Fitbit Inc (NYSE:FIT) stock is trying to rebound, after plunging following another ugly quarterly report at the end of January. Fitbit stock is up about 5% over the past month, in fact. With earnings now in the rearview mirror, investors are perhaps looking forward — and expecting a turnaround in 2017.
But FIT stock is not worth chasing — not even below $7. Yes, the company has a substantial amount of cash on its balance sheet. And it’s true Fitbit still has some brand cachet in the wearables space.
Fitbit also is unprofitable, however. Competitors including Apple Inc. (NASDAQ:AAPL) and Garmin Ltd. (NASDAQ:GRMN) are coming on strong. Fitbit’s acquisition of Pebble — itself a fallen angel — simply combines two struggling businesses into one. That’s rarely, if ever, a formula for success.
All told, Fitbit stock might look cheap, but it’s not … and there are plenty of reasons why it should get even cheaper.
The Numbers Don’t Add Up for Fitbit Stock
Investors can’t just look at the share price to find value. FIT stock has declined significantly, from around $50 as recently as 2015 to current levels just above $6. That hardly means FIT is ‘on sale,’ however.
For one, Fitbit wasn’t even profitable in 2016. Adjusted EBITDA was positive for the full year, at $30 million. But that figure excludes some $79 million in share-based compensation. In other words, the ownership of FIT stockholders was diluted by more than twice what the company brought in as profit — even excluding a number of other one-time impacts (including litigation spending from a battle with rival Jawbone).
Meanwhile, Fitbit lost $144 million in the fourth quarter alone, and is guiding for an unprofitable 2017 as well. Adjusted EBITDA guidance sits in a range between -$50 and -$100 million — plus another $100 million -$110 million in stock-based compensation. That’s despite a substantial amount of cost-cutting which is supposed to bring operating expenses down $200 million on an annualized basis.
Fitbit’s decline is truly shocking. This is a company whose adjusted EBITDA is expected to reverse from a $389 million profit in 2015 to a ~$75 million loss in 2017. A turnaround is possible, but it’s important to remember the old saw. A man can fall off a horse much quicker than he can get back on.
Competition Is a Major Problem for FIT
The problem with any turnaround case for Fitbit is that its problems aren’t entirely self-inflicted. Rather, competition has strengthened.
The most notable impact of late appears to have come from Garmin. While Fitbit sales are collapsing – down 19% in Q4 — Garmin’s are increasing. Garmin doesn’t break out sales of its fēnix product line, but in its 10-K the company attributed a 27% increase in Fitness segment sales to its wearables products.
Garmin is far from the only competitor, though it appears to be the largest direct competitor for Fitbit’s legacy products. And competition isn’t just impacting sales. In Q4, Fitbit had to ramp up discounting and promotions, giving up $42 million in rebates and channel pricing, according to the Q4 release. That’s almost 7% of gross revenue (rebates are accounted for by reducing sales, not increasing cost of sales).
And that $42 million comes almost directly off gross profit, significantly impacting gross margins.
Stunningly, Fitbit’s Q4 gross margin declined by more than half. The figure (on a non-GAAP basis) was 48.8% in Q4 2015; 2016 non-GAAP gross margin was 22.4%. An industry-leading Fitbit with little established competition could hold pricing in 2015. That’s clearly no longer the case. And that represents a huge roadblock in any Fitbit turnaround.
What Is FIT Stock Worth?
To be sure, Fitbit isn’t going bankrupt any time soon. The company closed 2016 with $660 million in cash and marketable securities, nearly half of its current market capitalization. As bad as 2017 guidance is, Fitbit still is projecting negative free cash flow of just $50 to $100 million. Even at the high end, Fitbit would have 5-6 years of weak results before solvency became a real concern.
But “not going bankrupt” doesn’t mean Fitbit stock is worth $6 per share. The company’s enterprise value (market cap less cash) still sits around $700 million. That’s a rather large amount for a company that’s unprofitable. And it’s a valuation that won’t be supported unless and until Fitbit can return to some sort of profitability.
That’s a long way off at the moment. 2017 guidance implies that Fitbit’s adjusted EBITDA, adding back dilution, will be negative $180 million. That’s with most of the $200 million in cost cuts hitting the income statement this year. The key question for FIT stock is how the company plans to close that loss.
It’s not an easy task. Flat sales would require over 1000 bps of margin expansion. But any gross margin expansion will be difficult given increasing competition. There may be some room for further cost-cutting: but the 2017 run rate for opex is guided to $850 million. Fitbit would have to cut more than 20% off that figure – after already cutting nearly 20% in recent moves.
Can a struggling brand competing against much larger firms really cut marketing? Are there that many redundant employees at Fitbit headquarters?
A Tough Outlook for FIT Stock
FIT stock needs Fitbit sales to grow. And it’s there that I’m most skeptical. The company did buy Pebble to more aggressively enter the smartwatch space, but that business is declining too: Pebble reportedly turned down a $740 million offer from Citizen Watch Co. (OTCMKTS:CHCLY) just two years ago to selling itself to Fitbit for just $23 million. And going head-to-head with Apple seems unlikely to fix Fitbit’s margin problems.
Fitbit simply looks cornered. I do think the company should sell itself — but the founders control the company and show little interest in doing so. But on its own, Fitbit looks too small to compete with the big boys. Yes, Fitbit stock is down over 80% from its highs — but with good reason. And it could, and should, get worse.
As of this writing, Vince Martin has no positions in any securities mentioned.