$GPRO is Turning Around

I wrote this report for myself on 22/11/2020. I doubled down on my $GPRO investment on that date.

>Recommendation to Myself

Buy. I am currently long GPRO. I bought at 4$ on Feb 2020 and multiplied my bet at 6.96$ in Nov 2020. I see an acceptable margin of safety with meaningful upside (also a large speculative component).

>Company Description

GoPro, Inc., GoPro hereinafter, develops and sells cameras and mountable and wearable accessories in the United States and internationally. GoPro also enables customers to edit videos via apps. GoPro recently launched a subscription service that enables customers to store unlimited content on the cloud, total substitution of camaras and up to 50% discount on gopro.com. GoPro distributes products through retailers and directly through its website, gopro.com.

>High Level Background

Content is (cash) king in the digital age. Selling online requires continuously producing and distributing engaging content to funnel potential customers towards sales. As we buy more and more online, content is increasingly relevant to business. GoPro. delivers tools that maximize content creation productivity. GoPro also has an extraordinarily strong brand. For example, in Q4 2019 it captured 93% dollar share of the action camera category in the US. In FY2019, 90% of GoPro´s revenue came from the $300+ price band products, up 62% from 2018.

>Hypothesis

Following many years of decline, the company is turning around. It is doing so by making notable advancements in 3 key areas, 2 of which have been greatly boosted by the pandemic:

1. Revenue: the company is now driving a hardware renewal cycle a la iPhone, as evidenced by the successful launch of Hero 9 Black during Q3 2020. Also, COVID19 is considerably broadening the use cases for GoPro cameras and in quite an unobvious way, has multiplied GoPro´s TAM by an order of magnitude. NASDAQ: GPRO Investment Prospect Antonio Linares Cuadrado (antonio@refego.com) 22/11/2020 NASDAQ:GPRO Antonio Linares Cuadrado
2. Margins: the company has been making moves to shift to a DTC model. COVID19 has accelerated this shift, enabling the company to unlock value in its distribution scheme and expand margins, changing the nature of the business model meaningfully.
3. Opex: since 2016, the company has been reducing operating expenses consistently. It is back to 2014 levels of leanness and there are signs the company is turning around culturally speaking too. This enhances the financial benefits of 1 and 2 above. I believe the above sets new horizons for GoPro. The company now has a bigger business opportunity ahead and is getting / is in shape to pursue it. I expect the company to produce an EPS of 0.66$ for FY2022 and I would not be surprised to see it trading at double digits soon.

>In Depth

Revenue: GoPro cameras are now going to funnel in part of the 50% of business travel and 30% of office life that is not going to come back, multiplying GoPro´s TAM. GoPro is also making better cameras and is driving a hardware renewal cycle.

GoPro´s revenue grew from 2014 to 2016 and it has been stagnant since 2016. In 2016, smartphones capped GoPro´s TAM considerably: smartphone cameras were good enough for most people.

Now, the COVID19 pandemic has drastically reduced travel and office hours. Non-essential meetings have become emails and that is not likely to reverse entirely. Bill Gates believes 50% of business travel and 30% of office live will never come back. I believe he is on the right track. Simultaneously, GoPro´s Q3 2020 sales were surprisingly high: market expectation was an EPS of $0.06 vs an actual EPS of $0.20 (during a rather doomy quarter). These are seemingly disparate facts. Some online research will reveal that people are starting to use GoPro´s as webcams and streaming devices. For instance, look at this video and observe people´s comments. Here is a comment to get you started.

People look terrible on standard webcams and when it comes to business, we know people go a long way to presenting themselves in a way that helps them connect with others. Look at this video (and don´t miss out on the comments) to observe the difference between how one looks in a standard webcam and in a GoPro. GoPro´s are substantially better webcams than traditional webcams and are way cheaper and more convenient than DSLRs. It is not far fetched to say that when teleworking, a GoPro is the new suit and tie.

Incidentally, GoPro has been launching software since July 2020 that enables people to turn their GoPro´s into webcams in a really easy way. In short, GoPro cameras are now going to funnel in / are funnelling part of the 50% of business travel and 30% of office live that is not going to come back, yielding a much larger TAM. COVID19 has increased GoPro´s TAM by accelerating digitalization across the board and boosting the role of video in our lives. In the 15th century, paper took off with printing techniques to accelerate diffusion of knowledge across the world. Now video is taking on a similar role, as we accelerate towards a digital future. Video is the richest form of media and will be increasingly pervasive, enriching digital interactions in all sorts of use cases.

To illustrate this, consider the rise of live streaming in online gaming (have a browse in Twitch and see for yourself what devices the community are buying)— Hero 9 makes high quality streaming easy too. Additionally, contemplate the evident rise of e-learning and telehealth. Video is key in both.

