Latepost Larn Pro: Photographic Television Set Camera Or Smartphone? Social Media Or Electronics? Toll Or Value?

My sixteen-year old, a sophomore inward high school, joined the investment guild at schoolhouse a couplet of weeks ago, as well as entered a stock-picking competition. Club members invest inward a stock or stocks of their choice, alongside the winner chosen inward almost 5 weeks, based upon cost appreciation. Thinking I would receive got roughly sage advice on where to invest his money, he asked me for roughly stock picks as well as I almost suggested that he lay all his coin inward GoPro, a selection that is clearly at odds alongside the prudent investing practices of diversification as well as perchance alongside conventional value investing precepts. While GoPro is non the investment I would recommend for my boy equally his Roth IRA investment (with existent long coin as well as a long fourth dimension horizon), inward a game alongside a five-week window, where the winner takes all, momentum volition musical rhythm out out intrinsic value as well as diversification volition live to a greater extent than hindrance than help. (Note that momentum fairy was inward GoPro's corner at the time, as well as has taken a interruption inward recent days.)  In this post, I accept a facial expression at GoPro, perchance the hottest stock of the year,  with the intent of non only agreement its intrinsic value (and drivers) but to create feel of the pricing game.

The Back Story

For those of yous who are non familiar alongside the company, GoPro makes cameras that yous tin privy attach to yourself as well as tape video of your activities. While that mightiness non seem exceptional, it is designed for high-energy physical activities, including running, stone climbing, swimming or hunting. You tin privy larn a mensurate of the company’s electrical flow offerings on its website. They include 3 models of the photographic television set camera (the Hero, the Hero 3 as well as the Hero 4), numerous accessories as well as 2 gratis software products (a GoPro App as well as GoPro Studio) to convert the recorded videos into watchable ones. The companionship believes that the creators of videos volition part them, non only alongside their friends, but besides alongside the full general public. In its most recent earnings report, it noted that GoPro videos published on YouTube had increased 200% over the previous year, launched a GoPro channel on Pinterest to attract to a greater extent than attending to the videos as well as 1 for the Microsoft Xbox. 

The company’s cameras receive got found a prepare market, alongside revenues hitting $986 1 chiliad one thousand inward 2013 as well as increasing to $1,033 1 chiliad one thousand inward the twelve months ending inward June 2014. In spite of large investments inward R&D ($108 1 chiliad one thousand inward the trailing twelve months), the companionship soundless managed to live profitable, alongside operating income of $70 1 chiliad one thousand inward that period. Capitalizing R&D increases their pre-tax operating margin to 13.43%, impressive for a immature company. The figure below looks at the evolution of revenues as well as units sold  over the history of the company. (You tin privy download the company's prospectus as well as its only 10Q.)

GoPro has been a stock on give notice since its initial world offering on June 26, jumping 30% on its offering date (from $24 to $31.44) as well as continuing its ascension to $94 on Oct 7, before falling dorsum to $78 on Oct xiv (the solar daytime I started the valuation) as well as to $70 today (October 15).

The stock has accumulated a large issue of song short-sellers, who are convinced that this is a high flyer destined for a fall, as well as many of them receive got been burnt inward the cost run-up, a fact alluded to inward CDC's statistic that almost 22% of Americans are physically active. Generalizing (and globalizing) this statistic to the smartphone marketplace yields a potential marketplace that is almost $80 billion inward 2014 (22% of $355 billion). That is in all probability to live an over estimate, since non all physically active people are "sharers" on social media. According to this survey, almost 31% of adults post videos on their social media site as well as it has both increased over fourth dimension as well as is higher amid younger adults (ages eighteen through 29), 40% of whom post videos. Using the latter statistic, the overall marketplace for activity cameras is $31 billion (in 2013), estimated equally 40% of $80 billion. Applying a 5% growth charge per unit of measurement on this marketplace yields a potential marketplace of $51 billion inward 2023. The painting present below captures the sequence of assumptions that yields this number:

2. Market Share & Profit Margins

The marketplace part as well as target turn a profit margin that nosotros assess for GoPro volition live a business office of the potential marketplace that nosotros consider for it as well as the contest inward that market. If nosotros define it equally the photographic television set camera market, the contest is already intense as well as dominated past times Japanese manufacturers:

If nosotros define it, equally I intend nosotros should, equally the subset of the smartphone accessory marketplace that wants active cameras (the $51 billion marketplace inward 2023 identified inward the lastly section), GoPro is the commencement mover inward the marketplace as well as has to a greater extent than growth potential (both because the marketplace is growing as well as it has relatively few competitors, for the moment).

