Peloton – Hard road home

Moving to subscription is going to hurt.

• Peloton is starting to move towards the subscription-based business that it always had to become but the legacy of hardware is hard to shake and brutally painful to wriggle free from.
• This is signalled by its cutting prices on some of its hardware and offering discounts to new subscribers in order to get the greater volume in the door that it needs to start making a profit.
• Peloton’s new Guide product is a camera with AI attached that assesses the movements of the user in order to give the necessary feedback to ensure that strength training is done properly.
• It was originally announced to launch at a price of $495 but now will be sold at $295 pretty much ensuring that Peloton will lose money every time it sells a device.
• It has also reduced the subscription that goes along with Guide from $39 per month to $24 in an effort to get as many users as possible using the product.
• The digitisation of personal training is the right strategy because, excluding the equipment, the marginal cost of adding a new user is almost nothing.
• This is where the new CEO looks certain to take the company and it is something that I have been expecting since the company first went public.
• The problem is that Peloton is still at its heart a hardware company and the boom in demand from the pandemic led the company to make commitments to manufacturing that will now need to be undone.
• The other issue is that while subscription is a much more profitable revenue stream, it is also much smaller in terms of total revenues making a high market capitalisation more challenging to justify on subscription alone.
• Furthermore, the immediate outlook is pretty bleak as the end of the pandemic means that gyms are open for business once again and rampant inflation will also damage the affordability of Peloton’s high-end equipment.
• Peloton currently expects that fiscal year 2022 revenues will be around $3.75bn but the majority of this is from sales of hardware meaning that there will be a big correction in revenues as the company moves entirely to subscription.
• Hence the reality is that the company is not really trading on a 2022 EV / sales multiple of 2.2x but something closer to 6x or 7x if one considers hardware to be a discontinued business.
• Peloton still has a reasonably good brand in fitness and so it has a shot at making this transition, but it will neither smooth nor easy.
• Competition is rising fast meaning that its need to cut costs and move towards profitability cannot impact the quality of the service that it offers.
• Furthermore, there are likely to be high costs associated with getting out of hardware which will erode the cash balance still further.
• Peloton has $1.6bn in cash on its balance sheet and its debt is convertible meaning that it may not have to pay down its bonds with cash.
• Peloton has a shot at recovery and this transition has been successfully navigated before, but the pain and losses are far from over meaning that I think that the shares can still go a lot lower before the bottom is in.
• I continue to have no desire to go bottom fishing for Peloton.