Peloton IPO – Frantic pedaling.

No telling when frantic spending can stop.  

• Peloton is to fitness what Lyft and Uber are to taxis. All have reinvented an industry and have reached scale, but appear chronically incapable of making money.
• Peloton is a connected fitness equipment company that also sells content (virtual classes) for its equipment and has filed its S-1, (see here) signaling its intention to go public.
• Its proposition is to create an ecosystem of connected devices (not unlike smartphones) that become virtual gyms as well as an exercise community in a direct challenge to physical gyms.
• The devices (spin bike and treadmill) are expensive starting at $2,000 which combined with a $39 per month subscription for the live and on-demand content which competes quite effectively with gym memberships.
• Furthermore, given the large upfront commitment, engagement is pretty good with 511,000 active subscribers, less than 10% churn and 577,000 devices sold.
• This 89% attach rate is an excellent indicator for the company’s outlook as the real value in this proposition will be the ecosystem that it creates and the value that it can derive from that.
• However, there is far more to an IPO than just revenue and this is where the proposition as a public market investment runs into trouble.
• A typical start-up life cycle is heavy losses while the product establishes itself in the market and then, as the company reaches scale, profitability and good cash flow.
• It is at this point that companies are ready for IPO as the outlook for heavily loss-making companies can be exceedingly volatile meaning that there will most likely be wild swings in the share price.
• This is not ideal for public markets as this volatility does not suit less sophisticated and unspecialised investors and can have a catastrophic effect on the public image of the company and demand for its products.
• In this regard, I think Peleton is very far from being ready for IPO.
• Hardware revenues are have been stable at 80% of turnover for 2 years with content subscriptions making up almost all of the balance.
• Gross margin is also relatively stable with both hardware and subscriptions earning around 42% – 44%.
• This should be the foundation for a profitable growth business but very high operating expenditure pushes the income statement heavily into the red.
• Research and development is just 6% of turnover while sales and marketing is 35% of revenue and general and administrative expenses is a massive 23% of turnover.
• This indicates that this product has very low barriers to entry meaning that the company is being forced to capitalize on its first-mover advantage before competition arrives.
• If it can become the go-to place to exercise, interact with other users and consume content, then Peleton will be able to make money but until then it will have to buy growth at any cost.
• Hence, the key risk that Peloton faces is that it will be unable to stop spending vast sums on marketing greatly hindering its ability to fulfill the promises that it will make when it hits the road to market it’s offering to investors.
• Furthermore, Peloton looks like a company that will face stiff competition possibly from one or more of the big digital ecosystems who will be more than capable of undercutting it badly.
• Sadly, I suspect that none of these risks will be reflected in the offering price meaning that, once again, investors will be asked to pay up for profits that have not materialised and ignore the very real risks.
• Hence patience is probably the best approach to this offering.
• I have no fear of missing out.