I’ll admit that I can see the outlines of a bull case for Fitbit Inc (NYSE:FIT). It’s true that FIT stock is down almost 88% from an all-time high. And Fitbit shares have been stuck in an exceedingly tight range, basically trading between $5 and $6 since late January.
But there are some pieces of good news.
The balance sheet is pristine: Fitbit has more than half its market capitalization in cash and marketable securities. Q2 earnings were a pleasant surprise relative to expectations. And the long-awaited Fitbit smartwatch should arrive in time for the holidays.
The problem for FIT stock is that the good news comes with plenty of bad news.
The balance sheet means a sale of Fitbit — which is unlikely — wouldn’t come at much of a premium. Q2 earnings were better than expected, but hardly impressive. And the Fitbit smartwatch is long-awaited in large part because it’s been long-delayed.
The story here still can work out, with the success of the smartwatch more and more looking like the key factor for FIT stock going forward. But as yet, there still isn’t enough reason to see a turnaround at Fitbit.
The Bull Case for Fitbit Stock
Coming out of second-quarter earnings, there is reason for some optimism toward FIT.
Gross margins held at a strong 42.2% in the second quarter, meaning the disastrous fire-sale pricing seen in the second half of 2016 likely is behind the company. Net and EBITDA losses narrowed markedly relative to the first quarter, and both revenue and earnings were ahead of Street expectations.
Even the most ardent FIT bull would admit there’s work to be done. But progress has been made. Inventories have come down substantially, dropping to $141 million at the end of Q2 from $230 million following Q4. Sales were down — but new products contributed more than 80% of revenue, showing that Fitbit’s R&D efforts still are bearing some fruit.
As noted, the balance sheet is cash-heavy: Fitbit has almost $3 in cash per share of FIT stock. That would seem to imply somewhat of a “floor” for Fitbit going forward, even if that floor is roughly 50% below the current share price.
Basically, the desks are clear for the arrival of the smartwatch, which CEO James Park said in the Q2 release would come ahead of the holiday selling season. If that product is a success, Fitbit’s fundamentals surely change, and the company’s losses likely swing to a profit. Just as importantly, the narrative surrounding FIT shares changes. Instead of being a struggling, rudder-less ship falling behind in an industry it helped create, Fitbit becomes a turnaround play.
The combination of fundamental improvement and investor optimism could lead FIT stock much, much higher.
The Bear Case
The bear case for FIT stock only differs from the bull case in terms of perspective. It’s true, for instance, that gross margin held in the second quarter. But revenue fell by 40% year-over-year, as did the number of devices sold. And new products are making a larger share of revenue because demand for original models is fading quickly.
Below the top line, adjusted EBITDA reversed from a $48 million profit the year before to a $28 million loss. That was despite cost-cutting that actually lowered the company’s operating expenses. At the same gross margin and operating expense levels, Fitbit would have to grow sales almost 20% just to get to breakeven on an EBITDA basis – and over 25% to get operating income into the black.
There simply is a long way to go in terms of growth for Fitbit to return to profitability.
Here, too, the case hinges on the smartwatch. And a bear would point out that the product has a lot of pressure on it. It’s not as if Fitbit can simply stabilize sales and generate value. It needs real and sustainable growth.
That means a win in the smartwatch category. But that means that Fitbit has to outmaneuver both Apple Inc. (NASDAQ:AAPL) and Garmin Ltd. (NASDAQ:GRMN), both of whom have beat Fitbit to market. It means that the smartwatch can’t “cannibalize” sales of existing products.
And it means that a management team whose execution has been spotty (to say the least) over the past two years has to be on top of the ball for what could be the company’s largest and most important rollout.
Stay Away From FIT Stock … For Now
The balance sheet does help here. But Fitbit needs that cash — because it’s still burning money. The company is guiding for adjusted free cash flow of negative $50 to $80 million this year. Even that figure assumes guidance is correct, which hasn’t always been the case.
The cash also limits Fitbit’s upside. Right now, the market values the business at about $675 million. Assuming that figure doubles, FIT stock still only moves to a bit over $8 per share.
That’s 50% upside … if everything pans out. Fitbit could be dead in the water if the smartwatch doesn’t hit. There’s simply nothing behind it. And that’s the problem with single-product companies like Fitbit and GoPro Inc (NASDAQ:GPRO) that lack the necessary scale for a retail environment dominated by Amazon.com, Inc. (NASDAQ:AMZN) and other e-commerce players.
There’s a lot of risk here, and maybe not as much as reward as one might think. If the Fitbit smartwatch is a big hit, Fitbit stock will ride high. But, at the moment, there’s just not enough reason to take that bet.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
