Peloton: Subscription, subscription, subscription!. the key to getting out of this mess is subscription!
Pandemic demand won't come back...time to pivot!
Update: Since the original publication of this article we have also published our analysis on their Q2 earnings, you can read that here: Peloton: Q2 Earnings
Peloton was founded in 2010 by John Foley with the purpose of connecting the world through fitness. Said in other words they created a new category in fitness called connected fitness. Peloton was one of the many companies that had huge demand during the Covid 19 pandemic, making it rise to a valuation close to $50 billion. Since, the company has dropped by 94% and is trading at $9.13 per share or $3.08 billion. The drop in value is not solely related to the drop in demand from the end of the pandemic, but also from the huge mismanagement during the recent quarters. Given this it is definitely a company that is worth looking further into detail to determine whether the 94% drop is justified and whether the company has a future or not.
Business Model:
Products and Services
Peloton currently offers:
Peloton Bike +:
Currently Retails for $1,955 or from $47/mo for 43 mos at 0% APR with Affirm. It also includes free delivery and setup. In addition to the purchase of the bike all access membership cost $44 a month.
Rent option: You could also rent the bike for $109 a month with free cancellation any time, free returns but with a $150 delivery fee. All access membership is included in the $109
Peloton Bike (Original):
Currently Retails for $1,195 or from $38/mo for 39 mos at 0% APR with Affirm. In addition you must pay $250 for set up and installation. In addition to the purchase of the bike all access membership cost $44 a month.
Rent option: You could also rent the bike for $89 a month with free cancellation any time, free returns but with a $150 delivery fee. All access membership is included in the $89
Peloton Tread:
Currently Retails for $2,345 or from $63/mo for 43 months at 0% APR with Affirm. You must pay $350 for set up and installation, in addition to the purchase of the thread all access membership cost $44 a month.
Peloton Guide:
Device connected to the TV that will track your movement and help you in your strength work out.
Currently starts at $295 (it could go up if you add dumbbells and other accessories) or $13 a month for 24 months. In addition to the purchase all access membership costs $24 a month. (Lowered vs other products, but this is only an introductory price)
Peloton App:
Thousands of classes, expert-level instructors and curated music, with no equipment needed
Subscription to the service cost $12.99.
Subscription works in many platforms, IOs, Android, Roku, Amazon Fire, Apple TV, etc.
Accessories:
Dumbbells $25 - $155
Cycling Shoes $125 - $145
Heart Rate band and monitor $35 - $95
Earbuds $23 - $85
Bikemat $75
Resistance bands $75
Workout band $70
Yoga Blocks $30
etc.
Apparel
Tops (tanks, T-shirt, etc.)
Bottoms (shorts, leggings, etc)
Bras
etc.
Key Metrics / Performance
Highlights from their recent performance in 2021:
$4 Billion in revenue 120% YoY
2.3m connected
2021 Monthly average churn 0.61%
$189 Million of net losses
Subscription contribution margin of 67%
Peloton has a fiscal year going from July to June, so to have better visibility we will look in detail at their quarter by quarter results. Revenue has clearly slowed down (graph 1) it has gone from $1.2 b at the quarter ending in March 2021 to $964m in Marc 2022. When looking at this in further detail in graph 2 and 3 it’s clearly a deceleration of the connected fitness revenue. This part of their business exploded during the Covid pandemic, but since vaccines were made available demand has been clearly affected and revenue coming from connected fitness has gone down by 42%. On the other hand, subscription revenue has continue to grow, and is 55% higher today when compared to the top of the pandemic in March 2021
Connected Fitness revenue is the transactional part of their business, these are the revenues dependent on the amount of bikes and treads sold. Subscription revenue includes the all access membership revenues and the peloton app subscription revenue. So subscription revenue will be a lot more stable dependent on net additions and churn while connected subscription is impacted by demand and seasonality more strongly.
Net additions of connected fitness had their best months during Sep 2020 to March 2021 with 747K additions during that time or about 374K per quarter. Now in the life post pandemic the quarter that ended in March had only 195K net additions, January to March usually are high seasonality months for fitness, since a lot of people have new year resolutions related to dropping weight. Given that, we could expect that April to Jun 2022 will be lower than 195K net additions.
