Fitbit Q2 15A – Peak performance

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Fitbit showing every sign of doing a GoPro.

• Fitbit reported blowout Q2 15A results but the shares fell 16% as gross margins saw some pressure from product mix.
• Q2 15A revenues / EPS were $400m / $0.21 compared to estimates at $319m / $0.08.
• Q3 15E revenues / EPS are forecast to be $335m-$365m / $0.07-$0.10 compared to consensus at $263m / $0.06.
• Given that this is the first time that Fitbit has reported to the market, it is of little surprise that estimates were handsomely beaten.
• However, what caught the market out was declining gross margins which were 47.2% in Q2 15A compared to 51.5% in Q2 14A.
• Fitbit attributed this to a substantial mix shift towards newer products where Fitbit has had less time to drive down the component costs compared to older products.
• This is counterintuitive in the world of consumer technology as typically the prices of devices fall faster than the components that are used to make them.
• This means that gross margins are at their highest at launch and then decline over the life cycle of the product.
• I suspect that Fitbit is currently able to hold its pricing flat over the life cycle of a product while still being able to optimise the cost of the components.
• This would explain this unusual state of affairs and its very high gross margins but it also strongly implies that Fitbit is currently operating without any real competition.
• This is unlikely to last and I suspect that as the market becomes more completive, Fitbit will have to begin cutting prices over the life cycle of its products.
• This brings us neatly to the ecosystem issue.
• By creating an ecosystem around its devices that users love and upload their data to, Fitbit should be able to isolate itself somewhat from the ravages of competition when it finally emerges.
• It is making the right moves in this direction, but in the grand scheme of things, its user count is tiny at just 9.5m at the end of 2014A.
• Fitbit has shipped 25m devices cumulatively and consequently, I think that the active user count of its ecosystem is probably somewhere around 13-14m users currently.
• Fitbit has decided to only update this figure on an annual basis but I think that this will be the most important metric going forward in terms of understanding Fitbit’s long term profitability.
• This is because if users love the ecosystem, then they will be predisposed to buy a Fitbit next time which will allow Fitbit to keep pricing and margins in the face of increasing competition.
• However, in the short term, I think that Fitbit is at risk of following exactly the same pattern as GoPro.
• GoPro rallied enormously on a wave of hype and optimism after its IPO that bore no resemblance to reality only to crash when the market figured out that its short term assumptions were too high.
• Following the correction, GoPro has traded much more in line with its fundamental performance and I think that Fitbit could easily follow the same pattern.
• Consequently, I see no reason to get involved with this stock at all until the froth has been wiped from the price of the shares.
• GoPro is much less frothy, is half the valuation and has a better grip on the importance of the ecosystem.
• It is GoPro that I would go to if I was forced to choose between the two.