Revisiting Peloton

[MajorFool20]

Let’s face it, Peloton has been a total stinker this year and has been a drag on my returns all year. They are down 37% YTD and flat over the last year due to reasons that have been well documented by the board. I can certainly understand why the majority of the folks here have moved on from this business since the opportunity cost of holding this has been substantial as most other stocks have done well. With that being said, I wanted to raise this business to the board once again because I am not confident that the stock fully reflects what’s going on with the underlying business.

What I want to focus on is the subscription revenue. Ultimately, this is the reason to own Peloton. Here is the breakdown of sub revenue over the last four years:

Sub Revenue 	
          Q1	  Q2	  Q3	  Q4	  FY				
2018	 $14.3 	 $16.5 	 $22.5 	 $27.0 	 $80.3 
2019	 $31.7 	 $37.3 	 $51.1 	 $61.0 	 $181.1 
2020	 $67.2 	 $77.1 	 $98.2 	 $121.2  $363.7 
2021	 $156.5  $194.7  $239.4  $281.6  $872.2 

QoQ Change %				
2018		15%	36%	20%
2019	17%	18%	37%	19%
2020	10%	15%	27%	23%
2021	29%	24%	23%	18%

YoY Change %										
2019	122%	126%	127%	126%	126%
2020	112%	107%	92%	99%	101%
2021	133%	153%	144%	132%	140%

Here we have a company that is growing their subscription revenue at well over 100% while at a $1B+ run rate. This to me is outstanding. They are growing pretty consistently at 20% QoQ. If they continue at this pace next year, they will end with subscription revenue north of $1.8B. They have already guided for 3,630 fitness subs for next year, good for 56% YoY growth, which will almost certainly be raised every single quarter.

Their subscription revenue is starting to become a larger percentage of their total revenue. This is a trend shareholders should like to see. It dropped in Q4 '20 and Q1 '21 when they sold a ton of bikes during COVID but it just hit a record high of 30% last quarter. Please note it is lower in Q2 & Q3 when they sell more hardware during the holiday season.

Sub % Revenues	
        Q1	Q2	Q3	Q4	FY
2018	25%	13%	16%	25%	18%
2019	28%	14%	16%	27%	20%
2020	29%	17%	19%	20%	20%
2021	21%	18%	19%	30%	22%

The best part is these subscribers tend to stick around. Their retention rate has remained consistent at 92% for the past five quarters. It does not look like many folks who bought a bike during the peak of COVID are cancelling their subscription. Their average net monthly churn has also held very consistent:

Avg. Net Monthly Churn	
        Q1	Q2	Q3	Q4
2018	0.52%	0.49%	0.55%	0.85%
2019	0.50%	0.52%	0.68%	0.79%
2020	0.90%	0.74%	0.46%	0.52%
2021	0.65%	0.76%	0.31%	0.73%

This all goes to show, their subscription revenue is growing at a very healthy pace and the members are not going anywhere. In addition to this, the subscription revenue is far more profitable than the hardware, of course. Sub gross margins have increased steadily the last three years: 43%, 57%, 62%. This trend should also continue.

After losing over a third of its value this year, Peloton finds itself valued at roughly $27B. If we were to value it solely off its sub revenue, it would trade at a TTM P/S of ~32. I would say that is pretty good value for a business growing ~20% sequentially with 62% gross margins.

Let’s compare that quickly with one of our favorite SaaS businesses, Cloudflare. Their TTM revenue is $530.6M, growing at 53% YoY and 10% sequentially. They are currently valued at $42B, which equates to a TTM P/S of ~79. Now I will readily admit this is an apples to oranges comparison, and Cloudflare is likely overvalued at the moment, but I find it striking. Does this kind of difference feel right to you?

The best part of all, is we are not even considering the additional $3.1B in revenue Peloton had last year from bike sales. Sure this comes at far lower margins but it is not meaningless. Ultimately, Peloton guided for $5.4B in revenue next year, good for 34% YoY. It is fair to assume this is heavily sandbagged and should be raised the next three quarters.

Given the current valuations seen across the market, am I the only one who thinks Peloton might be quite undervalued? I am not blind to all the challenges they have faced with their hardware (i.e. recalls, safety issues, supply problems, etc.), however I think a very strong case can be made for buying this business thanks to their incredible subscription revenue growth. Am I insane? Is the best behind this company? Are they headed for slower growth indefinitely regardless of their new tread launch and the jump into the commercial market? I have learned the hard way that it usually makes the most sense to own the best of breed companies that are firing on all cylinders. I know Peloton does not currently fall in that bucket but I tend to own a few more stocks and give a bit of a longer leash that many here. For what it’s worth, I can say that as a bike+ owner, I see the value in their offering and think there is still a long runway ahead.