The digital subscription base grew a lot during the pandemic with an average of 178K net addition per quarter. Just as the pandemic ended the digital subscription base remained close to flat (actually it was reduced but not by much) It was in the seasonality quarter of January 2022 to march 2022 that has gained 114K subs
Shifting focus now to their expenses and overall margins. It is important to continue to look at this quarter by quarter, it has been dramatic the changes in each quarter and helps give a better visibility on what is happening. Connected fitness side of the business has become unprofitable for the first time and the subscription side continues to bring more positive cash flow to the business. Peloton explained the connected fitness margin in the last quarter with the following statement:
“Our Connected Fitness gross margin was pressured by the August 2021 Peloton Bike price reduction, impact of accessory inventory write-down, higher logistics expenses per delivery, increased port and storage costs, and charges associated with the voluntary recall of our Tread+ product (approximately $19 million impact to gross profit in Q3)’’
The recall mention is related to a death that happened during 2021 involving their Tread, Peloton issued a recall in relation to this.
The new pricing is a more permanent impact on their margins and the storage cost will continue as long as they have a lot of unsold inventory.
Net income was stable and improving throughout the pandemic, once demand started to cool down their expenses have gone for a wild ride. From April 2021 to March 2022 they have accumulated a net loss of $1.9b. This is a mix of their gross profit of connected fitness coming down to stimulate demand, but most of it actually is coming from the OpEx side.
Their Opex began increasing just as the pandemic was ending. Sales and Marketing was below $200m during and before the pandemic, now it has been above and averaged, $272m with the biggest quarter reaching $350m. Similar thing happening with G&A, above $200m and averaging $241m after the pandemic (never above $200m during the pandemic)
The last quarter (Jan to March 2022) saw a loss of $757m, $374m of that loss represents special expenses, $182m for Goodwill Impairment, $159m in restructuring costs and $33m impairment loss.
Given the recent cash burn it is important to highlight the amount of cash they currently have. They closed last quarter with $879m, down from $1.6b in the previous quarter. In addition it recently raised $750 debt. (5 year debt) (and they had an unused $500m revolving credit line at the end of last quarter)
Restructuring:
Peloton got itself in a lot of trouble and by the looks of all the details, it was generally self-inflicted. The main issue was that they believed that the new growth was organic. They repeated the same thing over and over again. It was as organic as a pandemic was common. They made many decisions focusing the company resources in a configuration of a new reality that was not sustainable. Fitness at home will be a thing in the future, work from home will be a thing. More people will spend more time at home, but it seems that they went all in.
Acquisition of Precor for local manufacturing
Second factory in Taiwan
Over estimation of their demand and over manufacturing of equipment.
This has left the company in restructuring mode, which is the right way to go, but it has and it will continue to be painful.
The restructuring they announced early this year, if executed as they announced, will bring $800 million in annual run-rate cost savings across operating expense efficiencies and material improvements in their Connected Fitness gross margin. The COGS savings will primarily come from efficiencies in procurement, manufacturing, and logistics. Operating expense savings will come from a wide range of initiatives, including corporate workforce reductions, marketing spend efficiencies, changes to real estate strategy, optimized software costs, and more tightly controlled outside services spend.
Cost incurred so far in Restructuring:
Competitive Landscape
Competition for Peloton comes from many ways. There are competitors that are doing connected fitness, there is always competition coming from gym memberships, and last but not least competition from legacy fitness equipment companies.
Connected Fitness
Echelon :
Connected Bikes (from $900 to $2,300)
Rowers (from $1,000 to $1,600)
Treadmills ( from $1,300 to $2,500)
Fitness mirrors ( from $750 to $1,500)
iFit:
They own Nordictrack and Proform but also have launched their fitness content platform to go along in their new connected fitness equipment
Nautilus:
Paired with its digital fitness platform JRNY, Nautilus entered connected fitness through the VeloCore (from $1,799 to $2,199) bike and Treadmill 22 ($2,699), both under the Bowflex banner.
