GoPro Q2 2022 ER Digest
This is an update to my original GoPro deep dive, Q1 2022 ER digest. Below, you can find the format of this post and as always, feel free to skip to any section of your interest.
1.0 Thesis Recap and Digest Summary
2.0 The Subscription Business
3.0 The Hardware / Retail Business
1.0 Thesis Recap and Digest Summary
Content is king and directly equivalent to cash. Should you wish to sell anything online, which is an increasingly common desire, you need to create and share engaging content. Doing this for a living requires professional gear and it so happens that GoPro cameras are as good as they get.
This is why GPRO 0.00 continues to dominate the so called action camera market. Their products are the best and highly preferred by millions of content creators across the globe. Other bigger companies have tried to take on GoPro, but they have failed, because the company´s focus is hard to beat. The company has one of the strongest moats on Earth and its ability to evangelize customers is only surpassed by Apple and Tesla.
Since its IPO, the company has been mismanaged. Now, however, it is turning around and is becoming a cash machine. GoPro has gone from selling hardware once to its customers, to selling premium hardware and a subscription service, increasingly D2C via its website. The subscription service is priced at $49.99/year and offers great value to content creators.
The subscription business also has a fantastic financial profile, with a 70-80% gross margin. At 2M subscribers, which the company just surpassed on August 16th, the business yields $100m of recurring annual revenue. Currently, GoPro is trading as if only its subscription business existed, with the retail operation trading for free.
Additionally, as the company continues to move towards selling premium devices only, it becomes even harder for competitors to displace the company and this also yields a business with better margins. As such, GoPro is exponentiating its ability to produce cash and as it buys back shares, more and more of it is accruing to a decreasing amount of shares.
The whole turnaround is facilitated by Bryan McGee´s world class operational skills and by Nick Woodman´s ability to identify them and empower Bryan, to the extent that today, he is running the company and not Nick. Despite its dark past, the business is now exceptionally well managed, with a particularly lean OPEX.
If I showed you GoPro´s financials and current valuation, without you knowing the company in question is the GoPro that tanked since its IPO, you would quickly see that the market cap must 3X just for the company to trade in line with the rest of the market. The company´s moat is superb and so is the strategy / execution, so I believe this disparity will continue to accentuate through time until one day, suddenly, the market catches up.
2.0 The Subscription Business
GoPro funnels hardware customers in gopro.com into the subscription business by offering a discount. The amount of the discount is actually the cut that a retailer would be taking otherwise, if the hardware product in question were not sold D2C via GoPro´s website.
This raises some concerns about the sustainability of the subscription business, because customers are highly incentivized to subscribe just to save up on their statistically one-time camera purchase. Yet, the value proposal for content creators of the subscription is a no brainer. Also, management has said a number of times that retention is good.
For $49.99/year, you get:
Unlimited, automatic footage upload and secure storage in the cloud.
Total access to the Quik editing app, which costs $9.99/year (it now has 276k subs on its own).
Up to 50% discount on purchases at gopro.com.
If you are a content creator, just the part about uploading footage is worth it. The cost of the subscription is $4.16 monthly and it removes the pain of moving content back and forth manually. A 1 terabyte hard drive costs about the same as the annual subscription, but the pain of managing the content yourself is far more cumbersome - you just do not know it until you try it yourself.
At this stage, the viability of the subscription business can only truly be understood via qualitative analysis. My take is that it is viable and per the size of GoPro´s brand, I believe it will grow far beyond 2M subscribers in the coming years.
There is another dimension of the subscription business that I believe will take GoPro to its next stage, in which it also becomes a content production ecosystem. Quik was launched in Q1 2021 and in Q3 2021, the app had 168k paying ($9,99/year) subs. In Q2 2022, the app had 276k paying subs, so almost twice what it had around a year ago. What is interesting is that the Quik app is essentially a pay-walled relaunch of an old app GoPro was letting customers use for free, so very low capex.
The company is iterating the app to make editing and sharing videos seamless. During the Q2 2022 CC, management announced a new software launch this fall, which I expect will make the Quik app better. The point is, just like the subscription business started off silently as has grown to very relevant proportions, I believe so will the Quik app and so far so good.
As I have written about many times now, this will open up a broad avenue for GoPro, in which it can continuously add incremental value to content creators by making their lives (editing and sharing content) easier with every software update. Dollars will follow and probably with a similar margin profile to the current subscription business.
By 2023, McGee expects to see 2.2M subs, with subscription revenue growing 50% in FY2023. Not farfetched.
3.0 The Hardware / Retail Business
The hardware business is doing fine and is increasingly premium, as you can see below - the more expensive cameras make up for 86% of units sold, which is a new record. As GoPro continues to focus on the premium segment, its customer base is increasingly narrowed down to content creators that actually make money. This is an additional margin of safety during a hypothetical downturn.
Management has issued new guidance, stating that they expect to sell between 2.9m and 3.1m units, due to macro headwinds. They see retailers (potentially) reducing inventory and a stronger dollar, yielding FX headwinds of $10 million and $11 million in Q3 and Q4 respectively.
