Shares of Fitbit (NYSE:FIT) hit the market last week, opening over 50% above the issuance price of $20. There are a lot of reasons to like the company: excellent brand recognition, huge growth, and it's currently profitable -- a rarity in the tech space. While the market appears bullish on the company, there are some major potential issues looming down the road. Fitbit could feel some competitive pressure from Chinese manufacturer Xiaomi and its low-cost Mi Band, and full suite solutions from tech giants like Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) might deliver a GPS-like fate for fitness trackers.
A full transcript follows the video.
Vincent Shen: Get your portfolio in shape with Fitbit, on this episode of Industry Focus.
Greetings, Fools! Welcome to Industry Focus. I'm Vincent Shen with Dylan Lewis. I'm hosting today, filling in for Sean. How you doing, Dylan?
Dylan Lewis: Good, Vince. A little mix-up here.
Shen: Yeah, I'm getting used to a bit more of the hosting role here. So bear with me, audience. I think we have a really fun show today. Very timely too, because the company we're talking about actually just went public yesterday.
Lewis: Yeah. Fitbit just hit the market yesterday. Shares opened up at $30.40 Thursday morning, up 52% from their IPO price of $20. They closed about 48% up. They're up again today about another 5%.
Shen: Wow. So, definitely a successful offering by most standards.
Lewis: Yeah. The market seems very happy with the issuance. Into some background on the company -- the company's mission -- the company helps people lead healthier, more active lives by empowering them with data, inspiration, and guidance to reach their goals. How they're doing that with these wrist band fitness trackers that you probably see a bunch of people lout with.
I know tons of people here at Fool HQ wear them. They seem to be pretty popular. I know we can get them through our internal Gold system. I've definitely seen quite a few people with them out.
Shen: Yeah. I have to say, if I didn't wear the normal, more traditional watch and I had to pick up a technology focused wearable, Fitbit would definitely be in the running for me. I like it. They have six different designs, and some of them are much more minimal and it looks like a Livestrong bracelet. I prefer that kind of look. Definitely some good products.
Lewis: Yeah. Just some context for our listeners, in terms of product functionality, they're capable of tracking steps, calories burned, distance traveled, active minutes; and they provide a lot of this in real time. Some of the more advanced models can also handle sleep duration and quality, as well as heart rate and GPS info. So if you have an exercise route that you're regularly going on they can track you on that. They can also go with speed and distance.
Shen: Very nice. They also have a lot of analysis that you can do from the data that it collects, right? It's supposed to reinforce your fitness routine.
Lewis: Yeah. There's these nudges within this platform they built out to keep you going, and keep you motivated. So it's not simply something that's tracking, it's something that is actively involved in your workout.
Shen: Okay. So, how about this deal? Overall it traded up almost 50% on the first day. It seems like a pretty big success. I'm sure the company's happy. Was there any other details -- I saw the upsize. They did that twice, it seems.
Lewis: Yeah. That's always a good sign. Total size of the deal was around $36 million -- $37 million with rounding. The company itself issues 22 million shares, and internal shareholders and VCs that were involved in the deal early on issued about 14 million. So, looking at the internal ownership, not too much reason to worry here. Only about 4.4 million of the shares issued came from execs. The rest were private equity and VCs.
Shen: Just harvesting their investment share.
Lewis: Yeah, and I think it would be great to hear -- with your investing background, it's rare for us to get this perspective -- what the reaction would be from the team that might have underwritten this. You have some great perspective there.
Shen: Sure. Coming from the investment banking world and having worked on deals underwriting IPOs, there's definitely some very positive signs that this deal was going well in terms of high investor demand. Initially they filed at $14 to $16 per share for their range. The midpoint, gave them an implied valuation of $3.1 billion. They start marketing on the road show, they start meeting with these big, institutional investors, and the demand is very good. They're filling the book very quickly. So it allows them to refile.
They file an amendment, and they've raised the range now. $17 to $19 per share, and also they're allowing the secondary component coming from the inside stakeholders to increase how many shares they're selling as part of this deal. As if that wasn't enough -- that's already a good sign -- for the final deal they end up pricing above the range -- $17 to $19 -- they priced at $20. Pricing above an already increased range is a very good sign for high demand, and strong demand from the market.