To gauge the expected marketplace part that GoPro tin privy larn of this market, it is worth noting that spell it initially had the action-camera marketplace to itself, the contest is starting to accept cast from upstarts, established photographic television set camera makers as well as from some smartphone manufacturers. Even if GoPro tin privy constitute a create scream wages (by beingness the commencement 1 on the market), I don’t consider whatever potential networking advantages that GoPro tin privy convey to this procedure that volition allow it, fifty-fifty if successful, to command a dominant part of this market, equally the marketplace gets bigger. Drawing from the established photographic television set camera line of piece of job concern marketplace shares, I volition assign a market part of 20% (resulting inward revenues of almost $10 billion for GoPro inward 2023, i.e., 20% of $51 billion) , roughly similar to the 20% marketplace part for Nikon, the leading photographic television set camera maker, of the photographic television set camera marketplace inward 2013. (I am non drawing a straight off parallel betwixt Nikon as well as GoPro, but I am arguing the marketplace part breakdown of the activity photographic television set camera marketplace is going to resemble the marketplace part breakdown of the conventional photographic television set camera market).

On the turn a profit margin, GoPro’s commencement mover wages has given it a headstart inward this market, allowing it to accuse premium prices as well as earn a pre-tax operating margin of 12.5%. This is slightly lower than the margin (13.43%) posted past times the companionship inward the most recent 12 months, but the tendency lines inward margins for the companionship are decidedly negative:

This guess (12.5%) of the pre-tax operating margin is significantly higher than the 6%-7.5% margin reported past times photographic television set camera companies as well as similar to the 10%-15% margin reported past times smartphone companies; Apple remains an outlier alongside its pre-tax margin inward excess of 25%.  I am, inward effect, assuming that GoPro volition save its premium pricing, fifty-fifty inward the human face upwards of competition.

3. Investment Needs

While GoPro users may post to social media sites, GoPro is non a social media companionship when it comes to investment needs. While social media companies similar Facebook, Twitter as well as Linkedin generate their revenues inward advertising as well as receive got lilliputian demand for tangible investment, GoPro volition demand to invest inward manufacturing capacity to hit as well as sell to a greater extent than cameras. To guess the reinvestment needs, I made the supposition that the companionship will receive got to invest $1 for every $2 inward additional revenues generated inward years 1-10. This, inward turn, volition motion the provide on uppercase for the companionship from it's electrical flow stratospheric levels to almost 16% inward twelvemonth 10.

4. Risk

GoPro has a social media focus for its user-generated videos, but the companionship currently generates all of its revenues from selling cameras as well as accessories. There is the existent possibility, though, that the user-generated videos may receive got amusement value, which, inward turn, could atomic number 82 to other revenue sources (advertising on GoPro's YouTube channel or a dedicated media outlet for GoPro videos, for instance). That does seem a lilliputian far fetched at the instant as well as nosotros volition assume that GoPro's take away chances volition resemble the take away chances of high-end electronics companies. To guess a cost of uppercase for GoPro, I consider their electrical flow mix of debt as well as equity (2.2% debt, 97.8% equity) equally my starting point, as well as estimate a cost of uppercase of 8.36% for the company, declining to 8% past times twelvemonth 10 (with both reflecting the fact that the U.S. 10-year bond charge per unit of measurement dropped to 2% on Oct 14). This may strike yous equally low, but much of the take away chances inward GoPro is specific to the companionship as well as its marketplace as well as is hence non reflected inward the cost of capital.

5. Possibilities
GoPro's focus on creating partnerships alongside Xbox as well as Pinterest propose that it sees the possibility of generating revenues from becoming a media companionship (with the videos created past times its customers equally content). At the moment, using a contrast I drew before inward my post on Uber, this is to a greater extent than inward the realm of the possible than the plausible or the probable. If the value per part that nosotros obtain is simply a tad below the marketplace price, this possibility may live sufficient to disputation the scale towards buying but it cannot line of piece of job concern human relationship for a large chunk of the value today.

6. Valuation

With this spectrum of choices on the inputs (revenue growth derived from the full market/market part assumptions, operating margin, sales to uppercase as well as cost of capital), it is perchance to a greater extent than realistic to assess the value of GoPro equally a distribution than equally a unmarried guess of value.