To further illustrate the above, consider a simple analysis I have run on 3 different Google keyword searches: ‘gopro webcam’, ‘gopro streaming’ and ‘gopro vlogging’.

The analysis for the keyword ‘gopro streaming’ reveals a considerable surge in interest on the topic about 6 months ago (view the ‘Trend’ graph — each bar is a month and the last bar is the current month).. A total of 174,300 monthly searches (aggregating related keywords — people use slightly different keywords). There seems to have been some level of interest previously. A brief analysis for ‘gopro webcam’ reveals the same surge in interest 6 months ago- in this case, rising out of nowhere, with a total of 94,800 monthly searches. The trends are revealed for keywords such as ‘office chair’, ‘dell monitor’, ‘mousepad’ and others.

The analysis for the keyword ‘gopro streaming’ reveals a considerable surge in interest on the topic about 6 months ago (view the ‘Trend’ graph — each bar is a month and the last bar is the current month). A total of 174,300 monthly searches (aggregating related keywords — people use slightly different keywords). There seems to have been some level of interest previously. A brief analysis for ‘gopro webcam’ reveals the same surge in interest 6 months ago- in this case, rising out of nowhere, with a total of 94,800 monthly searches. The trends are revealed for keywords such as ‘office chair’, ‘dell monitor’, ‘mousepad’ and others.

I used Semrush to run this analysis and in my experience as a digital marketer, it tends to underestimate search volume considerably. All in all, you can see a large jump in interest both in using GoPro as a webcam and as a streaming camera (more so in the latter), at around the time the COVID19 psyop started. Of course, Google is not the only place people look for things, but it tends to be a good thermometer of the general psyche. The TAM expanding thesis first popped into my mind as an intuition and I was quite glad to see empirical evidence supporting it.

Incidentally, vlogging also seems to be taking off, although the trend is not as clear.

Lastly, GoPro is also making better cameras now and outdoor open-air activities are pretty much the only COVID free ones (especially the ones that make for cool videos). This is evidenced by the evolution of ASP (average street price) of the cameras: ASP of $274 in 2017, $265 in 2018, $280 in 2019 and most notably, 304$ in Q3 2020. I believe this is the product of the company´s renewed focus on driving a hardware renewal cycle. I have looked at plenty of reviews of the product and they are most favourable. It seems that the new camera has a series of new features that, whilst not revolutionary, are useful to content producers and set the camera apart from those of competitors, bearing some similarity to the iterative addition of features to the iPhone — they are not from another world, but once you get used to them you cannot really go back.

Operating Margins: GoPro´s efforts to shift to a DTC model have been boosted by COVID19. This has allowed them to cost-effectively funnel customers into a high margin subscription service, increasing margins and cashflow stability overall.

In the past, GoPro has sold most of its cameras through retailers. Naturally, retailers take a cut of the retail price. Now, the company expects to gradually shift towards selling close to 100% of its cameras through its website, gopro.com (DTC), during the next couple of years. The key driving force behind this shift is COVID19. Gopro.com achieved a record $81 million in revenue in Q3 2020, up 37% sequentially. Total revenue for the quarter was $280.5 million.

What this means is that GoPro can increasingly use the cut that retailers take (100$ per camera, on average), to finance itself. If you go to its website, you will see that that the Hero 9 camera is discounted by roughly 100$ if you pick the Hero 9 + subscription offer. The trained eye would see that GoPro is using the otherwise retailer´s cut to funnel customers into a subscription service that yields stable and recurrent income ($4.17 [monthly] or 4.99$ per month [yearly]). From what I have researched, it seems that this subscription service delivers considerable value to customers.

Through this DTC model, GoPro gets the operating margin it was getting through the traditional distribution model (around 35%) together with the operating margin for the subscription model (around 50%). This is likely to yield a higher operating margin down the line, unlocking value. The subscription service was launched in 2016 and it grew quite slowly to 200,000 subs by Feb 2019. The number of subs has grown considerably with the implementation of this strategy, growing 35% from Q2 to Q3 2020, up to 501,000 subs. Nothing like a good sales funnel and specially if its digital, with no middlemen.

For reference, 1M subs is equivalent to around 50M of yearly revenue, spread out evenly throughout the year. This is likely to yield higher FCF going forward. Furthermore, I suspect the subscription model opens the door to a future stream of additional high-margin digital services and I have a weird feeling it could pay off big with 5G down the line.

Operating Expenses: GoPro has been getting leaner since 2016. It is back to 2014 levels of leanness. It is likely to have optimized its culture too. This enables it to pursue the bigger business opportunity ahead.

Operating expenses as a % of revenue sharply expresses the increased operational efficiency of the company, back from its 2015–2016 slump.

