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Fitbit: The World’s Most Dangerous Tech Stock?

“My Sharona” by The Knack.

“Turning Japanese” by The Vapors.

“Groove Is in the Heart” by Deee-Lite.

In the music industry, we call them “one-hit wonders.” The artist notches a big winner, then disappears.

In the technology sector, such a fate often befalls tech companies, too. Only we call them “one-product wonders.”

They design items that go from being all the rage (Palm digital organizers or Blackberry smartphones, for example) to almost non-existent, if not completely extinct.

Ditto for their stock prices.
Well, we’ve got our next two big candidates in the tech world…

Reality Bites!

Writing in Barron’s, Alexander Eule argues that point-of-view camera maker GoPro Inc. (GPRO) is the next tech company to earn this illustrious distinction.

If he’s right, shares are in for a nasty downturn.

But I’m convinced that Fitbit Inc. (FIT) could just as easily beat GoPro to it. Here’s why…

When Fitbit shares debuted in mid-June, the usual IPO hype propelled the stock to a peak of $51.90 in August.

But as is usually the case, reality quickly set in and the price came crashing back down to a low of $31.25 in September.

Analysts swear that the pullback is a great buying opportunity. In fact, both FBN Securities and Morgan Stanley (MS) recently pounded the table and called for lofty price targets of $50 and $58, respectively.

I couldn’t disagree more.

At current prices, Fitbit is anything but a bargain.

Shares currently trade hands at nearly 40 times forward earnings and six times sales. Yet, the average stock in the S&P 500 trades at 17.6 times earnings and 1.7 times sales.

Can you say “overvalued”?

Granted, companies growing at above-average rates should command premium multiples. And Fitbit definitely falls into that category. In the last quarter, year-over-year sales blasted 252% higher.

But that type of growth can’t last indefinitely. And it won’t.

A Garmin-esque Tumble Looms for Fitbit

In fact, analysts already expect revenue growth to slow to about 40% in 2016.

But I expect it to be even slower because I believe analysts are underestimating the industry dynamics…

Tech research group Gartner predicts the wearable tech market will grow at a compound annual growth rate of 49% through 2020.

Fitbit has benefited handsomely from this robust trend, commanding the majority of the market share. But since the Apple (AAPL) Watch entered the scene in June, it’s quickly changed the competitive landscape. It’s already within striking distance of Fitbit’s pole position.

In the second quarter, for example, Apple shipped 3.6 million Watches, compared to Fitbit’s 4.4 million wristbands, according to market research firm IDC.

IDC concludes: “It’s worth noting that Fitbit only sells basic wearables – a category that’s expected to lose share over the next few years, leaving Apple poised to become the next market leader for all wearables.”

That’s being charitable. I’m convinced that total market share erosion is possible. Why?

Because Fitbit’s entire product line is going to be consolidated into a feature within another product.

Remember how Garmin Ltd.’s (GRMN) standalone GPS units were essentially consolidated into smartphones? We’ve got the same situation here.

It gets worse for Fitbit. The company can’t even pin any hopes on maintaining market share – or relevance, for that matter – by being the most affordable option. Because it’s not.

That distinction belongs to China’s Xiaomi. It sells a Mi Band fitness tracker for $15. By contrast, Fitbit’s trackers are priced between $59 and $249.

And of course, this isn’t a three-horse race. Fitbit also faces competition from Misfit, Withings and Jawbone, among others.

Fierce Competition = Big Trouble

What happens when companies are faced with a super-competitive market?

They usually do two things to boost sales – spend more on marketing and reduce product prices.

We’re about to witness both in the wearables market. And don’t just take my word for it.

“The current competitive environment in the fitness market necessitates more aggressive pricing with higher advertising expenses,” says Garmin CEO Cliff Pemble.

He should know, too. In the last quarter, Garmin reported its slowest-ever sales growth for its fitness segment.

Fitbit is treading down the same rocky path: Its future holds higher expenses and lower margins, which is nothing but a negative for share prices.

Corporate Wellness Won’t Save the Day

Fitbit bulls believe the trend towards “corporate wellness” could be a new and lifesaving growth driver for the firm.

Indeed, Fitbit shares rallied by 12% back on September 16 when Target Corp. (TGT) announced that it’s offering all 335,000 of its employees the Fitbit Zip – the company’s most basic device, priced at $59.95 – to help promote fitness and reduce healthcare costs.

Wishful thinking on the part of investors and Target executives.

Giving habitually sedentary employees a new gadget isn’t necessarily going to change their habits.

At best, their usage rates will match Fitbit’s existing user base. Remember, few people end up purchasing a second Fitbit device. And nearly 50% of users abandon their device in the first year.

Worst case, employee usage rates will be… well, worse!

If anything, the news shouldn’t have emboldened Fitbit bulls. It should have enraged Target shareholders, as executives more than likely wasted about $20 million on the employee “benefit.”

Fitbit Looking Flabby

Overly optimistic analysts might be able to prop up Fitbit’s share price in the short term. But eventually, reality is going to set in. And it’s not pretty.

Slowing growth, shrinking margins, no pricing power, increased competition, and eventual obsolescence all loom on the horizon.

Look for a strong holiday season showing for the Apple Watch, coupled with a mass exodus of Fitbit insiders when the IPO lock-up period expires on December 15, as a wake-up call for Fitbit investors.

In short, Fitbit remains a stock to avoid. And speculators might want to consider some long-dated put options.

Ahead of the tape,

Louis Basenese