And many others like, Wahoo Fitness, Volava, SoulCycle, Beachbody, Cultbike, Blue Goji, Techno Gym, Watt Bike, Arena, JaxJox, Oxefit, Speede Fitness, Tempo, Tonal, Kabata, Vitruvian, Boxx, Fiightcamp, Liteboxer, Carbon Trainer, Future, Forme, Mirror, Studio, Vaha, Aviron, Cityrow, Ergatta, Hydrow, Flexia, Frame, Onyx Interactive, Reform RX, CLMBR,
There are more than 40 companies doing connected fitness in some way or form, some are doing bikes, some are doing treads, others pilates, mirrors, weights etc. The likelihood is that many of these won’t make it and that there will be a lot of consolidation
Fitness Equipment Companies:
The traditional fitness companies are starting to enter the connected fitness market, but most of their business is still in cheaper or more traditional equipment. The four biggest companies in fitness equipment are Brunswick Corp, Chattanooga group, Icon Health and Fitness and life fitness. All of these are currently worth more than a billion and Brunswick is worth more than Peloton at $4b
Last of not least, now they have competition from Apple fitness as well, as of now is just content, but Apple’s name carries a lot of weight and could be an issue for their growth
Market Size:
From Peloton’s S1 we get a picture of the size of the market as they see it:
“According to a 2018 report by the Global Wellness Institute, the total global spend on the wellness industry in 2017 was $4.2 trillion, of which the global fitness and certain categories of wellness, including meditation and yoga, represented nearly $600 billion.
According to the International Health, Racquet & Sportsclub Association, or IHRSA, 183 million and 62 million people had gym memberships globally and in the United States, respectively, as of 2018.
Within our current and announced markets (the United States, the United Kingdom, Canada, and Germany), we estimate that 75 million people used treadmills and 27 million used stationary cycling bikes in the 12 months ended March 2019. In those same regions, we estimate that over 5 million treadmills and nearly 3 million stationary cycling bikes were purchased for in-home use in the 12 months ended March 2019.’’
Peloton SAM (Serviceable Addressable Market) is 14 million in total (from current markets) and 12 million in the US.
This could expand as brand awareness expands and as focus to digital app is enhanced.
Outlook:
Peloton has a rough road ahead, they just named Barry McCarthy as the new CEO. He has worked before in Spotify and Netflix as a CFO. He clearly has a background with strong focus in subscription businesses.
Some of the things they have mentioned in the recent earnings calls is that there will be more focus on subscription, there will be more focus on digital app. They mentioned in the call that the app has only 4% awareness in the country, so like they mentioned, is the best app that nobody knows about.
In addition, they just launched a new service that will allow customers to rent a bike or tread without. This should increase their total SAM
Some of the possible risks for the company are:
Running out of cash: The company has access to about $2.1b in cash. The last 12 months they have lost $1.9b (some are non cash expenses). At that run rate they would run out of cash in about 5 quarters. The company is undergoing restructuring and cost cutting strategies but also have said that they expect that they won't be cash positive until FY 2023. (Their fiscal year starts in June)
Shareholder Dilution: The likelihood that there will be any additional shares sold to the market is high due to the short amount of cash they currently have. This would dilute all current shareholders, hence, making it less attractive to invest.
Demand: Demand in their products has decreased since the end of the pandemic. Current demand of about 175K net adds in connected fitness per quarter is not only lower, it is also coming with almost no margin.
Inventory: They have a lot of inventory idle waiting to be sold. ($1.4b) That could be anything from 3 to 5 quarters of inventory, depending on how demands develops and how much demand there is in the new rent business
Idle Factories: They have two factories in Taiwan and have the Precor acquisition that was supposed to build products for Peloton in the US. These are all idle in terms of production for Peloton. All these 3 are property of Peloton and all these produce fixed costs that are having zero benefits. Though they have announced the closing of manufacturing plants. Is not very clear if this closure is for good or is while they lower their current inventory levels.
Market Share Falling: M Science has Peloton’s market share at 65% when considering products prices above $1,400 and it's starting to show a sign of decline. This both due to a lot more competition but also due to the size of the connected fitness market increasing.
Economic Conditions: We might be about to start a recession worldwide. Money is tight and customers will prioritize necessities. Connected fitness equipment for Peloton could have an even bigger hit in terms of lower demand. Timing is not great for a slow down for Peloton.
What could be the case for Peloton being a good opportunity for the next 10 years?
