Description

Fitbit is being acquired by Google for $7.35 per share in cash. The current price is $6.5, which represents a potential 13% upside. The stock closed at $7.14 on the day of announcement but has been declining since due to rising concern over regulatory approval. We believe the concerns are overestimated and the transaction is highly likely to close. Furthermore, a few days ago Fitbit shareholders overwhelmingly approved the buyout plan. For a full overview of the company please refer to nondescripthandle's 2018 write-up and buggs1815 2016 write-up.

Deal background

Fitbit IPO’d at $20 per share in 2015, surged to briefly trade over $50 before starting its descent to mid-single digits amid heavy competition, declining sales and persistent losses. Management began shopping the company in mid-2019 and quickly attracted strategic interest. The board would have been willing to sell out at $6 or even less but a bidding war erupted between Google and Facebook. Mark Zuckerberg negotiated personally and was willing to go up to $7.30, demonstrating the strategic value perception of the asset. To note, Google’s offer represents 47x management’s CY2024 non-GAAP net operating earnings forecast.

The transaction, which is expected to close in 2020, is now subject to antitrust review in major jurisdictions following the recent shareholder approval (though this was never the question as insiders had enough votes to ensure shareholder approval). Antitrust review is the main risk.

Antitrust review risk

The merger is subject to antitrust review in the US (DOJ), EU, Australia, Canada and possibly the UK. Google is also part of a general antitrust review of big tech companies that DOJ is currently conducting. The DOJ antitrust chief Makan Delrahim is a former tech lobbyist who lobbied on Google's behalf in 2007 for its DoubleClick acquisition. With the possible exceptions of the AT&T/TW deal and carmaker investigations, he has an apolitical and restrained enforcement record so far, mostly focusing on consumer prices.

Market share

Apple is the market leader of the North American wearables market including smart watches and fitness tracking bracelets with 37.9% (Canalys Q2 2019). Fitbit is 2nd with 24.1%. Samsung, which is rapidly gaining share, is third with 10.6%. Google doesn’t compete in that market, however its operating system is used by manufacturers such as Fossil which has 4.1% market share. Apple, Samsung and Huawei use their proprietary operating systems. The EU market is even more fragmented and Fitbit has even lower share and no market leadership. Market share should not be any cause for concern for regulators. If anything, the combination can more effectively challenge Apple, the market leader and thereby benefit consumers.

Data

Fitbit collects a large amount of health, fitness and location data from its users and there is concern that antitrust regulators would seek to enjoin the merger on those grounds. Although data has been widely discussed of late in antitrust circles, the U.S. antitrust agencies are yet to bring a case alleging that a firm’s mere acquisition or use of data constitutes an antitrust violation. Deputy Assistant Attorneys General Bernard Nigro Jr. and Roger Alford have advocated restraint in enforcement based on data ownership. Delrahim and Nigro Jr. have expressed that existing laws and tools are sufficient to handle antitrust issues involving Big Data. The potential add-on to traditional analysis DOJ has mentioned, without committing to any such application, is to view share in zero-priced markets as “measured by shares of control over data than shares of sales or any other traditional measures”. (Source: https://www.justice.gov/opa/speech/assistant-attorney-general-makan-delrahim-delivers-remarks-harvard-law-school-competition)

While Google will be adding Fitbit data to its existing data, including healthcare and location related from other sources, including from Project Nightingale that WSJ recently reported, possession alone is not an antitrust matter. Delrahim has confirmed “amassing a large quantity of data is not necessarily anticompetitive. The more complicated question for enforcers is how data is collected, analyzed, and used, and, most importantly, whether these practices harm competition”.

In the Google/DoubleClick case, for instance, the FTC examined the data issues in the context of the online advertising market and concluded that “the evidence failed to show that the accessibility to Google of any additional data would likely enable it to exercise market power.” It found that the combined dataset would not constitute “an essential input to a successful online advertising product” because several competitors “have access to their own unique data stores.”

In addition, in 2016, the European Commission approved the Microsoft merger with LinkedIn claiming “the combination of their respective datasets does not appear to result in raising the barriers to entry/expansion for other players in this space, as there will continue to be a large amount of internet user data that are valuable for advertising purposes and that are not within Microsoft's exclusive control.”

In Google/Fitbit, data is limited due to Fitbit’s limited market share, barely overlaps with Google’s existing data (Google’s Wear OS has little share), there is plenty of similar data available for Google’s competitors to acquire and would not cause market foreclosure. The Fitbit data cannot be claimed to be an ‘essential input’ to Google’s current products. This type of data is new to Google and it cannot be claimed that only Google would have the tools to manipulate the data, which was critical in the FTC’s complaint to enjoin Reed Elsevier/ChoicePoint.

