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For most of the past year, fitness device maker Fitbit (NYSE: FIT) was one of the darling stocks of growth investors. Fitbit had a popular product that came to market early, giving the company an entrenched position in the high-profile category of wearable devices.
And Fitbit is growing like a weed, racking up massive sales and earnings growth. The company recently released excellent third-quarter results which beat expectations.
But Fitbit stock hit a speed bump after the earnings report. The results themselves were fantastic, but investors got spooked after a major share offering.
Outstanding Operating Results
Fitbit makes wristbands and clippable devices that monitor a user’s physical activity and fitness levels. It tracks a variety of personalized metrics, including calories burned and distance covered. The devices were instantly popular with consumers, particularly millennials, who are much more health-conscious than previous generations.
This led to startling growth. Fitbit’s revenue soared 168% last quarter, year-over-year. Over the first nine months of 2015, revenue has more than tripled to $1.1 billion. The company is solidly profitable as well; net income more than doubled last quarter to $59 million. On a per-share basis, earnings clocked in at $0.24 per share excluding one-time items.
These results easily beat analyst expectations. Analysts had forecast just $0.10 per share of earnings on $352 million of revenue.
Going forward, Fitbit sees a smooth road ahead. The company raised its full-year revenue guidance to $1.77 billion-$1.8 billion. Fitbit is gearing up for a huge holiday sales season in the U.S. and is aggressively expanding its marketing and advertising in anticipation of robust fourth-quarter sales.
And yet, shares of Fitbit fell as much as 8% intraday on Tuesday, despite a fantastic quarterly report released after the closing bell on Monday.
Major Share Offering Spooks Investors
Along with its quarterly results, Fitbit announced it will sell 7 million shares on the secondary market, while existing shareholders will sell an additional 14 million shares. Those selling shareholders also allowed the deal’s underwriters to purchase an additional 3.5 million shares.
The need to raise equity capital is one of the pitfalls for recent IPOs. High-growth companies without a long history of profitability typically do not receive favorable terms in the credit markets. As a result, tapping the equity markets is usually the primary way to raise cash. This necessitates selling lots of shares, which dilutes existing shareholders.
For example, Fitbit’s current share float now stands at approximately 8 million shares. Clearly, this equity offering will greatly expand the company’s share count. That is why Fitbit’s stock price fell dramatically, even though the company posted stellar quarterly operating results.
Investors clearly did not expect the company would sell so much stock, but it makes sense to issue an offering before the lock-up period expires, particularly since Fitbit stock had been performing well. Year-to-date, shares of Fitbit are still up approximately 28%, while the S&P 500 index is down 1%.
Short-Term Pain May Lead to Long-Term Gains
Fitbit shares trade for 50 times trailing earnings and nearly 40 times forward earnings estimates. The stock appears richly valued on a number of traditional valuation metrics. For example, Fitbit stock trades for 7 times sales and 12 times book value.
As a result, it makes sense for the company to sell stock now at a great price. Current investors will suffer in the short term from the ensuing price decline, but if the company can use the proceeds to further its growth, long-term investors may continue to do well with the stock.
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