FIT Stock Plunge Shows That Wearables Are Risky Investment
Fitbit Inc (NYSE:FIT) stock crashed by almost 16% Monday following its dismal preliminary results for Q4 FY16, together with FY17 guidance that spooked investors. The following four key triggers explain what went wrong and what can be expected from FIT stock going forward.
1. Disappointing Sales for Holiday Quarter
The company announced preliminary Q4 2016 financial results that turned out to be weaker than expected. With the number of devices sold coming in at around 6.5 million, revenue for Q4 2016 is expected to be in the range of $572.0 million to $580.0 million, in contrast to the company’s previously announced guidance range of $725.0 million to $750.0 million. (Source: “Fitbit Announces Preliminary Fourth Quarter 2016 Results,” Fitbit Inc, January 30, 2017.)
For the full year 2016, Fitbit expects annual revenue growth to be around 17% from the previous forecasted growth of 25% to 26%. This big miss has crushed FIT stock.
Non-generally accepted accounting principles (GAAP) diluted net loss per share for Q4 is expected to be on the range of -$0.51 to -$0.56, compared to the earlier announced guidance range of $0.14 to $0.18.
These below-par numbers once again raise the question of whether there is much room left to grow in the wearables device market. And Fitbit may have taken excessive risks by acquiring the smartwatch maker Pebble, which may further weaken Fitbit stock.
2. Rising Costs Force Employee Layoffs
The rise in operating costs has become a major challenge for Fitbit, and the company announced a few steps to reduce those costs. Fitbit is targeting a reduction in the 2016 exit operating expense run rate of approximately $200.0 million, to approximately $850.0 million in 2017, which includes realigning sales and marketing spending and improved optimization of research and development investments.
Fitbit, which is the leader in fitness trackers, is also reorganizing its business by laying off employees. Fitbit will reduce its global workforce by approximately six percent, which would impact approximately 110 employees. These layoffs are likely to create a more focused and efficient operating model. The cost of these reorganization efforts is expected to be about $4.0 million, which would be recorded in Q1 2017. This could further hit Fitbit stock.
However, these announced layoffs may have a negative impact on the morale of the remaining employees, who may decide to leave the company for greener pastures. Although Fitbit management has said that action is being taken to retain employees critical to the achievement of business goals, this is going to be a challenge for the company and Fitbit stock in the coming days.
3. Weak FY17 Guidance Does Not Bode Well for Future Growth
Fitbit has clarified that it expects a challenging year-over-year comparison in the first half of 2017, given that new products were introduced in the first half of 2016, and those products represent 52% of the company’s revenue.
Moreover, the company has entered 2017 with a higher operating expense run rate than the first half of 2016. The problems are further compounded by the fact that the channel inventory levels are higher than expected. FIT stock was hit last month as well, on concerns about the high inventory of its trackers.
Based on these factors, the company has provided preliminary FY17 revenue guidance of $1.5 billion to $1.7 billion, which is way below the consensus estimates.
Fitbit guided for preliminary non-GAAP basic net loss per share of $0.22 to $0.44, and free cash flow of approximately -$50.0 million to -$100.0 million.
Its guidance for a long-term non-GAAP gross margin of approximately 45%, versus the previous 50% target, also raised alarms among investors. This lowered gross margin is a reflection of rising costs of manufacturing products, which is not a good sign, as competitors like Apple Inc. (NASDAQ:AAPL) are equipped with better resources.
4. Overoptimism of Fitbit CEO James Park
Fitbit co-founder and CEO James Park is confident that the holiday quarter performance is not reflective of the value of the Fitbit brand, its market-leading platform, and the long-term potential of the company. But his leadership is not inspiring enough confidence in the investors who have seen the Fitbit stock price plunge from the highs of $40.00+ to a record low of $6.00.
Park pointed out the growth achieved by the company in select markets like Europe, the Middle East, and Africa (EMEA), where revenue grew by 58%. However, this cannot take the focus away from the fact the declining sales in its mature markets are an ominous sign. It also implies that the wearables market as a whole is facing challenges, putting further pressure on companies like Fitbit and pulling down FIT stock.
James Park further said that the evolving wearables market continues to present growth opportunities, which the company will capitalize on by investing in its core product offering, while expanding into the smartwatch category to diversify revenue. But, as reported earlier, wearable devices have struggled to gain traction beyond early adopters, and consumers struggle to find reasons to buy smartwatches.
Park will have to do something really fast to save FIT stock from plunging further, as there are concerns that Fitbit’s investments in Pebble and Vector Watch also may not save it from further downfall.
Where Is Fitbit Stock Headed Next?
Since its initial public offering (IPO) in June 2015, Fitbit stock has had a roller coaster ride. However, the current situation may be make-or-break for the company and FIT stock. With increasing competition and rising expenses, Fitbit may soon find itself stuck in a market that is almost saturated, and may not grow as per the company’s expectations.
Recently, there was some optimism surrounding Fitbit’s partnership with UnitedHealthcare that introduced the program of providing discounts to its employees who achieve certain fitness milestones. But it is still clear how these wellness programs have pushed the sales of the company’s devices. FIT stock does not seem to be buoyed by these initiatives.
It may soon become clear to Park that technology hardware could be a low-margin business, laden with myriad risks, as is clear from the example of the action camera maker GoPro Inc (NASDAQ:GPRO).
The only silver lining for Fitbit stock could be if it can show a clear growth path through corporate wellness programs and develop ways to better monetize the data it collects from Fitbit users. FIT stock is likely to remain under pressure until more clarity emerges on its top-line growth and revenue diversification.