Will GoPro's $129 HERO Result in Unheroic Margins?

GoPro just unveiled its cheapest camera ever, the $129 entry-level HERO. The device can record 1080p wide-angle video at 30fps, 720p video at 60fps, take five-megapixel photos at up to five frames per second, and is waterproof in depths up to 131 feet.

GoPro's new cameras. Source: GoPro.

GoPro unveiled the camera alongside two new pricier devices, the $499 HERO4 Black and the $399 HERO4 Silver. The HERO4 Black can capture 4K video at 30fps, 2.7K video at 50fps, 1080p video at 120fps, and can take up to 30 12-megapixel photos per second. The HERO4 Silver can capture 2.7K video at 30fps, 1080p video at 60fps, 720p video at 120fps, and sports the same fast-shooting 12-megapixel camera.

While the HERO4 Black and Silver are welcome upgrades for GoPro's core product line, investors are probably wondering if the $129 HERO will cannibalize sales of its pricier products and result in lower margins.

Why GoPro needs a low-end action camera
According to IDC, GoPro controls 47.5% of the action camera market. Sony trails in a distant second with a 6.5% share. The rest of the market is fragmented among new players like Polaroid, Spy Tec, and Monoprice. Here's how GoPro's new HERO measures up against the low-end competition:

Source: Company and industry websites.

The new HERO doesn't really stand out in any department except for two things -- its brand name and its superior water resistance. Whether those two factors can convince casual action camera users to pay $30 more for the device, however, remains to be seen.

L to R: Polaroid's Cube, Spy Tec's SJ1000, and Monoprice's MHD Action Camera. Source: Company websites.

But the real threat doesn't come from individual competitors -- it's the fact that cheaper action cameras will lower customer price expectations, widening the rift between action camera enthusiasts and casual users. Another problem is that previous HERO users might realize they didn't need all the bells and whistles of the higher-end devices, and in the future purchase the cheaper GoPro HERO instead of the Silver and Black versions.

Margins vs. market share
This means that GoPro could soon be forced to sacrifice margins to preserve its market share.

Last quarter, GoPro's revenue soared 38% year over year to $244.6 million, but its generally accepted accounting principles-adjusted net loss nearly quadrupled to $19.8 million. That loss was mainly due to triple-digit increases in research, sales, marketing, and administrative expenses. Exacerbating the problem, GoPro still hasn't secured a contract manufacturing deal with Foxconn, which owns 8.88% of the company. Such an agreement could help GoPro lower development and manufacturing costs.

What's troubling was that GoPro posted gross margin of 42% last quarter, up from 32% a year earlier, which was completely offset by rising expenses. The company also stated in its 10-Q filing that it expects gross margins to decline sequentially in the third quarter.

Therefore, adding a low-cost camera that could cannibalize sales of higher margin ones is risky, but it's a necessary tactic to counter the rise of $100 action cameras.

The Foolish takeaway
GoPro's forward P/E of 88 and five-year PEG ratio of 3.4 clearly suggests the stock -- which has soared 280% since its June IPO -- is overvalued and has limited bottom-line growth potential. Launching cheaper cameras while incurring higher marketing expenses will also probably keep the company in the red for at least a few more quarters.

However, investors should remember that margins aren't everything. If GoPro can conquer the low-end action camera market with the new HERO, it can offset lower profit per unit with higher sales volume. The low-end HERO could also help GoPro expand into a new market that wasn't interested in the company's cameras before, dramatically increasing its user base and overall market share. That could fuel the growth of its video sharing network, which the company has repeatedly highlighted as a possible new source of revenue.

These factors could all lead to higher revenue growth, which might keep investors interested in GoPro, despite its bottom-line issues.