Fitbit: Does Pebble Make Sense?

| About: Fitbit, Inc. (FIT)
This article is now exclusive for PRO subscribers.

Summary

FIT is struggling through a tough time.

It’s trying to remake itself with a focus on healthcare.

Will buying smartwatch maker Pebble help or hurt?

Fitbit (NYSE:FIT) is a fascinating story right now. The company was one of the first to establish a name for itself in the smart accessory market. But as competitors came into the space, Fitbit hasn't been able to define its place in the relatively young niche particularly well. And now it's supposedly looking at buying smartwatch maker Pebble. What should investors make of all this?

Buyout

Right up front, I think Fitbit would be better off selling itself to a larger technology or healthcare company. It doesn't need to because it is still a profitable company that has no long-term debt and plenty of cash. (It had around $600 million or so in cash and marketable securities as of the latest quarterly report.) However, it is competing in an increasingly competitive space and with competitors that make it look like a minnow swimming among whales.

That said, what exactly is Fitbit looking to do right now? It has been spending heavily on research to expand its product offering from, more or less, simply helping track activity to helping consumers track their health. To put a number on that spending, the research and development expense in the first three quarters of 2015 was around $96 million… through the first nine months of this year it was $235 million. A big jump.

Think along the lines of analyzing sweat, so people wearing a device can get real time feedback about what's going on inside their body. Or providing body information to a medical provider for monitoring to ensure a patient is progressing as expected or that medications aren't having an adverse effect. These are interesting ideas, but it's pretty much what every wearable device maker is thinking about in some way.

Which is why Fitbit's size is such an issue. While Fitbit is profitable, it can't hold a candle to Apple (NASDAQ:AAPL). For example, in 2015 Fitbit had revenues of $1.8 billion and profits of $176 million. No question about it, that's a real business. But in fiscal 2015 Apple had revenues of over $230 billion and profits of more than $53 billion. Fitbit would be a rounding error for Apple, which makes one of the leading wearable devices (the Apple Watch). That isn't to suggest that Fitbit can't compete, but it does show that the competition is much, much bigger and better entrenched.

Buying a watch

Which is what makes the news that Fitbit is looking to buy smartwatch maker Pebble so interesting. The company is reportedly looking to get Pebble's tech with the idea that the Pebble name will be phased out. The cost is expected to be relatively small at around $40 million or so, according to news reports.

There's two interesting things here. First, Fitbit is actually strong enough to do this deal. That's not something you can say about a company like GoPro (NASDAQ:GPRO), which also is trying to move beyond its initial success in a niche sector. GoPro is bleeding red ink and burning cash. The fact that Fitbit makes money and isn't burning cash is a huge advantage and gives it much more flexibility as it looks to make its own transition. In other words, if it makes the right moves it might just be able to fight the industry's bigger players and make a place for itself at the wearable device table.

Second, Fitbit is making an aggressive move to expand what it does. On the one hand that means moving into even more direct competition with the likes Apple and Nike (NYSE:NKE). But that would have to happen anyway. So buying Pebble is, in some ways, a logical move. On the other hand, Fitbit now has to bring this new tech in and make it work toward the company's larger corporate goal and with current products. The tech industry is littered with acquisitions that don't work out as hoped.

All of that said, I'm left wondering if this is a Hail Mary pass, with Fitbit grasping for something to push it forward. That, in turn, would suggest that management doesn't think it's capable of reaching its goals through internal processes alone or with existing products. That's a worrying thought for a company that only makes a small number of niche products. While this is a particularly negative view of the situation, since Fitbit could simply be trying to buy a competitor before another company has the chance, I tend to be a glass half empty kind of investor.

No sure thing

In the end, Fitbit's financial story won't change materially because of a Pebble acquisition. It could move it more quickly towards its goal, or it could be a waste of cash and a big distraction at a crucial time. But, financially speaking, it isn't a life changing event.

That said, If you own Fitbit you'll want to watch a Pebble deal closely. If it doesn't go as well as expected it could hint at a bigger strategic problem for the company as it looks to shift in a new direction. And if it doesn't make the Pebble deal work, for whatever reason, I think Fitbit itself gets one step closer to being acquired.

Disclosure: I am/we are long AAPL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.