In a time of highly inflated valuations in the tech industry, Navi Hehar of Kerrisdale Capital Management found a particularly ripe short situation in 2014 via “action cam” producer GoPro (NYSE: GPRO). After its June 2014 IPO which made founder Nick Woodson an instant billionaire, GoPro stock went on a 180% upward rampage, appreciating almost seven billion dollars. Amid this steep rise Hehar went short, and he has since reaped a 28% return (65% annualized) as GPRO shares settled somewhat. We sat down with Mr. Hehar to discuss why and how GoPro expectations got out of hand and why there is still over-strong faith in the power of GoPro to meet high expectations.
SumZero: What about GoPro initially caught your attention as a value investor. What was the market missing at the time?
Navi Hehar, Kerrisdale Capital: Any time a business sells a product that you’re intimately familiar with, where you understand pricing power and competition, I think an investor should always carefully evaluate it. In my case, many of my friends own a GoPro, I’ve seen their videos, I’ve used their product on vacation, and I understand why people buy a GoPro camcorder vs. the competition. My investment in AMERCO (parent company of U-Haul) in 2012 was a function of the same process; I’ve used a U-Haul many times, I understand why I went to them and not someone else, and so that is the type of business I can invest in. My SumZero short on The Gap (GPS:US) follows in a similar vein.
With GoPro, what really piqued my interest was the fact that the company had traded up so far above its IPO price. In 2014, GoPro’s founder Nick Woodman agreed to sell shares in the company at $24.00 per share (~$3B valuation), yet when I posted my short idea to SumZero, they traded near $70 per share ($10B valuation). Was GoPro really worth half as much as Sony (which also owns the enormously valuable Sony Pictures and Sony Music franchises)?
Woodman could have sold a stake to a PE fund or VC fund, or possibly a strategic acquirer (like Sony or Apple). Instead, he sold to public market investors, most likely because they offered him the highest price. Conversely, public market investors were willing to accept the lowest return; either that, or they bought into a “story” that nobody else did.
If we look at GoPro’s IPO prospectus, it is clear that the “story” was the idea that GoPro was not a consumer electronics firm, but rather a content and media company. And being a person that understands what GoPro is, that story made no sense to me.
SumZero: What is the media business story?
GoPro’s prospectus highlights that GoPro has millions of subscribers on its YouTube channel, and hundreds of millions of views on its videos. It also highlights how GoPro is taking “its” content, and plans to translate that into a media franchise, possibly starting a television station, or monetizing its enormous YouTube fanbase.
GoPro investors have been enamored by the sheer size and scale of YouTube user statistics (hundreds of millions of users, millions of subscribers) but both the investment community and the research analyst community have failed to evaluate the actual revenue potential on the YouTube platform or the potential from a cable TV station.
SumZero: So you don’t think GoPro’s media business will be a success?
In my opinion, not at all.
GoPro is just the device people use to make videos; it doesn’t own or create any content. There is a big difference between being the movie studio that owns the rights to the Jurassic Park movie, and being the camera company whose cameras were used to film the movie. It’d be like calling Apple a pornography studio because people send each other naked selfies on their iPhones.
GoPro’s IPO prospectus is full of anecdotes about the amount of YouTube video content shared with a GoPro camcorder. But there is one major problem: GoPro does not own any of the content that is being produced with its product! Even worse, it doesn’t even own the primary distribution channel it uses to broadcast its videos. Its Youtube channel is owned by Youtube/Google – GoPro just gets some minor ad revenue.
Youtube’s most popular channels, which have billions of page views and millions of subscribers, barely make a few million in revenue. The GoPro TV channel made even less sense to me. How would the channel work? Would it just be random videos? Would there be different “episodes” tied to certain types of videos (like “surfing” between 8-9 pm?).
I think the media story is never really going to pan out to anything. The Youtube channel is great for brand awareness and convincing people to buy GoPro cameras in order to make their own cool videos, but I don’t think it will ever be a revenue generator.
SumZero: Aside from the “media company” story, what if the GoPro camera achieves an iPhone level of success?
The iPhone is the greatest commercial product ever invented. Part of its unique charm is that it is a very expensive product ($700 or so) that is totally worth it when we consider how useful it is, and people are willing to buy a new one every couple years for iterative improvements. An often overlooked factor is that since people carry their phones on them literally all the time, they tend to lose their phones, phones get stolen, phones break – this leads to a lot of extra phone purchases. Perhaps most importantly, even though iPhones face a plethora of Android competitors (many actually have better specs), people stick to the iPhone because users are entrenched into the Apple software ecosystem. This creates switching costs.
GoPro lacks almost all of these things.
Top end GoPro cameras likely have a very small addressable market. Your mom is probably never going to buy a GoPro. And she’s cool with that. Even if she did, she’ll probably buy the entry level one, not the $500 Hero 4. The entry level GoPro has far lower margins and faces far more competition from cheap knock-offs.
GoPro’s upgrade cycle is probably going to be much slower than an iPhone. Though some may upgrade to get the latest 4k quality (vs. 1080p) or for a new LCD screen camera, for many others, the iterative improvement probably isn’t worth buying a brand new camera. GoPro camcorders will also lack the “accidental” demand that iPhones enjoy from lost / stolen camcorders since people don’t carry them around all the time. Also, GoPro camcorders are not going to break often.That’s the whole point of a rugged action cam.
