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Should Fitbit Investors Worry About $50 Million Lost Revenue?

The Motley Fool Contributor
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Image Source: www.fitbit.com

In Fitbit‘s (NYSE: FIT) most recent earnings call CFO, William Zerella, said that Fitbit’s newest product, the Flex 2, “has supply constraints, which we expect will result in approximately $50 million of unfilled demand.” This comment, and lower than expected fourth-quarter guidance, caused Fitbit stock to drop a third off its already depressed price. Currently the stock is close to its all time low, down over 70% this calendar year.

Although this short-term sell-off may be warranted, I think patient long-term investors will benefit from owning this innovative, market-leading company with a huge network of connected users.

Why the sell off?

You can see (in the chart below) over the last six quarters that the year-over-year revenue growth percent (purple line) has declined significantly from triple-digit growth in the third quarter of 2015 to single digit growth projected for fourth quarter of this year.

Image source: Author’s chart from Fitbit’s SEC filings.

The fourth quarter 2016 revenue estimate bar has three parts; the blue bar represents the low end of the company’s estimate range ($725 million), the red bar corresponds to the $25 million that gets to the high end of their revenue guidance ($750 million), and the green bar represents the $50 million of lost revenue due to the Flex 2 production issues. Even if Fitbit got to the high end of their guidance in Q4, that would represent only a 5% year-over-year growth, which is troubling the market.

What’s up with the Flex 2?

Fitbit’s CEO and Founder, James Park, explained that the production challenges with the Flex 2 are due to the fact that this device is the smallest on the market today.

Really, the root cause is that Flex 2, even though it looks like a fairly simple device, is actually one of the more complex devices that we have designed and developed, and that’s due to its incredibly tiny form factor. It’s the smallest activity tracking device on the market. It was small enough that we actually had to move to a fully automated production process using robotics to manufacture that product. So there was a lot of things that we had to invent and learn along the way, resulting in you could say a non-optimal initial production process.

FitBit Flex 2 size.png

Image source: www.fitbit.com

The Fitbit Flex 2 is 0.44 inches wide and a third of the width of the smallest Apple Watch. The tracker for the Flex 2 weighs less than an ounce, is waterproof, and is removable from its band. Looking through the Amazon reviews for the Fitbit Flex 2, the small form factor has really appealed to customers and some remark that they don’t even notice they are wearing it. Because of the small form factor, the tracker can be placed in a stylish bangle or necklace for a more discreet look. CNET described the Flex 2 as “the most stylish Fitbit we’ve seen to date.”

Fitbit stated they were on track to get through these production issues and will be in a healthy supply position by the end of December, but that’s after the all important consumer gift buying window.

This manufacturing delay is impacting revenue this quarter. The result is that Fitbit will miss out on the holiday season and potentially concede sales and market share to competitors. However, investors should appreciate the fact that the company is pushing the envelope on its innovative designs, which is resonating with customers.

Does $50 million matter to long-term investors?

Despite the $50 million miss in the fourth quarter, Fitbit is number one in the wearables device market and is on track to sell a record 8.4 million devices in Q4.  These device sales will further expand the users in the Fitbit community, building on the company’s all important network effect. James Park has this to say about the benefit of his company’s expanding user community.
Fitbit is one of the largest fitness social networks. Due to [a] desire to participate in the social experience in the Fitbit app, we believe people are more likely to buy Fitbit over a competitor, because our friends and family are more likely to be users already, and people are less likely to leave to a competitor due to similar dynamics.
IDC released its most recent wearables device market share report for Q3 earlier this month. Fitbit is the number one wearable device manufacturer and has more market share than the next two competitors combined (Xiaomi and Garmin).

Image Source: www.idc.com

IDC highlighted Fitbit’s dominance in this category.

Despite recent negativity surrounding the company’s long-term strategy and stock price, IDC expects Fitbit to continue leading the pack in the near term.

As of the end of 2015, Fitbit reported a network of 16.9 million active Fitbit users. To put that number in context, it’s almost 5 million more people than are in the US Starbucks reward program as of the coffee chains most recent quarterly report.

Since Fitbit reported active user numbers they’ve sold another 15.8 million devices, around 44% of those who purchase a device become active users. Based on my calculation, Fitbit could have as many as 27 million active users at the end of 2016.

Does the $50 million revenue miss matter for long term investors? No, I don’t think so. As long as Fitbit continues to innovate, it will expand its community network of users and will maintain its number one position in this competitive wearables market.

Foolish Bottom Line

Innovation has been a hallmark of Fitbit since they were founded. In Fitbit’s S-1 filing to go public, innovation was listed as the first growth strategy for Fitbit.

We will continue to develop the world’s most innovative and diverse connected health and fitness devices and we plan to continue to make significant investments in research and development to further strengthen our platform through both internally developed and acquired technologies.

With the stock at an all time low, clocking in a price-to-sales ratio at an amazingly low 0.72, and an enterprise value of just over $1 billion, the market thinks Fitbit is registering zero beats on its heart-rate tracker. But at its current value, this innovative category leader, with its vast network of active users is worth teaming up with for a run and adding to your portfolio.

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Brian Withers owns Amazon.com. The Motley Fool owns shares of and recommends Amazon.com and Fitbit. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Members of the editorial and news staff of the Daily Caller were not involved in the creation of this content.

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