There is another information-rich signal in Q3 2020 that has caught my eye. Hero Black 9 is a commercial success thus far, even though the aggregate R&D spend of the last 4 quarters (Q4 2019 to Q3 2020, inclusive) is an all-time low and even though, as discussed, Q3 2020 had plenty of turmoil. To me, this looks like a company that has learned to optimize its R&D budget, exhibiting a lean budget together with successful commercialization of output.

Since the 1950s, companies that have learned to optimize its R&D budget, have been winners (read Phil A. Fisher). Paraphrasing “The Wealth and Poverty of Nations” book, by David Landes: manufacturing capacity does not automatically translate into output and output does not automatically translate into salability. Economic history teaches us that culture is most often the missing link and an optimized R&D budget, in my opinion, tends to signal a strong culture that is making it all work. If culture was not working, with a lean R&D budget, Hero 9 would have been a total bummer.

A demonstrated and ongoing focus on opex leanness sets the company up for success.

Balance Sheet: unmenacing.

The company has a net cash position of $146.9m and a total of $232.2m in non-current liabilities — most of it consisting in accounts payable.

Long-term liabilities amount to $232.2m. However, most of it consists of a convertible note of $175m at 3.5% maturing in 2022, with a conversion price of $10.6375. GoPro announced on 19/11/2020 that it was going to issue a further $100.0m of convertible notes due 2025, with a coupon rate of 1.25% and a conversion price of 9.3285%. The fact that most of the debt profile consists of convertible issues is reassuring to me, whilst it does present the risk of considerable dilution down the line.

The company has a current asset position of $536m ($107.2m of receivables) to a current liability position of $232.2m, yielding a working capital ratio of more than 2. Inventories amount to $144.2m and therefore, the current asset position minus inventories ($391.8m) is higher than the current liability position — meeting the acid test.

Inventory levels seem to be relatively healthy, with no significant sign of overexpansion (unlike in 2015–2016), as shown below. This also seems to be the case with Property, Plant & Equipment.

Cashflow: returning to healthy levels.

The company is getting back on track cashflow wise, as evidenced in the graph below. FCF is on the rise since 2016, when the company took measures to cut opex. Cash from Operations has been on the rise since as well, turning positive in the Current/LTM period. The net cash position has been slowly decreasing since 2016 and I expect this trend to reverse by the end of FY2020.

I have added the market cap to the graph, to further contextualize the evolution of cashflow. Furthermore, I would not be surprised to see the increasing FCF boost the results of the R&D efficiency outlined above and further compound with the expanding TAM.

Profitability: premonitory of a turnaround.

The company is now on a clear path to profitability, mostly brought about by cost reductions and by its ongoing capacity to dominate the action camera market. The hypothetical turnaround is perhaps most apparent by looking at the graph below.

Competition: GoPro has a proved ability to capture dollar share in a highly contested market, with far bigger players. This ability will enable it to seize the business opportunity ahead.

There are plenty of action cameras in the market at different price levels. However, the condensed wisdom is that GoPro is to action cameras what Apple is to phones and laptops. This is well summarised by the dollar share of GoPro in the US and EU: above 90%. This means that for every dollar spent on action cameras in these regions, GoPro is taking 90 cents. This is the result of a series of factors. The strongest one I believe is the brand, that as Simon Sinek would say, has a strong ‘why’ and everything it does is very well aligned with it. This can seem like quite a soft factor, but in my opinion, it is what has made Apple an almost $2T company — we humans are quite emotional beings. Paraphrasing Sinek, no one really cares if Michael Dell launches a smartphone that is twice as good as the iPhone and half the price — we all know this to be true.

GoPro´s main competitors are Canon, Sony, Fujifilm, Nikon, Ricoh, Xiaomi (Yi Technology). The list has a long long-tail and I will skip it, for your sake and mine. What must be noted is that the market cap of the smallest of above companies (Ricoh) is 4 times that of GoPro and from there on the multiple gets quite a bit bigger. With its puny market cap, GoPro still manages to fend of these companies and protect its dollar share and I believe that is all we need to know. We can count on the above companies to continue creating action cameras that put pressure on GoPro, but it seems that we can count on GoPro to carry on defending its dollar share.

Surely, GoPro´s traditional competitors will be observing the same trends that I observe (and that GoPro seems to be taking steps to capitalize on) — for instance, Nikon now allows their DSLRs to be turned into webcams, since August 2020 (let this serve as further validation of the outlined thesis). GoPro and its traditional competitors are now going to be moving in this direction.

