In this episode of MarketFoolery, host Chris Hill and Aaron Bush analyze the lone bright spot on Fitbit's (FIT) balance sheet, although this may be the beginning of the end. Meanwhile, shares of data analytics software company Alteryx (AYX) rise another 10%, while shares of medical device maker Abiomed (ABMD) fall more than 20%. Plus, Chris and Aaron discuss the current landscape of esports and potential investments in this growing industry.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on Aug. 1, 2019.

Chris Hill: It's Thursday, Aug. 1. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, first time in a while, Aaron Bush. Good to see you! 

Aaron Bush: Good to be here! Thanks for having me!

Hill: Can you believe it's August? I hate to sound like an old man, [laughs] but I started typing up my notes for today and was like, "Wow, it's August already?"

Bush: Yeah, that surprised me when I was typing the date on my notes. I was like, there's an eight? What's going on?

Hill: What's happening here? We've got software earnings, we've got medical device earnings, we've got video games to talk about. We've got to start with Fitbit, though. Third quarter revenue for Fitbit was higher than expected. Their loss for the quarter was smaller than expected. And nobody cares because they cut guidance for the full fiscal year. Shares of Fitbit are falling about 20% this morning.

Bush: For those of you who have not been following Fitbit closely, they changed their strategy a little bit. What they've done is they've lowered their prices on a ton of their different trackers in order to sell more devices. They've lowered prices about 20% year over year in order to sell 31% more devices. That explains most of the 5% revenue growth, but cash flows are still weak, so still pretty terrible overall. As a result of this, their margins have been hit. Because it's hardware, it never was a high gross margin business. But when you lower your prices 20%, that hurts you even more. 

A lot of the thinking about this is just realizing, hey, hardware is a tough business, so let's try to use our hardware to transition more into a services model where we can get as many of our devices out there and then start selling services. They've done that a little bit. Their services revenue grew about 16% year over year. They're projecting to have more launches around that in the next year or so. But even if you look a year out, that's still probably only 5% to 10% of revenue, it's just not that big of a deal. So, if you look at all these things and start piecing together that their core tracker devices are riddled with churn, in order to get more people, they have to lower prices significantly, and then they're leaning on services, which are still tiny and not growing all that fast, it's really not awesome. 

The only thing that Fitbit has going for it, and this has been stated for a while, is the cash that they have. About half of their market cap is in cash right now. That limits your downside. Obviously, it doesn't limit your downside that much, as you see today. But it's only valuable if you can figure out how to put that cash to work and do something with it. And I don't think Fitbit has those opportunities right now.

Hill: We talked about Apple yesterday. It's worth reminding everyone that Apple is the outlier when it comes to pricing power and hardware. Overwhelmingly, businesses -- and we've seen this in certainly the television business for years -- the cost comes down over time. That's playing out with Fitbit. Obviously, as you mentioned, Fitbit has a host of other challenges as well. But you touched on something with their cash. I look at Fitbit today, and the stock is at an all-time low, and I think if you're buying shares of Fitbit today, No. 1 on your list of reasons to buy it is you're hoping for a buyout. You're hoping that someone is going to come in and say, "You know what? There's a brand there. There's certainly cash there. So, yeah, we'll pay some amount of money for this." But I don't see a business reason to buy shares of Fitbit, other than you're crossing your fingers and hoping for, someone's going to pay a 25% premium for them.

Bush: Yeah. I would say the other part of that is just betting that services is going to be a bigger deal than people expect. It's impossible to ignore the fact that they have lost pricing power, that there is high churn in this hardware. And really, what separates Apple from a company like this is the software, it is the ecosystem that they developed, the App Store, all of those other pieces that someone like Fitbit will never be able to compete with. You'd be banking on a very narrow niche of services. They could pull it off, but it's going to be really, really tough to do. 

Hill: I saw this morning that Alphabet now has more cash on the balance sheet than Apple does. The number I saw was, Alphabet has about $117 billion and Apple has $102 billion, something like that.

Bush: So poor, Apple. 

Hill: [laughs] It was one of those things. It's like, Apple's not going to buy Fitbit. They've got the smartwatch. Maybe Google will throw them a little money. I don't know.

Bush: I don't know. I have no idea who would want to buy Fitbit.

Hill: Shares of Alteryx up 10% this morning and hitting an all-time high. Alteryx, not necessarily a household name. They do software for data analytics. You tell me, how good was their second quarter?

