Fitbit Q3 2016 Earnings Preview

Fitbit (FIT) will report its Q3 2016 results after the closing bell on November 2nd and too much anticipation as both bulls and bears have dug their heels in with extreme sentiment. Going into the company’s last quarterly release, shares closed the day around $13.30 and after beating on both the top and bottom line, shares rose to a peak of $17 post Q2 2016 results. However, and as anticipated, the share price has retraced and given up most all gains from the prior reporting period as of the close of trading on October 28th.  

Analysts’ estimates are calling for the wearable maker to report $506.93mm in revenues on  $.19 a share. This represents roughly 24% revenue growth and an earnings decline of $.05 a share from the same period a year ago. Earnings are expected to decline, in part, due to increased production, distribution gains and higher A&P spending from new product introduction. 

Valuing a One-Product Category Co. 

What has held shares of FIT down since reporting beats in each previous reporting period has been the nature of the business model which generally has found to deliver single-digit to low-teen multiples, even during periods of growth.  Fitbit is a one-product category manufacturer with no recurring revenues of consequence. With less than 1% of revenues coming from subscription services at such a mature stage in the company’s business cycle, it is unlikely that the company will ever scale this segment of its business. Most Fitbit and other wearable users have come to understand they don’t need to pay for a premium workout program and mobile workout applications have not proven to be practical. 

Without a recurring revenue business model, typically these hardware business models grow to the extent that distribution growth is available. As Fitbit matures, the company gains distribution and pulls forward sales growth that inhibits future sales. This is evidenced in the company’s revenue results over the last several years and forward-looking estimates. Please see the revenue chart below that recognizes how quickly Fitbit’s revenue growth is decelerating.

In 2015, Fitbit grew revenues 92%, but in 2016 the company is only expected to grow revenues roughly 40 percent. While 40% revenue growth is a great expectation and end-result, in 2017 the company is only expected to grow revenues some 16 percent (revised lower from 17%). Having said that, with each successive quarterly achievement in distribution gains, it becomes increasingly unlikely that Fitbit will achieve 16% revenue growth in 2017. It is important for investors to understand and accept that almost 2/3rd of Fitbit’s revenue growth comes directly from distribution gains/sell-in and expanded retail linear footage/shelf space. The actual sell-through of its core products is quite slow as wearables are non-essential goods and the majority of Fitbit’s products are bought as gifts, as evidenced by the company’s reporting of sales. More than 40% of Fitbit products are bought during holiday periods. Fitbit’s expansion objective was one of the main reasons the company issued an IPO, the capital raised through the IPO has helped the company with expansion efforts in 2016. The linear footage gains at existing retailers has been incremental in the company’s revenue growth this year.  More importantly, this was expected as most one-product category companies follow the same playbook. See photograph below:

In 2014, SodaStream (SODA) expanded its footprint at Wal-Mart (WMT) from 4 feet of retail space to 24 feet (a full aisle).  Unfortunately for SodaStream, the expanded retail space captured did not result in greater sales and eventually Wal-Mart discontinued SodaStream’s retail space at some 2,000 locations. While the additional sell-in proved meaningful for SodaStream, investors did not benefit as the sell-through was not to be had and as shares of SODA depreciated through 2014.

Referring back to the revenue chart, investors should also understand that until Fitbit reaches revenue equilibrium and saturates the global marketplace with its devices, an acquisition of the company is extremely unlikely and unprecedented for this particular business model. Essentially, any would-be acquirer would want to know the true demand for the product along with profitability post-market saturation.