Subscription Business: The opportunity in subscription business should be divided in two:
Digital app: The digital app is a low cost high margin product that is barely known currently. The product is about $12.99 and can be used with any other equipment not necessarily expensive Peloton equipment. Customers can use their all tread, their all bike, dumbbells etc, and subscribe to the great content they produce on their digital app. This could be one of the levers they could focus on specially during an economic slowdown. Where this solution is cheaper than your average gym membership, but allows the customer to remain engaged in their exercise journey. They have close to 1 million subscribers now, with over 60% margin. This is a low ticket but high margin product. That leverages on their installed capacity. Growing this product alone 4 fold would bring $150 to $200 million additional in gross margin.
Connected fitness Subscription (all access): They already have very close to $3m subscribers with very little churn. They need to continue growing the base. For this they need to continue selling connected fitness equipment, that is the difficult part. But they need to continue leveraging the digital app and the renting business as a gateway to selling fitness equipment. Their strategy could be similar to what the gaming industry did with video game consoles. They used to offer the consoles with very little to no operating margin, they were betting on generating a lot of high margin revenue from subscriptions and video game discs. Similar ideas could be followed by Peloton but with an improved operational efficiency, they can keep their new lower prices, but they must remain flat or close to flat margins. The rise in customer acquisition will continue to grow the already $300m+ revenues and $200m+ margins from all access subscription.
Subscription is their best chance for growth and survival. They already have a very good amount of subscribers that are loyal to the quality of the content and the brand. The field in terms of equipment might be getting more competitive and margins could always remain low. But the margins in the content side of the business are very good. Growing the app and growing all access base is their best bet.
Valuation
The valuation of Peloton has taken a beating, it has come from almost $50b to currently just about $3.08b. The value the company has destroyed is mostly due to corporate decisions. It was in a bubble for sure during 2020, but they did not take advantage of the opportunity. They made the wrong decisions and that is why they have a different management team
But is an opportunity long term? Is it right to lose more than 90% of its value? We did a DCF analysis to see the possible valuations in different scenarios
The main revenues streams considered in the DCF are digital app subscription, all access from connected fitness equipment owners, connected fitness equipment sales and renting of connected fitness equipment
Base case: $5.9b or about $20 per share. It is assumed that the demand has found its new level and remains about where it is today. At the same time the growth in subscribers and renting drive growth while margins improve over time (thanks to the high margin from the subscription base)
Conservative Case: $0 Demand goes even lower and subscription base is not enough to cover. The big assumption here is that demand would still go lower, meaning it still has not reached its low. This is something important to keep an eye on in the next few months/ quarters. If the demand has not stopped dropping this would be an issue and this scenario would be closer to being likely
Optimistic Case: $10b or about $37 per share. This scenario has demand growing again, not returning to the level that it had during the pandemic, but does settle above the demand they have today. Subscription services grow faster as well given the new management focus in subscription. Finally renting business accelerates as well
It is a risky company to invest in, the probability of going to zero exists. There is a lot of restructuring that must be done. The optimistic case is closely linked to their restructuring working. The next 4 quarters will give us a better idea, we will keep an eye on their future earnings and where the level of demand, subscription growth and cost cutting go. These things will give us clues if their restructuring is indeed working.
Peloton has created a new category, their brand is still loved by many and it is why it has great churn performance, the people that have their products, love their products. But corporate decisions have put them at risk of either getting acquired or going out of business. Time will tell, hope for the best for the Peloton team and its current investors.
Great piece! I'm curious what your thoughts are on the expansion of Operating Leverage as the company moves to a more variable cost structure? I haven't done the modeling, but my gut is that the improvement of operating leverage coupled with revenue mix shift to higher margin subs will result in some pretty incredible bottom line growth over the next 12-18 months. I'm interested if this comes out in the wash re: valuation in your model. Thx!
You missed Subscriber Acquisition Cost. It was running at $1K/sub, which would take 5-7 years just to recoup Sales & Mkt expenses. Even with a <1% monthly churn, the average sub will be gone before that. But wait, it gets worse. For this quarter, if they cut S&M expense to $200M, they are guiding to only 20k new subs! Do the math, that’s $10k SAC. Long story short, they lose $ on every sub. They will never recoup the S&M expense alone, never mind all the other expenses. This is a zero!