Bush: It really was a fantastic quarter, Chris. As you mentioned, Alteryx, they sell data analytics tools to mainly large organizations. What makes them special is, they don't just sell to data scientists, they also sell to who they call data citizens. This is anybody who doesn't have the deep technical knowledge. They can still go on and make use of these really powerful tools. So, even though data analytics is a pretty crowded space, what Alteryx does, there actually isn't much meaningful competition, and they're crushing it. Bigger picture, before jumping into the numbers, the main reason why growth-oriented stocks outperform is because they grow faster and longer than people expect. That is what Alteryx has been doing for a while. 

Their revenue growth is pretty insane. It's 59% year over year, but if you look at this same quarter two years ago, they were growing 52%; look at the same quarter last year, they were growing 54%, and now 59% this quarter. So, not only are they growing consistently fast, but they're actually growing even faster. The reason for that is, they continue to grow their customer base. It was up 34% year over year. And, their dollar-based net expansion rate, how they call it, was up 133% year over year, meaning that their existing customers spent 33% more than last year. The last piece of this that I think investors are fascinated by, apart from the growth, is they have 90% gross margins.

Hill: 90%?!

Bush: 90%. And it could go up from here. So, even though they continue to reinvest heavily in growth, marketing, R&D, this will probably be a business that generates 30% plus free cash flow margins over time. If you pair really fast growth, a really massive market opportunity with pretty limited competition right now with the potential to generate really high margins over time, it makes sense why this business has done so well as a stock and why it probably can continue for a while.

Hill: You mentioned how well it's done as a stock. It's tripled in the past year. Is today the day to buy? Clearly people are buying this stock. But how expensive is it right now?

Bush: If you just look at what the business is doing today, it is pretty expensive, trading at a pretty hefty price to sales margin. But that's not the right way to look about it. Right now, the market cap is about $8 billion. So, you really have to think about, can this $8 billion company be much larger in the future? I think that it can be because the whole realm of data analytics is massive, especially if they can better target people who are not in the core audience that a lot of data companies target. Companies continue to pile on quickly. As soon as they get in, they realize, this is a great product, and we're going to spend more and more money on it. I can see a future where this $8 billion market cap is much larger. There definitely could be bumps on the road, but I'm not too concerned about it right now.

Hill: And if you're concerned, just comfort yourself with that gross margin number. [laughs] 

Bush: A lot of the same concerns people have now could have been applied two years ago, but the company has accelerated their growth every year since.

Hill: Abiomed is a maker of heart pumps. Abiomed, today, at least, is similar to Fitbit in that first quarter results for Abiomed looked good on the surface, but they cut their sales guidance for the full fiscal year pretty significantly, I might add. The stock is down 24%.

Bush: Yeah. Not a great day for Abiomed. As you mentioned, they make heart pumps. They are the very clear leader in what they do. Under their Impella brand -- is what they call it -- their heart pumps dramatically improve survival rates and heart recovery rates. The technology of what they do is great. The patents that they have essentially mean that very few, barely anybody can compete with them in their space. So they've been growing very fast and very high margin. That's why it's been an interesting investment. 

The issues that we see this quarter actually started last quarter. Last quarter, the FDA issued a confusing letter to Abiomed's potential customers that made them believe that the Impella technology was unsafe, even though it wasn't. What management communicated last quarter is, we have some work to do in order to clear up this confusion. What's concerning about this quarter is that the issues seem to be larger than just that confusion. Even though the FDA helped clarify some things, it didn't really matter at all. Domestic growth didn't improve. Investors are now getting whiffs that there are internal issues. Management announced that they have to invest more heavily in training and education. They have to restructure their approach to distribution. They're seeking out other external opportunities. There's a lot of work to do in order to reaccelerate growth, which isn't awesome. 

It is interesting, it is different from Fitbit. It's very different from Fitbit in the sense that Abiomed is the best at what they do. They don't have meaningful competition. The market is massive, and they've proven that they can grow quickly with high margins. But issues can take time to solve and figure out, so it wouldn't surprise me if next quarter, we're still seeing them have to clean up some stuff, maybe the quarter after that. But from a very long-term perspective, Abiomed is still a very interesting business.

Hill: Yeah. The only thing they have in common today, besides their stocks dropping, is the headlines. As we talk about all the time, look beyond the headlines. There are headlines out there in the business media today that, if all you did was read the headline on Abiomed or Fitbit, you'd be like, "Wow. I bet that stock's doing well."

But it's interesting, you talked about, they really don't have meaningful competition. It's a nice reminder for people who are interested in doing a little digging and finding businesses that are the only ones doing what they do, you could do a whole lot worse than to dig into healthcare in general, but particularly medical devices. You find those companies that are just like, "Yeah, we're just going to do this one thing." And if it's a publicly traded company, and they're the only ones doing it, that usually bodes well for the stock.