McGee sounds very cautious in the first half of the call regarding the guidance, but then when asked again he says that sell through is “going to be about 3 to 3.1 million units”, versus the original 3.2m guidance. This is an interesting transition, although a very subtle one, which merits some elaboration.
What is interesting is that, with all the recession fears, the stock has gone down a lot over the past year, but GoPro sold 2.8m units in 2020, when the world was in quite a dramatic state. For a recession to effectively demolish the company or justify a fair value below $20 per share (assuming the sub business is strong), it must be far worse than that experienced in 2020 and the company actually came out greatly strengthened from that crisis.
10% of GoPro´s sales comes from international travel. During the quarter, America saw some weakness but apparently Europe and Asia began to open up, leading to a positive surprise. According to McGee, this channel is still at 50% of where it was pre-pandemic. The world is opening up, so there is still some alpha there and putting it all together, I just do not see GoPro selling a mere 100k more units than it did in 2020. It will probably sell a lot more than that.
“I think on the demand side, we're actually seeing stronger demand than we initially guided for in the quarter, which is very encouraging. July was nicely ahead of expectations. So we're seeing solid demand that really picked up in Q2, picked up more in Asia, and continued in Europe.” COO, McGee
Some further context here is necessary. Who bought (2.8M) GoPro´s during 2020 and why? It did not come across my mind to buy one, when I was locked up in my place for almost 4 months (Spain), but I did see a lot of people streaming on twitch, for instance and a lot of people generally making content. This is perhaps what is most under-appreciated about the company - people only make more and more content, no matter the macro backdrop and GoPros are amazing tools for that.
Gross margin came it at 38.30%, versus 39.79% in the same period last year. Coinciding with management´s comments, the business does seem to be experiencing some headwinds caused by:
A strengthening dollar
I would say that, on the positive side, GoPro is navigating the inflationary environment quite well, with no major supply chain issue or cash burn at any point. McGee said the following, regarding the supply chain going forward:
“We continue to effectively manage supply chain with third-quarter Camara secured, and the fourth-quarter pipeline is well developed.”
“We expect full-year 2022 gross margin to be at the low end of our target range of 40% to 43%, primarily due to a strengthening U.S. dollar along with some freight, and component price increases.”
Meanwhile, the company continues its quest towards quite exceptional leanness. As I wrote about in my original deep dive, I see quite a high level of innovation with R&D spend as a % of revenue hovering around all time lows. This an anti-fragile property.
McGee guides for an even lower OPEX going forward, which I think is prudent given the macro cloud lingering above our heads:
“We expect to reduce our 2022 operating expenses to a range of between $325 million and $330 million, down from $340 million to $345 million.”
Net income continues to be in the green, coming in at $2.5M versus . GoPro makes most of its money in H2 and H1 has been historically a red period for them, but as the company continues to turn around, red quarters in the low seasonality are a thing of the past. The resulting structural change in profitability is specially visible in the trailing 12 months plot above.
The balance sheet remains strong, with a meaningful net cash position. GoPro has an approved and active share buyback program for a total of $100m, with $78m remaining. I am glad to see management buying back shares during the current downturn, although it must be noted that they are not expected to reduce the number of shares outstanding in FY 2022, but rather to offset the dilution from SBC.
Total cash and ST investments is sitting at $322.5m at the end of Q, with LT debt at $140.5m. The balance sheet should afford GoPro some buffer in case the economy does turn apocalyptic.
Cash from operations came in at came in at $12.9m, versus $23.2m in the same period last year. This delta can be traced back to three things:
A lower gross margin in Q2 2022 versus Q2 2021.
A relatively larger SG&A expense in Q2 2022 versus Q2 2021.
A larger unusual item adding on to net revenue in Q2 2021.
What I can infer from the above is that indeed the cost of doing business is going up for the company, allegedly due to inflationary pressures. It does not quite render the turnaround futile, but it needs to be kept in check going forward. However, so long as the subscription business keeps growing and GoPro carries on making good cameras and buying back shares, it should to fine.
You can still see below that a positive cash from operations is a unique feature of the turnaround and in the next graph, the same applies to FCF:
GoPro has traditionally been regarded as a consumer discretionary company and to a large extent, it still is so today. However, as we move into the 21st century, content is of increasing importance and so the demand for high quality content creation tools will grow and solidify accordingly.
So long as GoPro continues making top of the line cameras, which it is per its growing average selling price (and my overall qualitative impression), the company should do fine. The business is definitely not immune to inflationary pressures, however and so it will be quite the acid test to see how McGee manages this going into the holidays.
The subscription business has a very long runway ahead and by the end of 2023, should be producing some un-ignorable levels of cashflow. At a PE ratio of around 2, the multiple has a long way up to trade with other living companies, if indeed the moat and execution turn out to be as strong as I believe - else, it will just be another value trap.
Until next time!
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The biggest concern about GoPro is competition. Insta360 looks like a strong competitor. It is ahead of GoPro on 360 camera and catching up fast on action camera. Check out its products and reviews at Amazon.