– Peloton benefits from expanding health and wellness industry, high sales growth

– Offers unique scalable subscription approach, but faces wall of increasing competition

– Numerous concerns: high product prices; sharply rising costs; material weakness

Peloton Interactive (PTON) shares are likely to be priced tonight, between $26 and $29 each, for a market cap of around $7.5 billion. The “connected fitness” firm is a fast growing and ambitious purveyor of gym equipment—with a twist. After buying their relatively expensive stationary bikes and treadmills ($2,245 and $4,295, respectively) the consumer subscribes, for $39 per month, to PTON’s unique and wide array of live training and workout streaming videos and classes, and to its vast library.

It’s a virtual gym and one of the big benefits is home access to workouts with some of the best-known fitness instructors. You don’t have to drag yourself down to a smelly, crowded gym. Moreover, the health/wellness industry is growing about 5% per year in the U.S. In its SEC filing, PTON says five million treadmills and three million stationary bikes were purchased in the US in the 12 months ended March, 2019.

PTON’s growth reflects that. In its fiscal year ended last June, revenue soared 100% to $915 million, 80% of which was products and 20% subscriptions. The latter grew 108% to 511,000. From its 2014 launch to FY19’s end, PTON sold 577,000 “connected fitness products,” mostly stationary bikes and some treadmills as of 2018, with 564,000 of them in the U.S. Another positive: PTON has little long-term debt to speak of.

Peloton IPO Offers Growth, Scarcity Value—For Now

In its S-1 filing, PTON says its fastest growing demographic is people under 35 and households with less than $75,000 per year. It claims an addressable market with current products of about 12 million U.S. households, of which it is about 4% penetrated.  Moreover, PTON estimates what it terms its Connected Fitness Subscriber Lifetime Value at $3,593 (equivalent to roughly 7.5 years of subscription) each, at a cost of just $5.

Scaling up the business quickly will be critical to PTON’s profitability, of which it has none. There’s little prospect of that soon. In FY19, it posted a net loss attributable to common stockholders of $246 million, almost five times the $48 million red ink in FY18, despite the addition of treadmill sales. Pro-forma, the loss was 84 cents per share.

Still, given the recent turmoil and delay of We Company’s (WE) IPO, investors searching for the next growthy IPO will likely bite on this one. There is public markets scarcity value to Peleton, too. Short of a broad market debacle this week, PTON’s impressive growth should make its IPO a success. And, surprise, PTON comes out just ahead of its seasonally two best quarters, fiscal second and third, where it typically makes 2/3s of annual revenue. That should provide support for the stock for a little while.

Nevertheless, there are numerous negatives that both traders and long-term investors need to incorporate into their thinking before making an investment in PTON shares. Some might find the company vulnerable, particularly in the longer run.

1 High sales growth is accompanied by even higher cost rises: in FY19 110% for cost of revenues; 127% for subscriber expenses; 232% for general administrative costs. Yes, it’s a young company but profits might be elusive for reasons I note below.

A screenshot of a cell phone Description automatically generated

2 PTON’s products are relatively high priced (bikes are $2,245) versus peers, substantially so in some cases. Yes, the company claims a uniqueness to its systems, but gym equipment typically sells on price. It’s not a Ferrari. (See examples below.)

3 Given the industry potential, it should be no surprise that PTON has plenty of competition from old hands and new in the industry: Nordictrack, Nautilaus, Echelon, Flywheel, and the neighborhood gym, to name a few. Peleton claims, for example, it’s monthly subscription costs less than a typical gym membership, but the latter offers you a plethora of exercise choices, unlike PTON. So don’t extrapolate PTON’s triple digit growth out too far. The annual subscriber churn is about 8%. Not particularly impressive.

4 So far, PTON’S treadmill product, which began selling in 2018, doesn’t seem to be getting much traction yet. The company hasn’t broken out treadmill sales and, according to a report from New Constructs, an independent forensics research firm, treadmills probably caused both the decline in PTON’s product gross margin to 42.9% in FY19 from 44.1% in FY18, and apparently the 440% rise in FY19 inventory balance to about $137 million. “We can’t know for certain without more disclosure, but if Peloton was selling lots of treadmills it would probably be quick to tell us.”

5 PTON’s addressable market of 12 million U.S. households seems too high. Yes, in America the rich are getting richer but they like to save money too.

6 Music—the Trojan horse here. Peloton’s subscribers expect to listen to music from their favorite artists while exercising. This costs. PTON must obtain both the publishing rights and the public performance rights for music offered. In FY19, that cost rose by $23 million, though PTON doesn’t give from what level in FY18. 

Moreover, getting music rights is a complex legal process in the U.S. and even worse overseas, where PTON claims an even bigger addressable market.  The music publishing industry is concentrated in a handful of record labels, giving PTON little leverage on royalties payment negotiations. (Earlier this year, a group of over a dozen independent music publishers sued Peleton for failing to obtain the necessary rights to stream their music, seeking $150 million in damages.)

7 Unfriendly shareholder governance: Class A shares with 1 one vote vs. 20 for Class B held by insiders and a classified board. Not unusual by today’s standards, but unappealing nonetheless. There is an acknowledged “material weakness” in financial controls. This should be remedied but it isn’t particularly encouraging. Employee options have a potential fair value of $1.1 billion, or 14% of the market cap. Wow.

Where could I be wrong?  The company’s addressable market estimate is correct and it grabs a large portion of it.  The faster PTON can scale up the more likely and more quickly profits will accrue.

Bottom Line: By recent standards, PTON isn’t egregiously overvalued and the IPO might even see a pop. However, in the long run, it’s hard to believe that Peloton’s equipment won’t end up like other in-home gym equipment and Tae Bo videos: collecting dust in the basement.

Disclosures (show)

Stay up to date with the latest articles and business updates. Subscribe to our newsletter

Articles Read 1/2

🎁 Unlock 1 extra article by joining our Community!

Stay up to date with the latest articles. You’ll even get special recommendations weekly.

Already have an account? Sign In

Want to receive Regular Market Updates to your Inbox?

I am your default error :)