recording of MMA and plenty other things. […] I'm going to get straight to the main course. The quality of the video alone is an embarrassment to Go Pro.

I've used the GoPro Hero 3+ Black and wanted something better. The AS100V Action Camera is better in just about every way: much better battery life; better picture quality; but most of all, it includes motion stabilization.

GPRO's cameras are not the worse but clearly some of the others are already at a level that’s quite acceptable. As a matter of fact, a section of the S-1 called “What makes GoPro unique” basically doesn’t say anything of substance.

Valuation

So here’s a rough valuation model based on the assumption that their market share will decline only by a quarter to something like 30%, that a quarter of all current sales are one time (which I also think is generous), and that all remaining revenue is from people purchasing [cameras and accessories] for the same amount in every 12-month period. Then let’s assume 3 years of rapid growth of 80%, 50% and 20%, followed by normal growth.

So even if we exclude debt and share issuance from options and grants, the stock trades at 4.4x 2017 sales. A fairer price for a camera manufacturer with competition would be maybe 1.0x 2017 sales, which is $18/share.

When you look at the valuation compared to electronics manufacturers (Sony 0.19x EV/sales or Nikon 0.55 EV/sales), it’s clear what’s going on. GPRO’s valuation of 75x forward P/E and 4.4x forward sales is very similar to that of other social media stocks. The bull thesis here is that they *are* a social media stock, and so one of the catalysts (maybe the most important, maybe not) will have to be connected with Mr. Market deciding what it thinks about social media stocks and about GPRO in that context). When that occurs, the price will decline. In the meantime, there’s also room for earnings or top-line disappointments, or just a plain old bear market.

-       lock-up expiring just in time for x-mas

-       revenue/margin disappointment

-       GPRO declines relative to “other” social media stocks

-       social media stocks decline relative to market

-       market declines relative to its historical valuation