Bush: Yeah, and finding situations like this is pretty rare, where the patents that they have that last for several years mean that they don't have meaningful competition for many years, giving them a chance to improve their technology, improve their sales base across the world, and then come out on the other side once others will be able to compete with a much more meaningful presence. So, yeah, thinking about the next six months or so, I really don't know what could happen with Abiomed. They could have continued issues and have to fix more things. But thinking about the next three to five years, nothing has changed from the opportunity standpoint.

Hill: Yeah, it is interesting, where you look at all of the underlying factors with this business. As you said, it's like, OK, yeah, long-term looks good. That being said, I'm already looking forward to three months from now. Not just what are their results, but what is management saying about the training, how it's been going, all of that stuff. 

Electronic Arts (EA -1.09%) shares are up this week. They had some pretty good first quarter results. This was after the market closed on Tuesday. I'm curious, because I mentioned this last week on an episode that for anyone who follows you on Twitter, you're one of the best people I've seen when it comes to the video game industry, the e-sports industry. You're doing a lot of digging into this. I'm curious what your take on the landscape is right now, particularly as we are just a couple of days removed from the beginning of the week, where it was one of those situations where, if you looked at the business news, and you looked at the news in the world of sports, you saw an overlap, because of the Fortnite competition and this 16-year-old kid winning $3 million.

Bush: I'm fascinated by this industry for multiple reasons. One, I think most people don't realize how big it is. It's much larger than the movie business, the music business combined. It's growing pretty well. But it doesn't get the headlines that the other industries get. I think we are reaching an important moment in the industry where events like the Fortnite World Cup, where a 16-year-old from Pennsylvania can come out and win $3 million, it catches people's attention. I think last year, the year of Ninja, and being the first mainstream gamer to make appearances in a big way, that was just the beginning. It's opened the floodgates to other opportunities like this. I think that's only going to become more common. 

E-sports is a big piece of that. There's some good and bad there, but that really is only a piece. If you look at all the things that are going on with digital, the emergence of cloud and subscriptions, mobile, there are a lot of really interesting trends going on just within the video game space. It's fascinating to figure out what's going to happen. But also, there absolutely will be opportunities there for investors to have really high returns. 

Hill: It's interesting, because when we think about exposure writ large, I think it's natural to think in terms of television. You think about the big money, particularly around the NFL, any of the major sports. We're able to track, both as investors and as fans of sports, the size of the TV contracts. The fact that e-sports doesn't have the TV exposure that it does, I think, is part of that disconnect, where people are like, "If this were a really big thing, it would be on Sunday nights, opposite Sunday Night Football," that sort of thing. I don't know to the extent that ticket companies or Live Nation or those types of businesses play into this, but when you look at the numbers of how many people are showing up to these events, that's the thing that, when I read that, that's where the light bulb goes off and I have to force myself to think, even though this isn't on Sunday night opposite the NFL game of the week, when you look at the numbers, how many millions of people are attending these events, it's like, OK, that's undeniable.

Bush: Yeah. I think for the Fortnite World Cup, there were a couple of million people watching online between Twitch and YouTube. I do think that digital sports will not have the same in-person draw in stadiums and arenas as mainstream physical sports. That's mainly because it's digital. Being native to the internet transcends loyalty to teams and regions. I don't know, younger audiences just prefer being online. But you can look at what certain leagues are doing. Activision Blizzard, for example, has launched a league for Overwatch and Call of Duty. Those are regional teams, where you're seeing not only investors within the e-sports space and existing organizations, but owners of NFL and NBA teams, they're investing in getting their teams ready. 

So, I do think we'll see a connection, where these worlds start to collide a bit more. There will be differences. But it is a very meaningful thing, and it's not even just in the U.S. It's probably a bigger deal in Asia, for example, and some e-sports in Europe, too.

Hill: Is it safe to assume that someone has already created an e-sports ETF or some sort of basket of stocks or something like that?

Bush: Yeah, it definitely exists. I was talking to a guy yesterday, actually, his name is Bill Hershey, he's the CEO of a company called Roundhill Investments. He recently started an ETF, the ticker is NERD... I know. It's a great ticker, right? He and his company, that ETF, they decide what companies are included based on how closely they are to e-sports, and their weightings are dependent on how close they are to e-sports. So, these things are emerging. I do think investors should pay attention to these things, because there are a lot of great companies that get roped into these ETFs and such. 

Hill: Aaron Bush, thanks for being here!

Bush: Thanks for having me, Chris!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery! The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Monday!