Fitbit Inc Stock Is Interesting… but the Math Just Doesn’t Work
Purely from a “feel” standpoint, I’m intrigued by Fitbit Inc (NYSE:FIT). The numbers aren’t great, admittedly. Third-quarter revenue declined 22% year-over-year, for instance, and sales are down 34% so far this year — but the FIT stock price does look cheap.
Source: Via Fitbit
Backing out some $660 million in cash and investments, the market is valuing Fitbit at just $930 million. Full-year guidance suggests at least $1.6 billion in revenue this year and implies an enterprise-value-to-revenue multiple of less than 0.6.
That seems attractive — if only from the “feel” standpoint I referenced earlier. Competition is intense in the wearables space, with Apple Inc. (NASDAQ:AAPL), Garmin Ltd. (NASDAQ:GRMN) and Samsung, among others, all targeting it.
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But the space as a whole is growing, and Fitbit seems to be finding a niche with its new Ionic smartwatch, as Laura Hoy wrote last month. Partnerships with insurers and with DexCom, Inc. (NASDAQ:DXCM) for glucose monitoring provide another potential growth driver going forward.
But the problem with the FIT stock price is that the math just doesn’t work. Feel aside, this is a sharply unprofitable company, with even Adjusted EBITDA guided to a ~$60 million loss this year. And that figure excludes a guided $90-$100 million in stock-based compensation. The cash balance affects potential M&A valuation — if an acquirer is even interested.
I’m not ready to write off Fitbit stock just yet; it remains a story worth watching. But the numbers need to get much, much better before FIT stock becomes a buy.
The Profitability Problem
Some back-of-the-envelope math shows just how far Fitbit needs to go to support even the current FIT stock price. Assume the company could, at some point, receive a 30 earnings-per-share (EPS) multiple — still high relative to the market. The current enterprise value of $930 million means FIT would need about $30 million in net income — or roughly $40 million before taxes, assuming tax reform passes and lowers FIT’s tax rate to ~25% (including California state taxes).
Fitbit’s depreciation is running at about $38 million annually, EBITDA in that scenario would need to be just under $80 million. Adding back stock-based compensation — profits created by diluting existing shareholders shouldn’t count — and the current loss suggests that figure, at the moment, is roughly negative $155 million.
This means that Fitbit needs to add in the range of $230 million in incremental pre-tax profit simply to support the current price. Assuming flat revenue, that would require roughly 1,400 basis points (bps) of margin expansion.
But how, exactly, are margins supposed to expand? Gross margin already is jumping ~400 bps this year, thanks in large part to last year’s disastrous Q4 on that front. Getting back to fiscal year 2015’s (non-GAAP) 48.5% would add about 5 points to margins.
Even in that scenario, Fitbit is only barely profitable in terms of EBITDA — and still unprofitable when counting the dilution of FIT stock. Operating expenses need to be leveraged, but Fitbit already has made reasonably deep cuts this year, with opex down ~4% year-to-date.
Revenue growth can help, but Fitbit, in this model, still needs at least $2 billion in annual revenue to become consistently profitable on a net basis. Analysts are expecting an increase next year, but to roughly $1.74 billion.
By any reasonable measure, Fitbit is years away from supporting its current valuation. And they have to be good years — with revenue rising, pricing power maintained and costs controlled. It’s a big ask, likely too big.
The Big Problem for FIT Stock Price
In theory, one option would be for Fitbit to sell itself. An acquirer could slash some of those operating expenses, boosting profitability quickly. A larger, more diversified company might have more pricing and marketing power with key retailers like Amazon.com, Inc. (NASDAQ:AMZN) and, in particular, Best Buy Co Inc (NYSE:BBY). Those two retailers combined accounted for nearly a quarter of the company’s revenue in 2016, per its 10-K.
But there’s a couple of problems with that scenario. Fitbit’s voting power is controlled by its founders, CEO James Park and CTO Eric Friedman, both of whom have shown no interest in selling. A logical acquirer really isn’t out there. Plus, a private acquisition isn’t going to happen until the company is generating free cash flow.
It’s worth noting, too, that the cash means a buyout offer wouldn’t even be that high. A buyout premium will only apply to the business, not the cash. A 30% premium would only result in a FIT stock price of $8. It’s hard to imagine Park and Friedman taking such a price given that FIT stock traded at those levels as recently as January.
So, while the business seems intriguing and a turnaround is possible, the FIT stock price simply doesn’t look all that attractive. On its own, any upside will require either huge outperformance in the near term relative to expectations or a lot of patience. And a buyout seems highly unlikely for a number of reasons. Between the two, the fundamental case for Fitbit stock just isn’t there… even if the business looks potentially intriguing.
As of this writing, Vince Martin has no positions in any securities mentioned.
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