Taking some arguments on to show the opposing view. I am by no means an expert in business administration so please do poke holes. It helps me learn!
Point:…looking ONLY at their subscription revenues, it is 156.5m, growing at 130% YoY with 58.5% GM, and with the entire PTON currently valued at $37 billion.
Compare this to say, Datadog, which will post on 11-10 let’s say between 150m-165m revenue representing 57% to 72% YoY growth with a continued GM of 80% and presently valued at $31 billion. (The reason for this revenue growth range is that they usually add 17 million QoQ revenue, plus a generous upside margin to reach +25 million QoQ.)
Wouldn’t you think that the lower margins of PTON subscription revenue (25% lower than DDOG) is more than compensated by its growth rate (double of DDOG at midpoint), and that in fact based on subscription revenue alone, PTON should be valued the same as DDOG?
Reply: Interesting point! You are right (if I did this math right) that the value of each dollar is equivalent when you factor in the different gross margins and growth rates (I didn’t plan that by the way, just came out the same), FOR TODAY…
$1 x 59% = $0.59 gross income x 130% growth = $1.36
$1 x 80% = $0.80 gross income x 70% growth = $1.36
…BUT the market is forward looking and we can’t cherry pick a small part of a business and compare it for overall market valuation modeling. This is where the difference in business model gets real important. PTON only got a 21% benefit from this growth. Next quarter they may get a bit more but not much. The rest of the business is dependent on producing and selling a new expensive thing over and over. Right now they are backlogged because of unexpected demand. That is a limiting factor. On the other hand, DDOG is going to grow its ENTIRE business by that amount again and again. The potential for a purely digital business to scale is worth far more.
Point: Gross margins going up is bad because “…this would be a sign that demand is tailoring off! The subscription count is a lagging indicator of user demand, especially with the current backlog. If anything, as an investor you’d want overall GM to stick as close to the hardware segment as possible for as long as possible.”
Reply: This makes no sense to me at all. We always want GM to get better. It means the business is operating more efficiently (operational leverage is improving, or management is bad and is cutting corners, which is a whole different issue). It has no correlation with demand as they can sign on more subscribers, while still selling greater numbers of hardware, and if the subscribers are more valuable (GM-wise) and outpace hardware, the GM will climb. This was my original point.
I see no reason why “subscriptions are almost guaranteed to follow hardware ownership count”. This implies that the only subscribers of content are those which have also bought equipment, which is not true at Peloton. If GM stuck to the hardware it would be a direct sign that the digital content subscription side is failing to grow, which would be a reason to sell in my opinion. Basically my thesis for investing revolves around them scaling beyond hardware before that business starts to tire out (which may take years, who knows). I feel like this is the company’s mission as well, even if they wouldn’t put it in those terms ;p.
In other words, they SHOULD be improving margins on subscriptions, even when there are fixed overhead costs, because you can sell to more people without paying more for the content (overhead only scales marginally as digital content only gets produced once and is then cheap to deliver over and over compared to physical goods). With hardware, the margins are much harder to improve as the economies of scale on real goods do not scale infinitely like digital goods. Real goods are made of real materials which have a raw material base value that you can’t reduce beyond without coming up with new materials or optimizing techniques. Even after making a million bikes the next one has similar margins. If it were digital that next one would be almost pure profit.
…and that is before you factor in that digital makes money again every month while hardware may last years before an upgrade is made (if it is made). So digital has two ways to reduce margins which compound on each other: selling to more people and selling to the same people longer. Finally digital can expand across distances without any issue (even getting translated if needed). Hardware has shipping and customs issues to solve in each new location which adds localized GM which has to be overcome by local scaling efforts again and again.