Peloton – The obvious move

The turnaround begins.

• Peloton has fired the starter’s gun on its turnaround by announcing its exit from making fitness equipment but the tepid reaction of the share price indicates just how much negative sentiment surrounds this company.
• Peloton is exiting from hardware in a move that had to happen as the hardware model has never worked (see here) and now leaves the company free to pursue subscriptions which is where the real value of this company really lies.
• The problem is that Peloton has not disclosed just how much this exit is going to cost and so I think that Barry McCarthy is going to kitchen sink the numbers again when he next speaks to the market (25^th August 2022).
• This will be the company’s FQ4 2022 and FY 2022 results giving the company a good opportunity to do a clean sweep and start its 2023 financial year with a clean slate.
• This is when I expect that the sentiment towards this company will bottom and so following what is likely to be another bloodbath, is when the timing could be right to take a position in the shares.
• This is because the sea of red ink that is swamping the hardware business is obscuring the subscription business which is a valuable asset in its own right.
• Peloton now has around 3m so far very loyal subscribers are paying $44 per month giving annualised revenues of $1.56bn.
• With a 70% gross margin and 10% OPEX, this would yield around $937m in EBIT and around $750m in free cash flow after tax.
• At a steady state with no growth and a discount rate of 10%, this is worth $7.5bn in today’s money which rises to $15bn if growth of 5% can be achieved.
• However, Mr McCarthy thinks he can grow this to 100m subscribers meaning that there is a great deal of upside if he makes only a tiny dent in this target.
• Peloton has continued to crater even after I started making nicer noises about it and now trades at a market capitalisation of $3bn which is not far off 1x FY2022 EV / sales.
• Sales in the coming year are likely to crash with the exit from hardware leaving the company on around 2x EV / sales which is pretty cheap for a subscription business with 70% gross margins.
• However, I suspect that more needs to be done on operating expenditure as the burden looks to be too great for the subscription business to carry on its own.
• These are the questions that Peloton should answer as it turns over a new leaf and enters fiscal 2023.
• With good answers to these questions, I suspect that it will not be hard to see a lot of upside in the shares especially given how much everybody now hates it.
• It is in precisely these sorts of situations where the real bargains are to be found for those with a spine and a bit of staying power.
• I can get to $23 per share without much difficulty on a DCF calculation, but this will need to be revamped when the company explains the manner of its exit and how much it will cost.
• I am getting ready to buy some.