In what appears to be a strange coincidence with GoPro (NASDAQ:GPRO) recent announcement that it was going to launch a consumer drone in 2016, the Federal Aviation Administration, FAA, has released a decree that will require most drone owners to register their devices in a bid to control the sharp increase in unmanned aircraft in US skies. Owners of drones weighing anything more than a half a pound, which virtually covers all drones bigger than palm-sized toys, will be required to register the devices on a government website and receive a unique user number which they will attach to their drones. The move by FAA has come just a day after GoPro announced the launch of its first consumer drone, the GoPro Karma, sometime in 2016. GoPro camera enthusiasts already use drones from companies such as DJI and 3D Robotics extensively to capture stunning aerial shots. Perhaps it was just a matter of time before GoPro decided to jump into the drone business.

Drone registration was widely viewed as the last step required to transform the drone industry from a hobbyist community to a fully-fledged mass-market commercial industry. GoPro released a teaser video titled 'Karma is coming in 2016' but didn't divulge any details about the design of the drone. The video’s sweeping footage clearly demonstrates the stability of images captured by cameras mounted on the device. GoPro stressed that the silky smooth images had not been stabilized in post-production editing, probably in an answer to Morgan Stanley’s latest bearish note on GoPro where the analysts said that they:

‘’believe that the bigger issue is that key challenges of off- loading, storage and editing content have not been adequately addressed for a product intended to be "taken anywhere to record everything."

Now that the FAA has officially acknowledged that drones are no longer a passing fad but are rather here to stay, what opportunities lie ahead for GoPro?

Sentiment change

It’s strange how quickly Wall Street and investor sentiment about a company’s prospects can take a 180-degree turn, sometimes in the course of just a few months. GoPro stock and Ambarella (NASDAQ:AMBA) stock made robust double-digit gains in June when it emerged that drones sales were soaring. Around that time, venture capitalists bestowed a $8 billion valuation on Chinese drone-maker DJI, maker of the popular series of Phantom drones, saying that the company was on course to achieve $1 billion in drone sales in the current year, a tenfold increase compared to 2013 sales. Subsequent results by Ambarella, the company that manufacturers the video encoding chips used in DJI drones, seemed to confirm that. AMBA even issued sales guidance that was a good 18% above consensus estimates, citing the launch of DJI’s Phantom 3 drone as a major contributing factor.

But of course those were the good old days before GoPro’s HERO4 Session woes surfaced. Now the general sentiment is that GoPro is a goner and not even drones can turnaround the company’s fortunes. GoPro’s sales projection for 2015 were cut from 10.6 million units to 9.3 million and Ambarella stock price fell by over 50%.

Ambarella Stock Price 6 Month Returns

Source: Ambarella stock price data by amigobulls.com

But that is a rather extreme view that is driven more by the negative emotions surrounding GoPro stock rather than solid facts. There are a few reasons that persuade me to believe that GoPro can actually succeed in the drone business.

First off, GoPro already enjoys a robust brand recognition, being the most popular action camera brand. GoPro camera users already buy their drones from the likes of DJI and Parrot which arguably do not enjoy the same level of brand recognition as GoPro. As long as GoPro can demonstrate that its drones are of as high a quality as its cameras, there is no reason why people will not buy them.

The second factor that will work in GoPro’s favor is that by bundling camera and drone sales, it’s likely to offer a more competitive bargain than if a customer buys a camera from GoPro and a drone from a third-party. Bundling products is frequently a successful strategy that helps companies price their products competitively and win market share.

GoPro is also likely to steal some business from its channel partners such as 3D Robotics. 3D Robotics has been selling drones for years, and has made GoPro its official camera for the company’s new line of products. 3D Robotics customers are likely to find it cheaper to buy the entire package from GoPro once the company launches its drones.

The biggest risk for GoPro is that its drones might turn out to be not quite as appealing as its cameras. Drones are technologically more complex to manufacture than video cameras. But going by the Karma video that GoPro released and its silky-smooth images, then this probably won’t be the case.

A more realistic risk is that GoPro risks alienating its channel partners such as 3D Robotics, who might decide to turn to GoPro’s rivals such as Contour, Polaroid, Sony, or even budget-maker Monoprice.

But overall I would say that the opportunity for GoPro in the drone industry outweighs the risk. The drone market is growing fast, and GoPro stock is likely to receive a higher multiple to reflect this once the company starts selling drones. GoPro will sell over 9 million cameras in the current year. Assuming the company hits sales numbers of 100,000 drones/quarter by the end of the second year after launch, and sells its drones @$1,500, then roughly a third of the company’s sales will come from drones. GoPro stock sports a low P/S multiple of 1.5. DJI’s P/S is 8. If we assign a P/S multiple of 5 for GoPro’s drone business, then GoPro stock could see its P/S ratio rise to 2.66, implying a 77.3% upside in the GoPro stock price.