Google has issued denials on data integration. On announcing the deal, Google said: “we will never sell personal information to anyone. Fitbit health and wellness data will not be used for Google ads. And we will give Fitbit users the choice to review, move, or delete their data”. As a worst case scenario if regulators really want to crack down on Google they may require a consent decree to make Google keep its promises. Google may well only need the data for its health initiatives though.

Google operates in two-sided markets where even if it causes harm to users or customers on one side of the market (such as on the search and data side), this benefits the advertisers on the other side greatly and there is a trade-off involved. There is precedent in the Ohio v. American Express Supreme Court case where harm to just one side was found insufficient to prove an antitrust violation. The breadth of its applicability is still untested but it is a card Google can play.

Privacy

Regulators have previously largely brushed off privacy issues. In its clearance of the Google/DoubleClick deal, the FTC noted: “At the outset, we note that some have urged the Commission to oppose Google’s proposed acquisition of DoubleClick based on the theory that the combination of their respective data sets of consumer information could be exploited in a way that threatens consumers’ privacy. This is not the first time that the Commission has been asked to block a merger, notwithstanding that the transaction is not likely to create, enhance, or facilitate market power in violation of the antitrust statutes we enforce. The Commission has been asked before to intervene in transactions for reasons unrelated to antitrust concerns, such as concerns about environmental quality or impact on employees. Although such issues may present important policy questions for the Nation, the sole purpose of federal antitrust review of mergers and acquisitions is to identify and remedy transactions that harm competition. Not only does the Commission lack legal authority to require conditions to this merger that do not relate to antitrust, regulating the privacy requirements of just one company could itself pose a serious detriment to competition in this vast and rapidly evolving industry.”

Privacy-related harm to consumers from a merger can occur when the privacy policies of merging companies differ and consumers are forced to accept an inferior policy of the combined entity. This can serve as a non-price aspect of competition. In its review of the Facebook/WhatsApp merger, the European Commission assessed the extent to which Facebook could strengthen its position in the online advertising market by obtaining access to WhatsApp’s user data, changing the privacy policy and integrating such data with its own so as to improve the targeting of its online advertising services. Facebook lied to the Commission stating that the integration of data sets was technically impossible and was fined for it a few years later. The regulator in its review accounted for the possibility of data set integration but concluded that the merger would not bring about any anticompetitive harm on the online advertising market. Rather, potential anticompetitive effects would be offset by a sufficient number of alternative platforms providing online advertising space and collecting user data that is not within the merged entity’s exclusive control. The EU wrote: “...regardless of whether the merged entity will start using WhatsApp user data to improve targeted advertising on Facebook's social network, there will continue to be a large amount of Internet user data that are valuable for advertising purposes and that are not within Facebook's exclusive control.” The EU has strong data protection and privacy laws that apply to whoever processes the data independently of any acquisition, reducing the range of any privacy-related harm. It is also considering new rules specifically covering tech companies and their use of data.

To note, Fitbit has less than a tenth of WhatsApp’s 2014 user base and is rapidly losing market share with plenty of data left over for others to collect.

Duration

The companies are prepared for proceedings to take a whole year, due to close during 2020. While we are prepared for lengthy scrutiny, our base case belief is that this is too conservative. Google/DoubleClick took about 8 months from deal announcement to clear but was much more complex with more antitrust issues to consider. The FTC cleared the Facebook/WhatsApp transaction within 2 months and delegated any privacy issues to the consumer protection regulator. Google’s Nest and other hardware acquisitions were cleared quickly. People may argue that we are in a different environment now but only a little over a month ago Google Cloud’s $2.6bn acquisition of Looker received a second request but was thereafter quickly cleared for a total duration of 5 months from deal announcement to clearance by the same agency that is currently reviewing the Fitbit deal.

Downside

The unaffected price before the deal rumors came out in September was $3.67 and the reverse termination fee due to Fitbit if the deal fails antitrust review is $0.96 per share. Fitbit is a declining, unprofitable consumer gadget maker with a trove of location and health data that, while unappealing to financial buyers, has interesting strategic appeal. Fitbit has no perfect comps but GoPro comes close with its sales declines and losses, even though it would probably attract less strategic interest. Adjusting for Fitbit’s $1.92 in cash, at GoPro’s price/sales multiple it would trade around $5.75 plus the break fee.

Catalyst

Deal closing