SumZero: Why do you think GoPro’s over-valuation was so egregious for so long, and what caused the return to reason which allowed your short position to do so well?
I think it is because it took a few months for the insider lock-ups to end. A few months after the IPO, as insiders began selling their shares to the public, it became tougher to find more and more investors willing to buy into the business at a $10-15 billion valuation, leading the shares to gradually fall to a lower level.
SumZero: Was execution difficult given that this was a short position? Was borrow expensive, and did the return opportunity justify the expense?
Execution was difficult because there was limited borrow, at a very high cost. That said, the borrow cost declined once insiders lock-ups expired. Given the extent of overvaluation (recall, GoPro shares had touched $90 at one point), the return definitely justified the expense.
SumZero: What were the biggest risks associated with the trade in your view?
As with any short, the biggest risk is just simply being wrong or being forced out of the position due to interim price swings. The second risk can be controlled by sizing accordingly, and the first – well that’s what investment analysis is all about.
SumZero: Is GoPro still attractive to short at today’s prices?
Yes I still think GoPro shares remain an attractive short. Ultimately, I think the main issue for them is going to be their small addressable market and lack of replacement revenue.
I think a good comparison is the iPod. The iPod is a phenomenal consumer product. It faces a plethora of “me too” competitors but people still happily buy iPods because they’re the best (perhaps most importantly because of the software ecosystem). Yet, iPod sales peaked in 2008 and are now down about 70% since then! Once iPod saturated its market, there really wasn’t anyone to sell a new one too. Nor were there any meaningful improvements.
The action cam market has exploded out of nowhere. And I think it’s going to be a “pop & drop” cycle like a lot of consumer electronics products. The ultimate question is how big will the “pop” be and how much cash can GoPro extract before the “drop”.
The consumer electronics industry has taught investors a painful lesson time after time: without a “software” component (like with iPods or iPhones) or a very expensive niche focus (like high-end Nikon cameras), mass market consumer electronics products almost always see drastic margin compression. GoPro’s 50% gross margins appear very likely to be lower several years from now.
SumZero: Given the large number of seemingly overvalued tech companies in today’s market, do you see other short opportunities?
Thin-float IPOs will always be an area that investors should evaluate for shorts. A couple examples that appear to have a similar setup to GoPro include Shake Shak (SHAK) and Fitbit (FIT). I can’t say that they are clearly shorts at this stage but I will keep an eye out.
SumZero: Tell me about your investing background and investing mentors and heroes.
I went to an accounting and finance-heavy undergraduate in Canada and have been working in finance (several years as an M&A banker, several years at hedge funds) since then. I started actively investing right at the start of college and continued to do so during the entire 15 year span since.
Like many people I’d say I’ve learned a lot reading and listening to Warren Buffett and Charlie Munger’s lectures. Monish Pabrai’s book the Dhando Investor has a great chapter on the Kelly Formula that I thought was really helpful in thinking about position sizing. I can’t believe that formula is never taught in finance books or MBA programs.
I don’t think I really understood short selling until I worked at Kerrisdale, which has been a phenomenal short-selling training ground. It’s a rare team that has produced an enormous profit shorting while the markets have been up over 100% over the past few years.
SumZero: How has your approach evolved over the years?
Over the past 15 years, I’ve really learned how to do some very complicated accounting analysis and financial modeling. I’ve also come to learn why Warren Buffett and Charlie Munger have never used Excel. Nobody has ever made 10x their money using Excel. More often than not, it just creates a false sense of precision. The bigger advantage is thinking broadly about how big a company can get, what its margin might be, how much capital it might employ, what the risks are if it screws up, etc.
Today, I try to focus on investments that fall into four buckets that I think tend to categorize opportunities for significant returns, both long and short. Finding companies that are (1) Market share gainers or losers (2) Margin changers – companies that I think will have dramatically different margins in the future, (3) M&A shops – companies that constantly acquire businesses or deploy capital and (4) Market dislocations like spin-offs, merger arbitrage, thin-float IPOs etc.
Another valuable lesson has been to look at equity a bit more like credit. Say a company earns $1/share and trades for $10/share. That’s a 10% yield. If the stock falls to $8, your yield goes up to 12.5%. It’s a nice bump up, but not that huge when I think about it today. Over the years I’ve become way more focused on finding growth; the real money is buying $1 EPS stocks that can grow to $5 EPS in a few years. Conversely, when shorting, I want to find businesses that will have EPS fall from $1 to $0.10, rather than shorting a stock that had its share price go from $10 to $12.
SumZero: Where else do you see value in the market today?
I’ve put up a couple write-ups on SumZero for investments I think could prove to be quite profitable over the long-term. Generally, I find my best investments during a period of panic, and over the past couple of years I’ve really focused heavily on financials. Today, I would think the oil & gas sector has to be one of the best areas to find great investments today. Unfortunately, by the time I figure out what is going on there, I’ll probably have missed the boat.
SumZero: What advice would you give to someone interested in pursuing investing?
I think for the vast majority of people, buying an index fund is the best investment. Only in the select cases, where you are quite sure a business is going to grow significantly, and keep its gains, should you bother buying single-pick stocks. I emphasize growth because I think investors focus too heavily on the PE multiple. It’s too short-term a metric to be meaningful in many cases.
SumZero: Thanks very much for your time and insight Navi, and best of luck.
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