GoPro Recalls High-End Drone, Faces Uphill Battle Against Smartphone Cameras and Drone Rivals

This column has been updated to note GoPro's recent Karma drone recall, and the recall's impact on GoPro's shares.

Much like Fitbit (FIT) , GoPro (GPRO) appears hemmed in by an addressable market for its core products that's much smaller than the company and its biggest fans once hoped. Unlike Fitbit, it's also contending with tough, well-entrenched competition in a market it has bet will act as a growth engine in the years to come.

The company's latest results and guidance bear this out. And a recall for its newly-launched Karma drone isn't going to make achieving the latter any easier.

Last Thursday, GoPro reported third-quarter revenue of $240.6 million (down 40% annually) and adjusted EPS of negative $0.60, well short of consensus analyst estimates of $313.4 million and negative $0.35. The company's guidance for the fourth quarter--a giant one both due to seasonality and the company's massive fall product refresh--was also light: Revenue of $625 million (plus or minus $25 million) and adjusted EPS of $0.30 (plus or minus $0.05) versus a pre-earnings consensus of $666.1 million and $0.43.

Shares fell 11% from Thursday's close to Monday's, before bouncing a little on Tuesday. The fact GoPro was already down 88% from its October 2014 peak going into earnings, and trading for only about 0.8 times its consensus 2017 sales estimate after factoring cash on hand, prevented the selloff from being worse.

But GoPro is off another 5% on Wednesday (in spite of higher equity markets) after the company announced it's recalling the Karma on account of discovering that a small number of sold drones have lost power during operation for unknown reasons. GoPro also disclosed it has only sold 2,500 Karma units to date; the drone was first unveiled on September 19.

One silver lining in GoPro's Q3 report: The company guided for adjusted operating expenses to drop to about $650 million next year from an expected end-of-2016 run rate of $780 million, and for the company's adjusted net income to be positive. A pre-earnings consensus called for GoPro to post 2017 EPS of negative $0.27. Adjusted operating expenses rose 33% annually in Q3 to $186.3 million, thanks to steep increases in R&D and sales/marketing spend.

But regardless of pre-earnings expectations and the spending guidance, GoPro's demand outlook looks pretty soft. While the midpoint of the company's Q4 sales guidance implies 43% annual growth thanks to the recent launch of the Karma and GoPro's Hero5 action cameras, it's still below the $633.9 million in sales GoPro posted in Q4 2014, the last time a major product refresh was carried out. And that time around, there weren't any drones to sell.

Admittedly, GoPro says production issues hurt its early-Q4 sales, particularly for the Hero5. But the company also claims the Hero5 issue has been addressed, and that the cameras are now at full production ahead of the holiday season.

New hardware or not, the fundamental problem for the Hero line remains the same: The cameras are beloved by a core base of action sports and outdoors enthusiasts--they still clearly find the superior image quality, recording abilities, endurance and accessory options of GoPro cameras relative to smartphones to be big selling points--but have failed to convince other consumers (generally hooked on smartphone cameras) the products are a worthwhile investment.

The issue here is not only that many consumers don't partake in the activities (skiing, surfing, hang gliding, etc.) that GoPro users frequently record video of, but that many of those who do only do so a handful of times each year. That makes it hard for them to justify spending hundreds of dollars on a camera to specifically record those moments.

GoPro has been betting its tiny Session cameras--a new one was launched in September as part of the company's refresh--would win over non-action sports enthusiasts, pitching it as a more flexible and durable alternative to smartphones for capturing everyday moments in the home and elsewhere. But that's clearly providing a tough sell.

Meanwhile, whereas GoPro plays the role of a well-established leader in the action camera market--rivals such as Polaroid and Nikon don't appear to have had much success winning over GoPro's core user base--it's playing the role of a challenger in the consumer/enthusiast drone market, where China's DJI remains the top dog and peers such as 3D Robotics and Yuneec also have meaningful positions.

Moreover, GoPro is wading into this market with a drone that costs $1,000 or $1,100 after factoring the cost of purchasing a compatible Hero5 camera to record footage. DJI and others sell drones featuring quality specs (if somewhat less impressive than GoPro's Karma). And shortly after the Karma launched, DJI unveiled the Mavic Pro, a $999 drone with a built-in camera that (like the Karma) supports 4K recording and can be folded up.

Reviews comparing the drones have often favored the Mavic Pro, arguing its design, weight, superior battery life, downward positioning sensors and autonomous navigation features outweigh the Karma's superior image quality, detachable camera and included Karma Grip accessory. A poll of more than 15,000 Verge readers found 64% preferring the Mavic Pro to the Karma.

For now at least, hopes that GoPro would take the drone market by storm haven't panned out. Rather, it's one of several notable players gunning for DJI's throne. That, together with an action camera market that isn't growing much (if at all) as the vast majority of consumers stay wedded to their smartphone cameras, is going to make for tough sledding.

And the bad PR provided by an early recall certainly doesn't help matters.

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