Less than two years after clearing $50, Fitbit Inc (NYSE:FIT) stock trades around $6. A series of disastrous earnings reports has sent Fitbit stock tumbling. The most recent was the disclosure of preliminary Q4 results last week, which imply a nearly 20% decline in sales year-over-year in the key holiday quarter.
Competition from Apple Inc. (NASDAQ:AAPL), Samsung Electronics Co Ltd (OTCMKTS:SSNLF), and Garmin Ltd. (NASDAQ:GRMN), among others, appears to be a key problem for the company, particularly in the U.S. The resulting decline in growth has had a substantially negative effect on FIT stock.
That’s not going to get better.
Lately, Fitbit has been compared to GoPro Inc (NASDAQ:GPRO), another company that drove explosive growth mostly off a single product only to see sales nosedive. The question is whether in this day and age, a single-product company can support the expense necessary to compete with behemoths like Apple and Samsung. The answer, at least from Fitbit and GPRO, appears to be no.
And that would seem to argue for a sale of FIT to one of those larger players. The problem for Fitbit stock investors, however, is that such a move seems unlikely — at least before it’s too late.
Why FIT Should Sell Itself
In response to the lower demand in Q4, FIT is cutting costs. It’s laying off 6% of its staff, part of an overall effort to cut $200 million a year in operating expense. That’s a substantial amount of savings, given that Fitbit stock has a market cap under $1.4 billion at the moment.
But what’s less important than what is being saved is what’s left: some $850 million in fiscal 2017, according to the company. It’s a huge amount of money for what, at its core, still is a single-product company. Yes, FIT is adding software to create a “platform”, and its product line goes beyond its most popular wearable. But compared to the diversification of an Apple or a Samsung, there’s no comparison.
Fitbit has to build an expense base to support one product; its competitors (even Garmin) support multiple products. That matters not only in terms of cost, but in terms of sales. It’s easier for Apple to cajole Best Buy Co Inc (NYSE:BBY) to push the Apple Watch when Best Buy is also selling millions of dollars’ worth of MacBooks and iPhones. FIT doesn’t have that leverage, and expecting it to compete with electronics giants seems simply foolhardy.
As for the cost structure, even with the $200 million in reduced spend, FIT is guiding for a loss next year. (That loss excludes the cost of stock grants issued to Fitbit executives, no less.) With one product, there’s no ability to spread out expense for everything from salespeople to R&D to IT. FIT is likely going to spend $240 million in 2016 just on sales and marketing — for one product!
That expense rose 23% through the first three quarters — the cost of trying to be David against multiple Goliaths. But the story seems likely to end much more poorly for Fitbit stock.
Why Fitbit Stock Won’t Sell Itself
From that standpoint, a sale of FIT stock to a larger player would seem to make sense. Apple, Samsung or Garmin all would make sense. The Fitbit brand remains strong, and an acquirer almost certainly could cut hundreds of millions of dollars itself. A slimmer (pardon the pun) FIT would thus add a nice amount of profit, even assuming a premium paid to acquire Fitbit stock.
There are a couple of problems with this scenario. The first is that Fitbit stock has a dual-class system. FIT is thus controlled basically by its two founders and venture capital firm True Ventures. One of those founders, CEO James Park, said in the release accompanying the preliminary fourth-quarter figures that the company simply was in “a temporary slowdown and transition period”.
As long as Park, along with True Ventures and co-founder Eric Friedman, believe the weakness is only temporary, Fitbit won’t sell itself. And if Park is wrong, and Fitbit is surpassed by larger players, by then, it will likely be too late.
Another issue, counterintuitively, is FIT’s huge cash balance. The company expects to have $700 million in cash at the end of Q4 — over half of its market capitalization. But that cash also limits the premium an acquirer will pay for Fitbit stock. The enterprise value at the moment — what the market says the business is worth — is about $670 million. Assuming Fitbit could get twice that price from an acquirer, it would have to sell itself for only about $9.30 per share.
So hopes of a FIT acquisition rest, essentially, on the co-founders of the company agreeing to sell the business for more than 80% less than it was worth less than two years ago. That’s a highly unlikely outcome. Park and Friedman are going to believe Fitbit can turn around — it’s their company. They turned their idea into a business worth over $10 billion not that long ago; it’s silly to think they would then sell it for a bit over $1 billion at this point.
And maybe FIT can turn itself around, which would certainly drive upside in Fitbit stock. But it seems a very difficult path. While it’s hard to think of a billion-dollar company as a “little guy,” Fitbit is a little guy when compared to its competition. And in this day and age, it’s awful tough for the little guy to go at it alone.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
