Fitness for the Future: Google acquires wearable device company Fitbit in $2.1bn deal

Alphabet Inc. [GOOGL:NASDAQ] – Market Cap as of 09/11/2019 $903.46bn

Fitbit Inc. [FIT:NYSE] – Market Cap as of 09/11/2019 $1.83bn

Introduction

On the 28^th of October 2019 initial reports suggested the interest of the tech giant Alphabet, the parent company behind Google, in acquiring Fitbit, a wearable device company. Finally, on the 1st of November, an official report revealed a $2.1bn deal, which shocked both companies share price over the following days.

Acquiring Fitbit doesn’t only mean acquiring its revenue, which is mainly supported by selling its fitness tracking devices. It also means buying a massive amount of sensitive information, such as users’ locations and biometrics, should the users agree, and a recently announced coaching service named “Fitbit Health Solutions”.

For Fitbit’s shareholders, an acquisition from Alphabet could mean giving the appropriate resources to an expanding and cost-intensive business that characterized long-lasting financial losses.

About Alphabet Inc.

Since 2015, Alphabet has been the parent company of Google Inc—a firm which initially launched as a search engine in 1988 and became popular in the years 2000s publishing products such as “Gmail”, “Google Maps” and “Google Chrome”. It also completed a number of acquisitions to expand its scope and breadth of offerings, such as “YouTube”. Now Google stands with about 114,000 employees throughout 70 offices in 50 countries, making Alphabet a worldwide operating and known multi-product company.

Its advertisement business “Google Ads” makes the company over 80% of its revenue, dominating with a 37% market share. Moreover, this business is among the profitable for the company, with a profit margin of about 26% compared to the average 21% of the company. The remaining 15-20% of its revenue includes selling smartphones and wearable technologies, or other revenue from other Alphabet’s subsidiaries. However, the company is not a major player in smartwatches and might aim to catch up on its competitors Apple and Huawei. Thus, the company relies greatly on its advertisement business, which has become an issue in cases brought against the company regarding new antitrust regulations. For this reason and more, Alphabet is focusing on long-term investments particularly in areas such as Customer Products, as well as Cloud and Machine Learning to support revenue growth.

Over the last twelve months, Alphabet has been expanding considerably through long-term investment and acquisitions, creating over 6,450 jobs and increasing revenue by 20% to $40.5bn in its third quarter, released on the 29th of October.

Its third-quarter earnings, however, also revealed significant rising costs which are a result of the quick expansion. These costs included investment in buildings and computing capacity needed for expected growth in demand, which accounted for a 23% rise in Alphabet’s direct costs. Additionally, general and administrative costs rose by 50% to $2.6bn as well as labour costs related to acquisitions. Following the quarterly earnings reports, the market reacted to a strong decrease in profit margins and earnings per share, causing a fall of 2% in Alphabet’s share price which could seem quite negative considering the firm’s growth expectations.

About Fitbit Inc.

Founded in 2007, Fitbit is a Silicon Valley company known for being the pioneer behind wearable fitness devices. The firm launched the initial version of its iconic wrist-worn device in 2009, which at first only connected via tether to a Fitbit account on a computer. As the technology behind the product developed, as did the device itself. Fitbit most recently launched the “Fitbit Ionic” in 2017, which is a smartwatch geared to compete with larger players such as Apple and Huawei. Despite the fact that Fitbit once was the biggest player in the wearable technology industry, it fell behind Apple and Huawei as they expanded their new smartwatches to their existing clients and creating a loyalty scheme for those who used their smartphones, both of which Fitbit couldn’t replicate.

Fitbit is a global company, with 14 offices in 9 countries, and also play a significant role in wearable technology for health and fitness. With a market capitalization of $1.8bn, the company offers a wide range of smart-watches and trackers which provide most of the company’s revenue and compete against Huawei and Apple’s technologies. Fitbit is also phenomenal in terms of collection of data on health and location, which is used to provide understanding to users about their fitness, but could also provide a great understanding of potential customers for the Fitbit and competitors—one reason for Google’s interest.

