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MagicDiligence (< 20)

Fitbit's Valuation Is Absurd



March 15, 2016 – Comments (0) | RELATED TICKERS: FIT , AAPL , UAA

We haven't been shy about expressing our opinion that one of the more attractive recent additions to the Magic Recipe Spell has been fitness tracking wearables kingpin Fitbit (FIT).

The stock's path since the IPO late last June has been pretty remarkable. On its first day, stock closed 50% above its IPO price of $20/share, and soared all the way above $50 in early August, before steadily sinking down, down, bottoming out at around $12 and only recently rebounding a bit to $14.50 - still well under the IPO price.

Today we are left with a true value stock. The company's 12% earnings yield (EBIT/EV) ranks it in the 88th percentile of the market.

At that price, we must have a beat-down, no-growth company, probably with financial issues, right?

Well, let's take a look.

The Fitbit Bull Case

I'd wager most readers are familiar with Fitbit. The company is the market leader in wearable fitness devices, with a nearly 30% market share. The current product line is:

Zip and One: Clip-on fitness trackers, Fitbit's first products. The One is a more modern evolution of the Zip.

Flex: Fitbit's classic fitness tracking bracelet, with just a set of LED pips for indicators.

Charge: Adds an LED display screen with sleep tracking and time functionality.

Alta: A recently-launched, more fashionable version of the Charge with some phone notifications and changeable bands.

Charge HR: The Charge with an optical heart rate monitor.

Blaze: A new product with smartwatch-like features such as a color touchscreen, changeable bands, smartphone alerts, and heart rate monitoring.

Surge: Will probably be superceded by the Blaze, has same features but no color, not touchscreen, has no changeable bands, is not as fashionable, and costs more! Does have GPS though.

Aria: Fitbit's connected scale product.

The wearables market is a rapidly evolving one, but a big and growing one too. IDC estimates the market will grow a staggering 28% annually through 2019, from 80 million units in 2015 to about 215 million, making it at least a $30 billion dollar market.

The "bull" case for Fitbit is really as simple as that. Enormous addressable market, market share leader, strong consumer brand. I've seen Fitbit compared to GoPro (GPRO), but that seems misleading to me. This is no niche market - this is a widely appealing general consumer product market with global potential.

Why Is Fitbit So Cheap?

Given this compelling, so-easy-a-child-can-get-it bull case, why does the stock trade so cheap?

Has the growth story run its course? Not really. Fitbit delivered a 92% year-over-year revenue increase in its most recent, all important holiday quarter. And 2016 guidance still calls for over 30% revenue growth for the full year. That's above growth estimates for this sector at large. If the market thinks a "deceleration" to 30% growth warrants a 12% earnings yield, the market is absurd.

Are there financial issues? Nope. Fitbit is plenty profitable on a GAAP basis, with an 18.3% operating margin for 2015. The company has no debt, either, and almost $700 million in cash on the balance sheet.

Will competition hurt future results? A-HA! Houston, we - might - have a problem. Just look at this list of current competitors in the fitness tracking wearables market:

Apple (AAPL), with the Apple Watch.

- A whole slew of smartwatches running Google's (GOOG) Android Wear, including devices from behemoths like Samsung, ASUS, LG, Motorola, Huawei, and others.

- Traditional watch makers adding fitness tracking features to normal looking watches, such as Fossil (FOSL) and TAG Heuer.

- Direct competitors in wearable fitness trackers, such as Polar, Garmin (GRMN), Jawbone, Basis, and Mio.

- Athletic apparel companies entering the wearables space, notablyUnder Armour (UA) with its HealthBox.

That is a truly imposing roster of competition, including some enormous global competitors with world-class brands.

The market is worried, and rightfully so, that all of this competition will draw customers away from Fitbit, and hurt their margins as prices are pushed down. That is really the big fear here, and it is not an unreasonable one.

Can Fitbit Survive - and Thrive?

In my opinion, the fear is a little bit overdone. Okay, probably a lot overdone!

First, Fitbit has already established a well-recognized consumer brand. When a consumer decides they want a health tracking device, a Fitbit will unquestionably be in consideration. It is synonymous with the space, something that can't be said for Android Wear devices or old-school watch makers like TAG Heuer.

Second, Fitbit is already focused on the low-end of the market, where the bulk of the volume is going to go. The Zip is about $50, and the main other low-cost competitor - Misfit - was gobbled up by Fossil last year. The Flex can easily be had in the $70 range, and Charge can be found for right around $100, cheaper than most of the competition. Put together Fitbit's brand recognition with its price advantage, and it is not hard to see new consumers continuing to enter the market with a Fitbit. Also, already low pricing makes it difficult for larger competitors to price them out.

Finally, as stated earlier, this is a truly HUGE potential industry. There is plenty of room for multiple players, including Fitbit. Even if Fitbit can only capture 15% of this market - a conservative assumption - that would still represent more than a doubling of revenues in 5 years. Some of those weaker competitors are going to drop out or scooped up in time.

Put together these advantages with a truly cheap valuation and you have what I believe is an attractive entry point to an emerging brand in a large category. MagicDiligence thinks the stock is reasonably worth $34, which represents 135% upside to the current stock price. Even if our assumptions are way off, that is a pretty healthy margin of safety to work with.

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