Description

GPRO, Inc. (GPRO) is trading at a ~13% unlevered FCF yield on depressed 2021 volume/FCF due to COVID, but on normalized FCF pro forma for the FCF generation in 2021, GPRO is trading at 25% unlevered FCF yield.  It has a significant margin improvement story due to the mix shift to DTC and an emerging subscription business growing at >100% on both subs and revenues.  I believe the company’s guidance for the full year assumes no improvement from vaccine distribution and that most countries remain effectively shut down thereby limiting travel.  Because GoPro’s business is defined by human activity and sharing experiences (management’s own words on last conference call) I believe it represents one of the better investments for the inevitable recovery in leisure travel.  It would not be unreasonable to see ~$20 share or ~120% upside to the stock assuming a 14x multiple on next year’s cash flow. Moreover, assuming the subscription business garners a 10x EV/S multiple, investors are getting the hardware business of GPRO for free to negative value.

History

What was once a high-flying action camera company, GPRO’s saw its prospects quickly fizzle since its units peaked in 2015. After reaching $12bn+ in market cap post its IPO, GPRO has seen its market cap erode by nearly ~95% by mid-2020 before recovering through the 2H’2020. Currently, its market cap stands at ~$1.3bn still 90% below its all-time high. The crux of its demise stemmed from advancements in the iPhone camera technology coupled with an attempt to appeal to the mass market without an ability to connect to the consumer post sale. Essentially, GPRO was trying to compete with competitor products selling at half the price on the same wholesale shelf space. Moreover, post the sale of the initial camera, GPRO had limited influence over its consumer’s propensity to shop exclusive GPRO accessories or upgrade to the next iterations of the camera as the CRM file resides at the wholesale partner. Ultimately, it culminated in unit sales peaking at ~6.6mm and declining by over 35% to ~4.3mm by 2017 (source: Company Filings)

GPRO did recognize its errors and repositioned the brand in 2017 to focus on more high-end cameras, which culminated in the launch of the HERO 9 Black Camera in 2019. This camera is arguably its best marquee product and a meaningful upgrade over prior iterations. It comes with a 20MP camera, 5K video resolution, front facing screen for video blogs, Next-gen video stabilization and horizontal leveling, meaningfully better battery life vs the HERO 8, color LCD screen with live preview, and a microphone that provides improved wind and external sound reduction. It has lived up the hype and has been able to secure reviews that put it ahead of the Apple 12 iPhone (source: Google). I think 2020 could have been a colossal year for the camera if not for COVID which led to declines in both sell-through as well as a significant channel destocking (~800K of inventory in the wholesale channel - more on this below). 

Alongside its revamped product portfolio, GPRO launched its own digital subscription offering. At ~$50/yr, the GPRO subscription provides subscribers with automatic saving and uploading of photos, unlimited cloud storage capabilities, video editing (app has the capabilities to autogenerated video editing to save users time in video creation), warranty package/protection plan and exclusive discounts for a multitude of GoPro products. For GoPro enthusiasts, the app pays for itself in a matter of weeks. However, for everyone else, when factoring the convenience of automatic file uploading/sharing in combination with the cost of a 200GB iCloud storage plan running at ~$36/yr, the incremental $1+ for a subscription plan is a compelling value proposition. Furthermore, once GPRO can capture the customer’s payment information, the ability to upsell and communicate with the customer improves substantially. GPRO ended the year with >700k subscribers and expects to be at two million by the end of 2021, driving $100mm of subscription revenues.  The numbers speak for themselves as the company could be hitting the upward sloping part of its S-Curve adoption curve.

Opportunity

1.     DTC Mix: We believe COVID has served as a blessing in disguise for both the company and investors alike. First, as the case with many consumer products companies, GPRO was forced to focus its efforts on DTC (direct to consumer) and e-commerce. What started as a choice, quickly evolved into a necessity and we believe will ultimately will lead to higher long-term margins and better data on the purchasing patterns of its customer. GPRO’s DTC mix has gone from ~12% in 2019, ~31% in 2020, and is expected to be 40-45% in 2021 as per guidance.  Assuming 50% is achievable over time, this mix benefit drives $.35-$.40/share of incremental earnings annually v 2019 levels.  

2.     Subscription Revenues: COVID enabled the company to become more inward looking and recognize the power of the subscription model. As the case with any subscription business, the underlying revenues are highly visible and predictable. In GPRO’s case, the subscription business also entrenches their position with the customer. Once a customer signs up with his/her credit card, the company’s ability to upsell increases substantially. Moreover, once the consumer has his information on file, GPRO can maintain an ongoing relationship with the consumer. The company has seen exponential growth in its subscriber growth through COVID which has been driven by its bundled HERO 9 offering. Consumers have been aggressive in taking advantage of this offering with ~85% of HERO 9 cameras (through Q3’20) purchased alongside a subscription. Now it is too early to confidently calculate the LTV of these customers, but the company has indicated that so far, they are seeing good retention rates and a low level of churn.  If the company can achieve its target of ~2mm subscribers ending 2021, that would amount to $100mm of run-rate subscription revenue. At 10x, that would equal the entire Enterprise Value of the company based on today’s share price and ending 2021 net cash.  To the extent one resists evaluating this as a SaaS revenue stream, it is worth noting that it adds ~$.25/share in incremental earnings as compared to 2019 levels.

1.     Cost Structure: GPRO’s insular focus on its operations have enabled it to take significant operating expenses out of the system. For example, in 2018/2019 the company was operating with ~$380mm of SG&A and we think that “normalized” SG&A is closer to $300mm.  The company is guiding to $310mm at the midpoint for SG&A in 2021, but this reflects meaningful investment in the DTC business some of which is one time oriented.  This improvement in the cost structure adds an incremental $.35-$.40/share in earnings v 2019 levels.   

2.     Sell-in vs Sell-through: Prior to COVID, the company was selling in about ~4.3mm cameras a year from 2017-2019. They have undergone a significant period of destocking with sell-in lagging sell-through by ~800K in 2020 and another ~200K in 2021.  This mismatch negatively impacted earning by more than $.40/share in EPS last year distorting the underlying earnings power of the business. 

Ultimately, we believe that the “normalized” sell-in for this company is 4.1mm units per year. We think about 200K units of the 2017-2019 sell-in levels came from low end cameras and on the fringe wholesale partners. As a reference point, GPRO has gone from having ~50% of its cameras above the ~$300/camera price point to >85%. While GPRO guided 2021 sell-through/sell-in of 3.5mm/3.3mm, we believe the company assumed the COVID “status quo.” Post vaccine, we believe the normal unit count normalizes quickly to 4.1mm and could easily exceed that due to pent up demand for travel; for example, we believe GPRO gets 10%+ of its units from Duty Free stores. Ultimately, that means “normalized” earnings power here is $270mm+ of EBITDA and $1.42+ (pre converts) FCF/share. Assuming the subscription business is worth 20x EV/EBITDA, we are getting the hardware business for free. Regardless of whether one chooses to value this business on a straight P/FCF approach or a SOP basis, we believe upside here is $18-$25/share.

Disclosure: At the time of publication, the author and/or its affiliates hold a position in GPRO.  This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author and/or its affiliates hold a long position in the company covered herein and stands to realize gains in the event that the price of the stock increases. Following publication, such parties may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this article has obtained all information contained herein from sources believed to be accurate and reliable.  The author makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use.  All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.

Catalyst

Stronger earnings as compared to consensus