Peloton – Beauty Parade

Peloton goes on the block.  

• Amazon, Nike, Apple and so on are thought to be considering a purchase of Peloton, which while it has a pretty good fitness brand, also has a business model and demand outlook that is likely to make potential acquirors think twice.
• The notion that Peloton may be acquired sent the shares up 27% in after-hours trading and those in the frame to acquire the company declined to comment.
• Peloton is increasingly looking like it is going to struggle to make it on its own.
• There are two reasons for this:
  • First, demand, which has done a shift from more demand than the company could handle to more bikes in inventory than the company can sell.
  • This has been exacerbated by a big increase in capacity and a move to in-house manufacturing almost exactly at the point that demand was peaking.
  • The net result is that the company now has much higher fixed costs and commitments than it did when demand was much higher.
  • Hence, a downsizing is needed which is going to be both painful and expensive.
  • It also means that the long-term is nothing like that which was promised, meaning that the company’s shares are worth much less.
  • Second, the Business model, which has been flawed from the beginning.
  • When Peloton was listed, it was touted as the Apple of the fitness world in that it was making 40% gross margins on the bikes that it sold.
  • However, it turns out that bikes are much easier to make than iPhones especially when the user does not have to own the hardware in order to access the software.
  • As a result of bikes making up the vast majority of revenues, profitability and cash flow came under immense pressure as soon as competition picked up.
  • This has also been a significant contributor to the falling financial performance and adds difficulty to the investment case for an acquiror.
• One acquiror could be one where the Peloton equipment fits into an existing offering in the space and where manufacturing scale can be leveraged. e.g. Technogym.
• The other could be a digital ecosystem that is looking to expand its ecosystem into fitness and can absorb meaningful upfront losses while the Peloton brand beds in and expands its reach.
• Apple would appear to be a good fit, but I do not agree with this view.
• This is because Apple makes money by keeping its ecosystem exclusive to the devices it makes and then charging a premium to access the ecosystem.
• This is the secret to its very high gross margins compared to its Android competitors.
• For this to work, Apple would have to remove 3^rd party device access and re-establish the very high price that Peloton was able to charge during the pandemic.
• This will be easier said than done which is why I think that Apple is unlikely to acquire Peloton.
• Amazon is a potential acquiror as it currently leads in the smart home and is willing to spend vast amounts of money on experiments.
• Nike is also a potential acquiror although this would mark a departure from its regular business, and it lacks both scale and experience in hardware and electronics manufacturing.
• Hence, I am not convinced that there will be many takers at this price, meaning that there could be further to fall once buyers fail to materialise.
• There remains no reason to bottom fish this one and anyone who holds it and is waiting for a recovery should take this opportunity to cash out.