The third quarterly report which counts until the 28^th of September 2018, shows that Fitbit, despite its $347.2m in revenue, is currently a loss-making firm. However, its losses of $26.7m are 61% smaller than the previous quarter, depicting a potential recovery. In the past three years, Fitbit’s net income has been highly volatile but always negative, and the research and development costs have been almost as much as sales and marketing costs. In such a competitive market, Fitbit might struggle to finance its expenses in the future. Fitbit’s costs in R&D, which is essential for the survival of the product and its competitiveness in the market, depend highly on Alphabet’s future investment.

At the initial IPO in June 2015, Fitbit offered its shares at $20 per share, and reached $47.49 soon after, but has declined since then to a minimum of $2.88, which occurred not long before Alphabet’s offer.

Industry Overview

At their inception, wearables were the hallmark identifier of the health-obsessed first adopter. As the market expanded to smartwatches and other, more fashionable devices, the traditional customer base expanded with it. Wearables, once hemmed to the fringes of society, became mainstream.

By 2023 the wearables market is expected to represent a $54bn opportunity, with revenues from smartwatch sales alone expected to double to $34bn by 2023. In contract, the healthcare tech space is expected to be worth $24bn by next year. As the opportunities around both of these spaces have grown, as have the number of competitors. Fitbit, the pioneer of the wearable devices craze, grew its userbase and offerings through partnering with health insurers and completing tuck-in acquisitions in the healthcare market. But while Fitbit was busy becoming synonymous with “digital health”, other players, such as Apple and Samsung, were busy branching their own extensive hardware experience to the wearables market. Currently, the top 5 companies by decreasing market share are Xiaomi, Apple, Huawei, Fitbit, and Samsung—with market positions ranging from 17.3% to 9.4%. Collectively, the top 5 players capture 65.7% of the market and have increased their shipments of wrist-worn wearables by 28.8% since 2018 to reach nearly 34.2m units. Despite their already dominant shares of the market, competitors like Apple and Huawei are continuously expanding their offerings through aggressive advertisement and development campaigns, the most recent of which allowed them to grow their collective market share by 12 points since Q2 2018.

But despite the rosy forecasts for the health wearables market, it does remain threatened by a number of factors—most notably privacy laws and the protection of user data. In 2011, a scandal hit Fitbit’s users, as well as their rapid growth, as it was revealed that information about Fitbit users’ sexual activity could be publicly accessed online. While one-time security glitches are often quickly resolved, they have a lasting impact on customers’ perceptions of the security of these devices and the threat they pose to their own privacy. This point becomes doubly important when considering the fact that the majority of future value for health wearables lies in the troves of data it collects from its users.

To build consumer confidence and public trust, the majority of wearable producers have publicly acknowledged their commitment to data protection and privacy—with some even vowing publicly to never sell the data to a third-party provider. However, this adherence to data privacy may not last forever, as paradigm changes in the healthcare industry drive a greater need for this trove of information. Healthcare is shifting to an era focused on patient outcomes and wellness, alongside new forms of payment systems to value these services. Health data can achieve everything from a holistic view of the customer’s health to the enabling of further research for providing quality care. Its growing volume, with a CAGR of 36% through 2025, can be monetized in a number of different ways, many of which do not entail the outright sale of data to another provider. A major way this data is expected to be monetized, without infringing on the privacy of individual consumers and to the benefit of all parties, is through data analytics. For instance, adaptive analytic techniques on combined clinical and claims data could reduce unnecessary clinical procedures and drive greater care coordination. Another option is to offer data-oriented personalized products as an add-on to existing services, such as offering personalized health reports that are more accurate than a patient’s existing electronic health records. Large companies, partnered with a nationalized healthcare system or private health providers could then use these profiles to offer tailored recommendations on a real-time basis to potential consumers.

Deal Structure

If Fitbit’s shareholders agree, Alphabet is set to acquire 100% of Fitbit and its $1.2bn worth of assets ($300m less than the previous year) completely in cash, valuing its stocks at $7.35 per share, considerably higher than the closing price on Friday at $4.32. As anticipated, the acquisition would also involve the passing on to Google of the user data such as health, biometrics and location. Alphabet is expected to make use of its deep revenue reserves to finance the deal. Antitrust authorities are currently revising the deal. If they were to authorize the transaction, the deal is expected to be closed next year.

