- GoPro shares have been selling off after Morgan Stanley severely cut the company's Price Target citing weak demand for the company's Session camera.
- Morgan Stanley noted that customers were showing preference for Hero4 Silver’s LCD screen and superior video quality to Session’s much smaller form factor.
- But how justifiable is the PT cut?
Shares of action camera manufacturer GoPro (NASDAQ:GPRO) have been selling off after Morgan Stanley dramatically downgraded the shares and cut its Price Target (PT) to half from $62 previously to just $35 citing poor performance by the tiny, $400 Session camera, one of GoPro’s latest cameras. GoPro stock has been badly hurt this year. GoPro stock is down 53% YTD.
Morgan says that its latest checks on Session showed that customers prefer Hero4 Silver’s LCD screen and superior video quality to Session’s much smaller form factor. The analysts noted that weak demand had prompted GoPro to dramatically slash Session’s price by $100 just a few months after the camera’s launch. Meanwhile, the analysts pointed out that GoPro’s latest video-editing tools are not nearly as good as existing iOS/Android apps, and the company’s media and software sales are unlikely to move the needle relative to hardware and camera sales.
Punching holes in Morgan Stanley’s bear thesis
While it raises some important points about GoPro, Morgan Stanley’s bear thesis appears a bit far-fetched. GoPro is unquestionably a very innovative company. The company has launched at least 5 new camera models over the past 11 months alone. This include the HERO4 Silver that is supposedly cannibalizing Session sales.
GoPro’s New Cameras (Session at foreground)
What strikes you as quite odd about Morgan Stanley’s downgrade is the weight that analysts have attached to Session, which is really nothing more than a product extension. Morgan’s $27 price cut equates to about $ 3.5B worth of market cap slashed from GoPro on account of a single camera underperforming. GoPro exited the last quarter on a $1.7 billion annual revenue run rate. GoPro sports a P/S ratio of 5.6. This suggests that Morgan Stanley thinks Session would have brought in at least $740 million, or 44% of GoPro’s revenue, had it performed according to expectations, and possibly a lot more since the camera certainly won’t be complete failure.
Notice that this is simply a case of one of GoPro’s cameras cannibalizing sales of another model and not a much worse case scenario of consumers preferring models by rival companies. Mind you HERO4 Silver that is ostensibly causing Session woes retails at exactly the same $400 price tag that Session carried before the price cut, which is a lot more preferable than would be the case if consumers were going after a cheaper model. Whichever way you cut it, it’s hard to justify such a huge PT cut on the basis of a single camera underperforming.
I believe Citi’s analysis of the Session price cut is a lot more spot on than Morgan Stanley’s. This is what Citi had to say after GoPro announced Session price cut as couple of weeks ago:
We believe the price cut creates another headwind to revenue, GM and EPS in Q4.
We lowered our Q3’15, Q4’15 and Q1’16 numbers on 9/16, and are modeling GoPro shipping 5% fewer cameras in Q4’15 than in Q4’14, as the sell-in of the new products occurred in Q3 this year, vs. Q4 last year. Our Q4’15 revenue estimate of $560M is $139M below Street of $699M, so we believe there is downside risk to Street numbers in Q4.
We estimate the price cut could impact corporate gross margin by ~3 points until the inventory of the HERO4 Session is worked through, assuming 15% of total sales are being driven by the Session priced at $300 (the GM impact would be ~6 points if 30% of total sales are driven by the $300 Session).
You will notice that Citi’s worst case scenario is modeled on Session driving 30% of GoPro sales during the fourth quarter, which seems to be a much more reasonable assumption than the nearly 50% of sales that Morgan Stanley seems to have worked with.
The second part of Morgan Stanley’s bearish thesis is founded on the [incorrect] assumption that people will stop buying GoPro’s cameras and go back to shooting their videos using their smartphones simply because they sport better photo editing software than the average GoPro camera. But this kind of reasoning appears to be a stretch because smartphones were still around when GoPro started selling its extreme-action video cameras yet the cameras have managed to comfortably cut themselves a respectable niche. Moreover a smartphone is not particularly suited to capture the action when a guy is out surfing with friends.
Morgan Stanley, however, did raise a valid point about GoPro’s software sales not being enough to move the needle relative to hardware sales. Although GoPro has been trying hard to paint itself as a media company, it remains in essence a hardware company since 99% of its revenue is hardware-based while software sales account for only 1%. GoPro stock sport a PE ratio of 27, which though much lower than where they stood at the beginning of the year, is nevertheless considerably higher than the valuation of hardware-driven companies such as Apple (NASDAQ:AAPL). But, the company has lately been making big moves to introduce new revenue streams, such as video licensing which has good revenue potential as I pointed in this article.
Morgan Stanley’s thunderous PT cut on GoPro on the account of a single underperforming camera appears stretched. Session is just one of the five new cameras GoPro has launched over the past one year. GoPro is compensating for weaker Session demand with higher HERO4 Silver sales. There is really no good reason to panic here.