Rex
Long PTON… for now

P.S. Cody Rigsby (bike instructor) was recently picked to be on Dancing with the Stars. He began his first dance this week riding a Peloton bike. This is some great publicity for the business but also speaks to the power of the brand that they have an instructor selected to be on Dancing with the Stars.

[sarksnz]

Yes, I too am long PTON (small position). I think Peloton is a binary stock, with 2 potential narratives:

1. Pandemic will be over, or people won’t care, and it’s back to the gym for them, ie, Peloton is a fad. remember Tae bo, Bowflex, Zumba, Ab roller… etc.

or

2. Workouts from home are the future, and Peloton is the biggest, stickiest mover in that space, and will own a big chunk of that TAM for the foreseeable future.

There’s not much in between as far as I can see.

The big difference between Peloton and the other stocks covered on this board is the timeframe of that narrative. Almost all of the other stocks have their narrative happening right now, not at some point in the future.

Any lag creates uncertainty, and the risk of the dreaded “something else happening”.

But, as you point out, their results to date are pretty compelling, and are suggestive of narrative 2, which is why I have a position.

Of course, it’s been a less than stellar move to date

cheers
Greg

[TMFMktmusician]

I think Peloton is a binary stock, with 2 potential narratives

I disagree with this. Much like the return-to-work/work-from-home debate, the outcome likely lies somewhere in between.

What I’m interested to see is how the precor acquisition impacts the business’s growth and expansion. In a world where they’re able to successfully integrate into gyms and hotels, they may be able to make up for any post-pandemic churn as people return to gyms.

-CMFMktMusician
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[GolfCaddy4PLynch]

Hi MajorFool,

I think you’re making a very compelling argument. Peloton is also moving into apparel, which is a high-margin business and I think they will be successful there.

• I agree with the high-level narrative that the pandemic isn’t over and the world is not going back to the way it was. SoulCycle is closing studios, they just shut one down near me. FlyWheel went completely bankrupt. There is less competition IRL all time time.

• It’s a complex business as you have pointed out with many moving parts and synergies between them that MBA types love to gush over. I am actually a fan of these types of businesses because complexity can be a moat. But it makes it hard to value for investors.

• I also think the share price drop was warranted given all the supply chain problems they are having. It’s been weeks since my wife ordered me a Peloton hoodie and it still hasn’t arrived, and they don’t know when they will get it to me. But I got a 20% coupon for more apparel. LOL.

• The biggest difference between Peloton and Cloudfares is that it’s a nice to have, not a must-have. So it should trade at a lower multiple. At least that would be my logic. Peleton is still a hardware company with complex logistics software vendors don’t have to deal with.

But the bottom line is when I just looked up LULU vs. PTON.
LuluLemon has a TTM PS of 10.
Pelton has a TTM PS of 7.

Maybe PTON is a buy right now?

[IRdoc]

As a consumer brand it has potential, but one of my issues with PTON is that the upselling is limited. I guess you’d have to consider the apparel business as a way for them to increasingly monetize users. But otherwise they aren’t really able to sell more to their customers. Some digital users will eventually buy a bike or treadmill and sign up for the full subscription, but that’s still just a one time thing. Whereas SaaS companies sell more modules or seats, or more usage, or at least Roku can sell more or charge more for ads.

Upstart is extremely early in its field so I’ll give them a pass.

As for the LULU comparison, the main difference is that you don’t need to actually exercise to wear their clothes. It would seem silly for a non-Peloton user to wear Peloton apparel. Peloton is so strongly tied to the bike.

[PaulWBryant]

Rex,

I saw a pretty big slow down in your QoQ subscription numbers:

QoQ Change %				
2018		15%	36%	20%
2019	17%	18%	37%	19%
2020	10%	15%	27%	23%
**2021	29%	24%	23%	18%**

But I admit, the numbers still look rather large – 18% is something we’d be thrilled with from most companies. But look at the raw numbers:

2020    6.2    9.9    21.1    23.0
2021   35.5   38.2    44.7    42.2

Not only has the subscription growth completely leveled off in Fiscal 2021, it actually declined in the most recent quarter. I think we can make excuses for this quarter, but the 4-quarter trend looks bad. That’s the reason for the bolded percentage-slow down above, and the reason it will continue toward 0% or even less, rapidly. And the explanation is likely churn. They can only add a certain number in raw dollars, and eventually the math says their churn will approach the same number.

