poses serious risks to investors/Valuation Risks/UPDATE: 7 reasons GoPro's stock is likely to get dented
6:01a ET October 2, 2014 (MarketWatch) Share
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UPDATE: 7 reasons GoPro's stock is likely to get dented
By Jeff Reeves, MarketWatch
GoPro pulled off an amazing IPO in June, offering at $24 a share and then doubling in just a few trading days.
Now the shares are up almost fourfold, above $90, and some traders are eyeing triple digits for GoPro (GPRO) stock as short sellers get squeezed out of this momentum darling.
While GoPro is undoubtedly an exciting brand, it poses serious risks to investors.
While the bears have been burned betting against GoPro stock during its adrenaline-filled run during the past few months, I have a few reasons why it may be wise to cash out your shares if you're an early investor. Or, for swing traders, why an options position to the downside may make sense.
Short Covering Fuels Rally: The shorts have been hating on GoPro since its debut, with the last data from mid-September showing about 8.5 million shares held short.
Since the stock has gone nowhere but up, that has meant a lot of short sellers have been forced to cover their trades in the past few weeks. Part of that might be quarter-end activity to simply get the trade off the books, and part might simply be capitulation.
But don't confuse short covering with believers buying into GoPro.
Valuation Risks: I'm not just talking about the staggering multiple of about 90 times future earnings.
I'm also talking about the fact that, at IPO, GoPro managed to convince investors that it was very much a media company and that it had revenue potential from hosting videos taken by extreme-sports enthusiasts who use its gear. While that's a possibility, anyone who has followed digital media knows that web-based advertising is a deflationary market.
That means that even if GoPro does launch a successful media network, it still could fail to justify this high valuation.
Profitability Struggles: I'm not so concerned about that 90 forward P/E because many early stage companies trade at those levels.
What bothers me is that earnings are so darn small: a mere $61 million in total profits last year on a current valuation of $11.4 billion! The argument goes that it's easy to correct a high P/E when earnings double, but given that GoPro has operated at a loss in five of the past eight quarters, color me skeptical. Consider that despite good revenue growth in its July earnings report, GoPro posted a GAAP loss of 24 cents a share and then slumped over the next few days.
Creative Accounting: You might be wondering why I just said GoPro was unprofitable when many reports claimed it posted 8 cents of earnings per share last quarter.
Well, that's because GoPro is just another high-growth tech company that thinks it can get away with its own bookkeeping methods to dress things up instead of following generally accepted accounting practices.
GAAP numbers can't be discounted, especially since, unlike a fashionable cloud-computing company, GoPro is basically a consumer-electronics company.
I don't like that some Silicon Valley firms use non-GAAP numbers, but I can at least understand it when your value is derived from "users" and lines of code.
But GoPro? Sorry, you don't get to use your own accounting practices when you're selling what amounts to an updated camcorder. Wall Street won't be fooled by this creative accounting forever, and will start expecting serious results.
Margin Pressure: Digging deeper into profits and valuations, it's worth noting that margin pressures are bound to crop up in the quarters ahead.
As mentioned, the media plans call into serious question the ability of GoPro to maintain the 42.1% gross margin it posted in the second quarter, given the obvious pressures of online advertising. Furthermore, the GoPro of today still is very much a gadget company -- and one that's being forced to go low-end, as evidenced by its new $129 Hero model that's supposed to appeal to the more casual user.
There is constant competition from small upstarts or even smartphone accessories such as near-indestructible cases and harnesses. That is forcing GoPro to focus on accessibility, and makes its plush 42.1% margin hard to believe in going forward.
High-end performance cameras are a niche product, and the growth GoPro needs will require it to go down-market at smaller margins.
Charts Show Resistance: For those who are technically minded, there are a host of warning signs regarding GoPro. Around $100 or so, the charts are showing a ceiling for GoPro after a killer September rally. A bullish flag pattern resolved with a strong finish at the end of the month, but now the stock is well above its 20- and 50-day averages.
Furthermore, the RSI readings are above 80 (on a scale where 50 is fairly valued, and 100 is incredibly overbought). Even if the stock can mount another leg higher, which I doubt, it seems to have entered another consolidation phase, just in time for its earnings report in about a month.
Lockup Expiration Looms: The lockup period -- the time immediately after an IPO when insiders cannot sell -- ends Dec. 26 for GoPro.
This is going to be murder for the stock, considering a lot of early investors can cash out just in time to dress the windows on the fourth quarter and year-end performance.
To make matters worse, trading will be incredibly thin in the week between Christmas and New Year's, and the shares could be extra volatile. Remember, on the first day after Twitter (TWTR) investors were allowed to cash out their shares, it plunged to an all-time low as stockholders bailed out.
GoPro might not show signs of distress immediately, especially because it's such a sentiment-driven company. As such, I would never short-sell this company even if I think it's a dog.
But I am, however, watching longer-dated puts as a possibility. I'm particularly interested in the GPRO puts with January expiration.
Right now, contracts with strike prices around $90 are targeting a breakeven somewhere around $65, which would demand a 27% move down -- possible, but admittedly a tall order.
If breakevens get in the ballpark of $70 or even $75 -- as in, buy the $90 puts at $20 a contract for a $70 target -- GPRO options could be worth a trade in the weeks ahead.
Given the potential of another weak profit report in November and the weight of lockup expiration in late December, there could be some big volatility in the months ahead for this company.
-Jeff Reeves; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires
October 02, 2014 06:01 ET (10:01 GMT)
Copyright (c) 2014 Dow Jones & Company, Inc.SN201410020040822014-10-02 10:01:00.0007SNB1LUMQ0U7V3QE54RSGAM43GDJNF
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