A key observation is that the possibility of turning action cams into webcam-like devices is brought about by software updates and therefore the marginal cost is relatively low. I expect action camera market incumbents to generally benefit from the expansion of the TAM, for this reason. However, I think GoPro is going to benefit more in terms of the appreciation of its share price as it is far smaller than its competitors and the increase in its top line will be percentually larger relative to the delta of its cost structure. Conversely, it will represent a smaller increase percentually in the top line of its larger competitors.

This move is going to have the action camera market incumbents collide with webcam market incumbents such as Logitech, D-Link Systems, Lenovo, Microsoft and others. Competition is not going to be light. However, action cams are better cameras than webcams and this I believe gives companies like GoPro a competitive advantage. I also believe this advantage over webcam market incumbents will be a major catalyst for M&A.

Furthermore, I believe GoPro´s ‘why’ (if I have managed to convey its importance — otherwise read Simon Sinek´s book ‘Start With Why’) will be a key asset going forward and makes it a highly likely M&A candidate. Its ability to capture dollar share in the action camera market should transfer to this newly forming market space. Although it will be a rocky ride, we are still talking about a company that is managing to decrease its opex and increase its margins — marginal success in the new direction should translate into a meaningful share price appreciation.

Management: the CEO is on a pedestal and the track record is dubious. I give the management a vote of confidence, nonetheless.

Nicholas Woodman´s compensation is twice double that of his #2 and he has a controlling share (60%+ of voting power) of the company. Effectively, the hypothetical investment relies on Woodman´s jolly spirit. This is perhaps the greatest speculative component of the investment, followed by the yet to be proved TAM expanding thesis. Here, I give way to my intuition, which tells me to trust the management.

In breaking down this intuition, the most explainable aspect of it is that I have found that my brain seems to infer a more mature management per the increased operational efficiency and a renewed focus on meeting customer expectations, which is somewhat evidenced by the hardware renewal inertia — there is something about the Hero 9 that I like. There is also the R&D efficiency which I pointed out earlier. I had a funny feeling about GPRO about a year ago (I bought at around 4$) and now it has become a downright magnetic attraction so I´m going with it. I get a good feeling about Mr McGee too.

Margin of Safety: moderate.

Since 2014, the company has demonstrated the ability to keep dominating / selling cameras to adrenaline junkies, in the otherwise dwarfed action camera market: these folks are not going away. In the US (accounting for 50% of GoPro´s revenue), GoPro captured 93% of dollar share in Q4 2019. In Europe, during the same period, close to 83% of dollar share. Somewhat weaker figures follow in Asia. Social media followers increased by 29% YoY in 2019. In short, it looks like GoPro is going to keep selling the cameras to its stable customer base. More assuring figures here.

Assuming that we all go back to the office and the TAM expanding thesis fails, should yearly revenue stay where it is (which would not be farfetched), a slight further reduction in operating expenses together with a slight further increase in margins (through the shift to DTC that is clearly working, per the increase in number of subs) to a FY opex of around $300m keeps the company profitable. It has a bog-standard balance sheet, is producing FCF and its profile debt is largely convertible and therefore not too menacing. I see an acceptable margin of safety and a moderate risk of loss of principal, buying at the $6-$7 range.

Risks: plenty.

The world is an uncertain place. These are the fundamental risks that I see:

1. The management might not perform.

2. Some new superior tech might enter the marketplace — after all, the acceleration in video is likely to draw attention. I am sure there are plenty of Chinese individuals working hard at this.

3. The TAM expanding thesis might not play out or GPRO may fail to capture value at all, failing to make its way through the newly competitive environment (which as mentioned, will be intense).

4. GPRO may fail to continue to operate with leanness and / or shift to the DTC model.

>Conclusion

GoPro has 2 key assets that enable it to pursue an expanding TAM brought about by COVID19: its brand and its camera expertise. It has silently and explicitly taken steps to embrace this opportunity, by launching software that enables its cameras to be easily used as webcams and promotional videos such as this one throughout Q3 2020. These steps correlate with a far higher than expected Q3 EPS and so does the jump in search volume for the keywords ‘gopro webcam’, ‘gopro streaming’ and ‘gopro vlogging’ (and their related keywords). It has the financial health and the focus on leanness that will enable it to make a good attempt at seizing the business opportunity that these correlations may be signalling.

I currently observe that the company is undervalued. My acid experience in digital marketing has lead me to trust ‘cybercrums’ as the ones I have presented and for this reason I believe that the market has not fully begun to factor in the implications of what lies ahead, whilst it has discounted the improved financial health of the company. The outcome is uncertain, but I think there is an acceptable margin of safety. Additionally, I also believe that if the outlined play should come into fruition, the inter-mingling with the deployment of 5G will be surprising, to say the least, as video takes on an even bigger role in our lives- computer vision algorithms are thirsty for data that can unlock value in verticals.