They also increased the size of the deal allowing the inside stakeholders to sell a bigger component. Like I said, their original valuation was about $3.1 billion at the middle of their range, but the final deal had them at $4.1 billion. At the end of the day, after trading, up 50%, they went up to $6.1 billion. I'm sure the owners and big stakeholders decided that the executives of the companies are very happy with those gains.
Lewis: Yeah. That's a pretty bullish outlook and a pretty favorable market reaction so far that we've seen. I think one of the interesting things to note; first day trading pretty much locked up around $30 and hovered within a very tight band. Maybe $31.25 and $29.50. It was pretty tight in there. There wasn't a ton of volatility in the first day.
Shen: Yeah. It was a little surprising. There's always going to be some shifting around, especially right when it opens. It was almost like a straight line after that first two hours of trading. What do you think, though? $30, $6 billion valuation, these tech companies -- GoPro (NASDAQ:GPRO) debuted to similar fanfare. They ran into some issues. You mentioned -- I thought that was a great comparison how similar they are. They have this dominance over this niche. So what do you think?
Lewis: I think when you're looking at a company coming public and you're getting a first look at their financial statements, you want to benchmark them to something. It's a little tough here because there isn't another pure play fitness tracking company out there that is strictly in that space. You have some of the other companies -- Google, Samsung, Apple -- that are also involved in wearables, but it's such a small part of their business...
Shen: It's a drop in the bucket for them.
Lewis: I think GoPro is actually a great parallel for them. It's a hardware company with the added value of a platform. In Fitbit's case it's the add-on incentives that keep people going. With GoPro it's the media platform that they're trying to build up and sell. Then I think another huge strength here is the product name. It's synonymous with the broader category. People are colloquially saying "Fitbit" to broadly refer to fitness trackers. You have that same brand recognition with GoPro. People aren't saying "Action Cameras", they're saying "GoPro".
Shen: That's right. "Do you have a GoPro?" Exactly.
Lewis: So, that's awesome from a brand recognition standpoint. They're also facing a very similar cast of competitors that are looming off in the distance that could come in. You have your Apple, Google, etcetera, that might be creeping in, off in the distance. I think more than anything else, it's surprising to see a big tech company with a splash IPO that is profitable. This is something Sean and I joke about on the tech show all the time. In 2014 they had a net income of $131 million, which is rare.
Shen: I think that definitely contributed to at least part of the reason why the reception was so hot for this. Going off that, you mentioned the income was $130 for 2014; that's up very, very rapidly because in 2013 it was a net loss of about $52 million. It looks like their margins -- they're able to spend more on research and development as well. Their stem marketing efforts and because their margins are still strong their sales are growing so rapidly. From 2011 to 2014, sales have gone up about 50x.
Lewis: Yeah. That's crazy.
Shen: Year over year from first quarter 2013 to first quarter of this year, they're up about 200%. It definitely has those growth numbers that people want in tech and it's profitable, too.
Lewis: Yeah. It's kind of the 'best of both worlds' situation. I'll say another huge strength for them is their gross margins. You look at their 2012 growth margin; it's around 35% that dipped down to 22% in 2013. Then up to 48% in 2014. I think that's something they were able to achieve through economies of scale and hitting a critical point in production and distribution. So, those kind of margins allow them to double up their R&D costs -- sorry. Quadruple their sales and marketing expenses in 2014 -- which are great things if you're trying to grow a company.
Shen: And they're still profitable, too. On top of all that. I had some numbers here just to give you an idea. I think they said that since their inception they've sold about 20 million devices.
Lewis: Just about, yeah. Keep in mind that half of that 20 million was just sold in 2014.
Shen: So that demand is hitting that tipping point.
Lewis: Yeah. This is a very [...] market. People are having a lot of trouble projecting out exactly what it's going to be, and what the major player's going to be. I talked about their gross margin as a strength before. I think there's a very real possibility that could see some competitive pressure in a little while.
Shen: So, speaking of that; you mentioned how some of the mega tech companies like Samsung, Apple -- Apple, obviously just released this watch that has some biometrics testing stuff like the Fitbit does. It has some similar features, though it's probably a little bit higher end, more fashion oriented. Whereas this is much more utilitarian. I always hear about threats from China and Xiaomi; what's their deal here?
