Source: Fitbit
Although it's rather early in its publicly traded history, share of health-wearables maker Fitbit (FIT +0.00%) are doing well. After coming to market with an IPO price of $20 per share, the company's shares are trading near $40 per share, hitting a speed bump after a good earnings report was overshadowed by news that 14 million shares were prepared to be sold in a follow-up offering.
During an interview with CNBC host Jim Cramer, CEO James Park discussed the company's value proposition. Referring to his company as a "digital wellness company," Park played up the company's "software and social layer" as being "the most important thing," presumably to rebut charges the company is simply more than a device company.
There's just one problem with this comment -- when it comes to Fitbit's monetization model, the company is a device company. And I don't know when being a device company became such a dirty word, but it reminds me of another former-high-flying company that's recently hit a rough patch: GoPro (GPRO 12.74%).
The GoPro story should give Fitbit reason to pause
One can't help but notice the similarities: After coming to market, GoPro also jumped to 100% gains quite quickly as growth-focused investors piled into the investment. Other similarities include both being in the wearables category, although one is tracking and one is video inspired, and both are marketed to fitness-focused consumers.
Another similarity is both companies' antipathy to being referred to as a device maker. For GoPro, the company played up its media and social ambitions of its GoPro content network, although the company noted its "capture devices provide substantially all of its revenue" in its S-1 IPO filing.
As a result thereof, the company traded at valuations reserved for social-media companies like Facebook and Twitter at that time. When the social-media related fervor died down, as GoPro still isn't reporting meaningful revenue from its content, the company's valuation is now in line with a fast-growing device company, as the stock has fallen on a per-share basis from nearly $100 per share to a quarter of that figure as of this writing.
None of this is to say that GoPro is a poorly executing company or a subpar investment going forward, but I feel investors would have been better served by CEO Nick Woodman playing down its media ambitions until the company had a tangible, realizable content-monetization plan. The extreme valuation encouraged shorts to pile in and started a cascade of negative press when the company was unable to grow into those lofty figures.
Let's look at Fitbit's quarterly report
In Fitbit's recently filed quarterly report, the company noted it generates "substantially all of our revenue from the sale of out connected health and fitness devices." Simply put: Fitbit is a device company, at least as it relates to how the company makes money.
That doesn't mean the software and social component isn't important, as they lead to a stickier customer experience with more repeat transactions. But, from an investment standpoint, both of these companies should be considered device companies.
Furthermore, and this is what confounds me, there's nothing wrong with being a device company. I understand the allure of being classified as a social-media company, as these companies typically receive higher valuations due to the fact their ad-based business model generally has a better gross-margin profile with fewer top-line fluctuations.
Device manufacturers, on the other hand, have to continue to buy raw and semi-finished inventory, assemble, and sell finished products. If there are any negative impacts in any of these processes, it would result in a worse-than-expected quarterly performance. Add that to a finite addressable market, and investors tend to pay less for device makers.
The bigger risk to Fitbit
The bigger risk to Fitbit other than lower valuation multiples, and one I feel has already played out with GoPro, is the company continues to perform well on an operational basis, but investors don't benefit because the stock was so richly valued in the first place. Even with its post-earnings drop, Fitbit still sports a price to sales ratio in excess of five, while GoPro once traded in excess of a PS ratio of nine before its current price drop pulled that valuation below two.
The risk you over-promise and under-deliver is too high to talk about services and software when you aren't currently monetizing those outlets in a meaningful way. I'll repeat, there's nothing wrong with being a fast-growing, new-technology device manufacturer -- if the designation is good enough for Apple, the largest publicly traded company, and a company with tangible software and services revenue, it should be good enough for Fitbit and GoPro.