Deal Rationale

At first glance, Alphabet’s acquisition of Fitbit represents another overextension of the tech giant’s reach into healthcare, justified by a vague message to “improve the world”. However, the acquisition becomes more justifiable when analyzing industry trends for healthcare wearables and the vast importance health data will take on for the next generation of care providers, as well as Alphabet’s previous activity in the sector.

Alphabet has been slowly shifting into the healthcare industry for years now, as shown by its existing partnerships with Google Fit and Wear OS. The firm has also invested in other company’s R&D for wearable devices, such as its $40m investment into Fossil Groups’ R&D team. This interest in wearable devices comes on the advent of years of a slow shift into hardware development and the production of consumer products such as Google Pixel, Google Nest, and Chromecast — all of which were created as an attempt to diversify Google’s revenue streams away from advertisements and search engines. Acquisitions are a common tactic used by Google to further internal hardware development, as shown by their purchase of smartphone maker HTC in 2017 for $1.1bn, a deal that spurred the future improvements in the production of the Google Pixel. Through the Fitbit acquisition, Alphabet is obtaining the pioneer in health wearable technology and the 4^th largest competitor in the industry, boasting a 10.1% market share and 32% YoY growth in device shipments. Additionally, Fitbit brings an extraordinary number of high-quality partnerships with healthcare stakeholders to Google, from large foreign governments such as Singapore to health insurers and corporate wellness programs. In this sense, Fitbit allows Alphabet to join the sector with the positioning necessary to become a leader in the healthcare wearables space, something that could not be obtained through smaller investments and joint ventures. But, the most valuable aspect of this acquisition is the sheer volume of consumers, nearly 26m, that Fitbit can offer Google, as well as the millions of bytes of data they will provide the company with moving forward.

Wearables represent a massive future opportunity with a nearly $54bn market value expected by 2023. But the data they produce is by far the most valuable aspect of the entire sector. While Google has pledged to not use the data in the personalization of Google Ads, there are plenty of other ways the company can choose to monetize the information without breaching any privacy laws. For existing Fitbit consumers, Google can offer additional products such as personalized health reports that are updated on a real-time basis. From a business perspective, Google can also market their tools as a solution to the healthcare industry’s need for greater data in clinical trials, that could then be used as the basis for a new value-oriented pricing system. Fundamentally, Google is diversifying its current offerings by breaking into an area that is in desperate need of data analytics driving innovation. In many ways, this is a win-win deal for both the company and the healthcare sector.

From Fitbit’s perspective, the deal also offers considerable positive factors. Over the past three years, Fitbit has been losing market share and brand appeal due to the emergence of larger players such as Apple and Xiaomi, many of which benefit from economies of scale, greater capital, and larger R&D capabilities. By pairing themselves with Google, Fitbit will finally have access to the advantages propelling technology firms to the front of the market, in addition to other resources such as hardware, software, and AI development skills.

Market Reaction

As soon as Alphabet expressed interest in acquiring Fitbit last Monday, its shares benefitted from a 30% rise in price to an initial $5.64. On Friday, the price reached a maximum of $7.26, a level that hasn’t occurred since the beginning of 2017. This reaction suggests that investors believe Alphabet will give Fitbit a promising future. Of course, Fitbit’s products would receive the appropriate resources for its innovation under Alphabet, but the latter’s master plan is still obscure considering Alphabet’s generosity.

On the other side, Alphabet’s stocks seem to have had a short-lived rise of 2% in share price to $1289, and in the following days, it reached $1291.44, a new historical maximum for the ever-growing company.

These movements suggest that some investors view Fitbit as a good investment for the tech giant. However, at the same time of the announcement, Alphabet published its third-quarter earnings, revealing increasing costs which got in the way of the share price appreciation.

Advisors

Qatalyst and Fenwick & West advised Fitbit on the acquisition. Alphabet’s legal counsel included Cleary, Gottlieb, Steen, & Hamilton, while financial advisors were not disclosed.