Lewis: Xiaomi is looming in the background. If you look at the major wearable vendors there's some data from International Data Corp that looked at Q1 shipments. Fitbit had about 3.9 million shipments in Q1. Xiaomi -- Chinese producer -- had 2.8 and they are just starting to ship out internationally. So, Fitbit products generally range from about $60 to $250. Xiaomi sells a $15 fitness tracker, which is tough to compete with.
Shen: That's very low on the price point. That's a really easy way for people to get into this market; to try something at almost zero investment. $15? That's not even close to the next cheapest product, probably.
Lewis: Yeah. I think there's the thought that maybe $15 is too cheap for American consumers. If you're going to commit to something you want to pay a certain amount for it. So Fitbit might benefit from being in what is a prestige pricing against Xiaomi, I think.
Shen: I think there's some strength there. Maybe people not trusting a foreign producer for quality; but that's a huge threat coming down the pipeline. At the very least though, Fitbit's products range from about $60 to about $250. So there's a range. Some people will want to try it initially, minimal features, they can go $60. Then somebody who wants the full watch that -- I believe has functionality with your cell phone, taking calls and things like that -- you can go up to the $200, $250 range. That definitely helps that they diversify what their target market is as well.
Lewis: So, Xiaomi is a big threat and I think one of the other big things people need to watch with Fitbit -- this might not be an immediate concern, but it's something down the road -- is being displaced by a more all-encompassing technology. So this is something that we saw with GPS systems like Garmin in the mid, early 2000s.
These were seemingly great companies and then, here comes the smart phone. They have the GPS capabilities on the smart phone. It totally decimated the core market for these companies, and caused them to have to pivot into something else. So I think as you see the Apple watch the apps get better, the ecosystem build out, and the integration become better; that's another thing they have to be wary of.
Shen: Sure. I have two more things that I would like to discuss. The first one is just your opinion on this. You don't have to commit. Do you think this is a stock that you would buy into?
Lewis: I think short term it's a nice opportunity. I love that it's profitable, I love the growth rates. They were up 175% in revenue 2013 over 2014, which is awesome. That's fantastic. I worry about the long term prospects because I think we're going to see something similar to what we saw with GPS systems.
Shen: Yeah. The potential for technology and consumer products; there's always potential for that game changer thing to come out and just ruin everybody else's market and profits, essentially.
Lewis: And as soon as one of those conglomerates is willing to commit the resources to really building out a robust system, they can hang out.
Shen: Fair enough. So, the last thing was actually something that came up in the news and soiled this really great IPO process. That is a lawsuit that Jawbone -- which is one of Fitbit's main competitors for the wearables and gadget market -- basically suing Fitbit for poaching employees, and in the process those employees -- before leaving Jawbone -- were taking sensitive, internal documents. Presentations about future strategy and things like that. What do you think?
Lewis: Yeah. That's interesting. That's very tech, I feel, to have that stuff going on. It's definitely something to keep an eye on. I don't know what kind of liability that's going to be long term.
Shen: I think it's too early to tell. But it is interesting -- "True case of corporate espionage".
Lewis: Yeah. You said they were grabbing stuff off thumb drives and sending stuff on personal emails.
Shen: So, that's just something to keep in mind, too. Like I said, it's a little early to try and determine what might happen with the legal proceedings, but that will be something they have to -- I think Fitbit's in a good position to handle that too. They have quite a bit of cash from this offering to deal with any legal battles, right?
Lewis: Yep. Very exciting company. A couple things to keep an eye on down the road.
Shen: Exactly. All right, well thank you very much, Dylan.
Lewis: Always a pleasure.
Shen: Appreciate that. Before we go, I want to make everybody aware of a very special offer. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner. We're offering the lowest price out there for all of our Industry Focus listeners. It is $98 for two a two year subscription to Stock Advisor.
You will get two stock recommendations every month with insight from our team of analysts. Just go to focus.fool.com to take advantage of that deal. Once again that is focus.fool.com. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. This is Vincent Shen for Dylan Lewis. Thanks for listening to Industry Focus!