Reading this distribution, yous tin privy consider spell the expected value across the simulations is only $33-32/share, good below the marketplace cost of $70, in that location are outcomes that deliver values higher than the marketplace price. Put differently, spell I intend that the companionship is over valued, in that location are pathways to values higher than $70. They volition require GoPro to (a) expand the marketplace for cameras to novel users (physically active, over sharers) (b) discovery a strong, sustainable competitive wages over its imminent competition, perchance alongside a networking border (giving it higher marketplace share) as well as (c) save its premium pricing edge. 
(You tin privy download the base illustration valuation past times clicking here)

A Pricing of GoPro

In keeping alongside my declaration that much of what passes for valuation inward exercise is actually pricing, permit me create the pricing illustration for GoPro. To cost a company, in that location are 2 key questions that receive got to live addressed: who (or what companies) yous are pricing your companionship against as well as what metric (revenues, mass value, earnings etc), yous volition purpose inward the comparison.

The essence of pricing is that yous purpose the marketplace pricing of comparable assets/firms to determine a fair cost for your asset/company. There is, however, a subjective element to determining these comparable investments, as well as that comes into play alongside a companionship similar GoPro, alongside the next possible choices.

1. Existing photographic television set camera manufacturers, roughly of whom (Sony as well as Panasonic) are much bigger players inward the electronics market. (Sample of 10 companies, all of them Japanese)
2. Leisure production manufacturers, which includes a various grouping of companies that industry  gym equipment (Life Time Fitness), golf game clubs (Callaway Golf) as well as bicycles (Cannondale), on the rationale that these appeal to the same physically active marketplace equally GoPro does. (138 global companies)
3. Electronics companies, which includes all consumer electronics companies listed globally. (103 global companies)
4. Social media companies, which includes a wide mix of businesses roughly of which derive their revenues from advertising (Facebook, Twitter), roughly from subscription-based models (Netflix) as well as roughly from a combination (LinkedIn). (13 social media companies)

Stock prices cannot live compared across companies, since they are a business office of the issue of shares outstanding. Consequently, pricing stocks requires scaling the stock cost to a mutual variable available across the companies beingness compared. This variable tin privy live revenues, earnings (net income, operating income or EBITDA), mass value (book value of equity or invested capital) or a revenue driver (users, subscribers). 

Bringing together these choices, nosotros tin privy compare GoPro's pricing alongside that of comparable companies, using dissimilar comparable companionship groups as well as pricing metrics:

Based on marketplace prices on 10/15/14 & trailing 12-month data

This is a simplistic comparison, where I receive got used the median values for the sectors involved as well as non controlled for differences inward fundamentals (growth, take away chances as well as cash flows) across companies. However, fifty-fifty this rudimentary analysis seems to indicate to the reality that the marketplace is pricing GoPro to a greater extent than equally a social media companionship than equally an electronics, photographic television set camera or leisure production company. In fact, using that logic (that GoPro is a social media company), yous could fifty-fifty create a contorted declaration that it is inexpensive (at to the lowest degree relative to revenues).

For the lastly few days, I receive got been reading anguished arguments past times roughly who receive got sold curt on GoPro almost the market's irrationality as well as wondering when it volition come upwards to its senses. Pricing GoPro equally a social media company, which is what the marketplace is doing, is neither illogical nor irrational, equally a pricing machinery as well as spell I may non grip alongside it, it besides suggests to me that having a curt seat on this stock is equally much a bet against all social media companies, equally it is a bet against GoPro. 

Summing up

It is difficult, but non impossible, to justify buying GoPro on an intrinsic value basis. To larn to a value of $70 per share, GoPro volition receive got to attract novel users (physically active over-sharers) into the marketplace as well as fend off contest alongside innovative features that create networking benefits. That is a narrow path, which volition plausible, does non encounter the probability tests that a value investor should apply to an investment. At the same time, the pricing dynamics inward the market, where GoPro is beingness priced equally a social media company, operate against those who receive got bet against the stock, expecting a quick correction. My guess of value is conditioned on my assumptions almost the full market, marketplace part as well as turn a profit margin as well as it is solely possible that I am missing GoPro's potential inward the amusement market. Given how addicted nosotros are to reality shows, it is solely possible that our amusement a decade from at nowadays volition accept the cast of watching each other (or Kim Kardashian) hike, hunt as well as swim as well as that GoPro volition live the beneficiary of this development. As I intend almost this prospect, I am non certain that I desire GoPro to live successful!

Attachments:

1. GoPro Prospectus
2. GoPro 10Q (June 31, 2014)
3. GoPro Intrinsic Valuation (Base Case)
4. GoPro Simulation Assumptions as well as Valuation Output
5. GoPro Comparables (Peer Pricing)

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