To put it in terms of things we’re used to seeing, their NRR is not 130% or 110%. It’s something around 90 or 95%. That’s why I sold, and why I’m not interested in getting back in.

In general, when we step out of our comfort zone looking for companies that don’t have steady growth, (in my opinion) we need to find something like what Peloton was* when you first brought it up, Rex: true explosion. Like Upstart. Failing that, I think (for my $ at least), “slow” and steady SaaS wins the race. (Especially when “slow” means 50% or 60% YoY growth instead of 100% or 200%).

That said, I don’t know what this should be worth. Maybe you will time it correctly and make some money. But that’s difficult, and I haven’t had much luck with it.

Bear

*look at the raw subscription numbers exploding in fiscal 2020. Contrast that with 2021.

[jwiest]

Given the current valuations seen across the market, am I the only one who thinks Peloton might be quite undervalued?

I will never own this stock. I may miss out in the short term, but:

1. It is a fad, or at the very least fad-adjacent. All these things are. You can tell by their own marketing. They are selling their original bike at $600 off, which means they have extra stock they have to move, and the only people they can move it to are people who wish they had one but couldn’t afford it before…but it’s still a major purchase for most of the population.

2. Their appeal is too mercurial. Stock holders are going to have to keep a sharp and constant eye on intangible things like cultural shifts and other fitness fads that might come along and replace it. Their quarter to quarter results are going to reflect this, and be somewhat impossible to predict. At best their growth trajectory will be cyclical, but then it’s just a market-timing exercise.

3. Their moat is tiny. Their ads and products appeal to a very small portion of the population. I’ve been noticing brand-name competitors also marketing in the same space now, and keep in mind the competitors don’t have to be “bikes”. Treadmills and stair masters compete in the same space. Saw an ad the other day for a running machine that was speech-aware and let you call out a desired sound track. I’m guessing many people would prefer that than being yelled at by some sweaty Adonis named Chad

4. Their growth is done. That’s a bold statement, but anyone who wanted a Peloton probably has one. If you’re not in the rather small niche of the population who a) has the real-estate space to devote to a bike and b) the means to acquire one, you probably never heard of it. So branching into clothing is kind of pointless. Everybody needs shoes, so Nike can do this. Nobody needs a Peloton, so Peloton clothing means almost nothing to most people.

TL;DR - approach with caution, it’s a lot of work and too many unknowables.

[HTXfool2020]

As a peleton user who has the bike who absolutely loves my peleton I refrain from being an investor. Two things in particular that have frustrated me are:

1. The company has two types of memberships the basic digital package/ and the subscription membership which you need if you have the peleton bike. The company has cut the price of the basic digital membership to try to lure in new customers however do not ever reduce the price or discount the prices for long-standing customers. In my mind you should reward the loyal customers rather than the new ones.
2. They have recently slashed the prices of the hardware by 400 dollars. The original bike which used to be 1895 is now 1495. To me this is reflective of a growth slowdown coming out of the pandemic.

I continue to be a fan of the ecosystem but have my frustrations with the business.

[qwsong]

I wonder why Peloton not to lower their subscription from $50/month to like $10 or $15/month. I am not comfortable to pay $50 but may be good for $15. In that way, they may increase membership by 10 folds or more, thus selling a lot more equipment. Last time I am thinking about buying a Petoton Bike or Tread, the one stopper is the high price tag and lock-in of their subscription.

[sarksnz]

Some more points/counterpoints here,

1. They ship physical product and have been shipping constrained for much of the past year.
2. They’ve dropped marketing until shipments have caught up (which they have now).
3. Churn is pretty stable over the last 8 quarters at least.
4. Net retention is very stable.
5. In my search, 2nd hand Peloton bikes are very rare.
6. Tread is just starting.
7. New markets overseas (Germany and Australia) are just starting.
8. Apparel?
9. Compared to gyms, a Peloton sub is super-cheap.
10. Margins are dropping as they re-invest.
11. Precor investment was tied to both production capability but also commercial sales force (into hotels, corporates etc).
12. Supply chains are hard.
13. Cash burn is high, and not expected to improve over the next fiscal year.

They do note seasonality over summer.

marketmusician points out that my ‘2 narratives’ is actually a continuum, and the question is where on the continuum you think Peloton will end up.

jwiest’s final statement pretty much nails it “it’s a lot of work and too many unknowables”. Maybe too many unknowables is a bit absolute, but there are a bunch of moving parts, and macro uncertainties which are less pronounced with software companies.

cheers
Greg