Description

Fitbit is the market leader in a fast growing consumer product category, wearable trackers.  The pessimism about competition and fad risk has become too great and as such we think Fitbit presents an opportunity on the long side.

Business Description:  San Francisco-based Fitbit, Inc. is a leading manufacturer of wirelessly-enabled wearable fitness trackers. The company produces products that measure data such as number of steps walked, quality of sleep, calories burned, heart rate, and other personalized metrics.

Investment Thesis:  Fitbit is the category leader in wearable trackers with nearly 80% (dollar value) market share of the 78+ million unit global market growing at 30% (see http://www.idc.com/getdoc.jsp?containerId=prUS41037416).  Despite fast growth and good profitability, the company trades at a low multiple of earnings (~11x option-expense loaded EPS ex cash).  This is for a company that is expected to grow EPS in excess of 20% for the next several years and that has organic revenue growth of over 30% this year (something that is pretty hard to find).  We believe that Fitbit will retain a prominent place in the large and fast-growing wearables market.

So why is the stock so cheap?  There is a large short-interest in the stock (30% of the float).  Our belief is that the short thesis is two-fold: One short thesis is that fitness trackers are fad. Second, there is a fear that larger competitors such as Apple and Google will come down market from smart watches into fitness trackers and take a bunch of market share from Fitbit.  Indeed Fitbit’s recent high end product launch (the Blaze) incorporates some smartwatch-like features and seems to have exacerbated this worry.  People also worry about commodity fitness trackers from Xiaomi taking share from Fitbit.

We think these worries are misplaced.  In terms of competition, Fitbit seems to be competing well (their recent products are outselling the Apple Watch for instance).  Low cost international competitors like Xiaomi have yet to make meaningful inroads in developed markets, but may take share in emerging markets.  Jawbone has lost all kinds of market share and is on life support.  Nike and Under Armour have yet to make inroads.  Garmin is an admirable competitor for the hardcore athlete, but has not gained market share.  It is looking more and more like Fitbit is the “Kleenex” brand of wearable fitness devices.  Fitbit is investing heavily in R&D to stay in a strong position.  Look at the smartphone market as an example of how wearables may play out. Apple has only 20% market share in the global smartphone market and has done well nonetheless, and we think there is room for Fitbit to do well in wearables even if competition heats up.  

To address the fad risk specifically, thanks to the communities features anyone with a Fitbit account and some coding skill can track how many people are in a community and how many are active each month.  We have done this for a sample  of major metropolitan groups across the globe (a sample size of over 30,000 users).  The data is remarkably consistent.  About 55% of Fitbit users actively use their device while the rest are indeed sitting in a drawer.  We track this data monthly.  If we see a dip in active users as a percent of the total, we may change our mind, but for now we think the majority of people actually use their Fitbits and we think we have found a viable way of “tracking” usage rates.

Longer-term we think Fitbit has numerous opportunities to morph it’s business model from a simple consumer product play to something much better, more defensible, and valuable. Quantifying personal data is likely to increase -- not go away.  Indeed, one day, we expect that doctors will leverage sensors to monitor cholesterol, blood sugar, etc. and pre-diagnose problems for patients.  While not a part of story today, we do think eventually this is a market Fitbit will be in a position to pursue.  The use of Fitbits in over 100 clinical trials is an early indication of the medical potential of personal data tracking.  Another major opportunity for Fitbit is to find ways to monetize and leverage their community/platform and the data they have about millions of users.  The company will become much more if it can effectively leverage the “ecosystem” it has created.  Having a large stash of user activity, sleep, diet, etc. data will make Fitbit customers sticky as few will have the technical know-how to export their data (even though Fitbit does allow this).  Finally, we believe Fitbit will continue to make inroads in the corporate wellness space, where activity data can help companies reduce their healthcare costs.

Valuation

Fitbit is cheap.  It trades at 11x 2016 EPS ex options (yes, they are options abusers) if you back out the $3.27 per share net cash position.  On an EV/EBITDA basis the company trades at 4.6x. There are not great comps for this one.  Garmin is probably the best and it trades at 18.6x 2016 EPS and 9.5x EV/EBITDA.  GoPro is probably the best example of a disastrous consumer fad stock. It is losing money but has an EV/Rev of .83x 2016 revenue.  Fitbit is at an EV/Rev of 0.8x for 2016.  So it is completely priced like a money-losing broken fad stock already.  There is no doubt in our mind that the private market value of Fitbit exceeds $18 per share, potentially by quite a bit.  Indeed, if the stock stays here, we’d be surprised if someone doesn’t make a bid for the company.

Risks:

• This is a fad and everyone puts their fitness tracker in a drawer a few months from now.  We are actively monitoring active users on the web communities to keep an eye on this risk.

• Apple, Google, Xiaomi or others comes in and take market share from Fitbit.

• People decide they want a more advanced smartwatch instead of simpler fitness trackers.

• If Fitbit fails to innovate, they may fall behind.  Management is spending a ton on R&D, so we think they understand this, but there is no guarantee their R&D efforts will result in successful new products.

Catalyst

Continued strong results from Fitbit.

A potential acquisition proposal by someone who needs a better wearables effort (AAPL, GOOG, MSFT, etc.)?