Peloton vs. Unity – Tale of two crashes

Peloton is cheap but Unity is not.

• Bad results from both companies caused further share price declines but Peloton is moving into deep value territory whereas Unity by any measure remains expensive.

Peloton FQ3 2022 – Kitchen sinks the numbers

• Peloton reported weak results as the CEO effected a hard reset but there is some light at the end of the tunnel and there is very little doubt that the shares are now on sale.
• FQ3 2022 revenues / EBIT were $937m / LOSS$735m way below expectations of $972m / LOSS272m.
• However, if I reverse out the one-off restructuring charge of $158.1m and the goodwill impairment of $181.9m, the real EBIT loss was $395m which is still way off expectations.
• The rest of the miss came from gross margins which were 19.1% compared to forecasts of 24.7%.
• On top of this came guidance that was well adrift of expectations with revenues of $675m – $700m miles adrift of forecasts of $821m and the admission that the company needs more money resulting in the issuance of a 5-year bond for $750m.
• A set of results as bad as this would have caused the stock to halve or more a year ago but yesterday the shares declined a relatively timid 8.7%.
• This is a clear reminder of just how far the shares have already fallen, how much the market already hates this company and how low the valuation now is.
• It has been obvious from day 1 that the new CEO, Barry McCarthy who came from Netflix and Spotify (both subscription businesses), is going to take Peloton in this direction and it is on this basis that one has to look at the company.
• The recovery scenario remains hardware at zero operating margin and subscription providing all of the profit of the company.
• Peloton now has 2.96m subscribers who will soon be paying $44 per month giving annualised revenues of $1.56bn in annualised revenues.
• 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.
• As of 11^th May 2022, Peloton’s market capitalisation is $4.3bn and its net cash position is $24m however it is almost certainly going to burn more cash and go heavily into net debt territory before it turns around.
• If I assume a further $1.5bn in cash is burned over the next year or two, then there is still upside to $6bn in a steady-state scenario (40%) or $13.5bn (213%) if 5% growth can be re-established.
• Furthermore, on the headline numbers, Pelton now trades on an EV / Sales of 1.1x compared to roughly 14x when the shares were at their peak.
• I think it is pretty safe to say that all of the air has come out of the Peloton bubble and if Barry McCarthy pulls off his recovery even to a steady-state, there is a lot of value to be had.
• This, of course, is the big if and right now the market has zero faith in his turnaround.
• Peloton is now at the point where I am going to dig out my spreadsheets and have a proper look, but I suspect there will be time to think carefully about the proposition as there is still some pain to come.

Unity Q1 2022 – The wrong quarter to make a mistake.

• Unity fell 30% in after-hours trading as the company reported Q1 2022 results that missed expectations and guided for slower growth clearly demonstrating that there is still air in the Unity bubble.
• Q1 2022 revenues / adj-EPS were $320m / LOSS$0.08 compared to forecasts of $321m / LOSS$0.08 but it was guidance where the real problems were.
• Here the company is guiding for Q2 2022 revenues of $290m – $295m well adrift of forecasts of $360m.
• This signals a big slowdown in growth as the low-end of this range represents just 6% YoY.
• The full-year forecasts were also hit with 2022 revenues of $1.35bn – $1.43bn compared to estimates of $1.49bn, representing 22% to 28% growth in revenues YoY.
• All of these shortfalls are due to internal issues and execution problems within Unity itself and it looks like Unity is struggling with problems not dissimilar to those endured by Facebook when it went from fixed to mobile 10 years ago.
• These problems relate to the Unity Operate business where game developers use Unity’s platform to operate their games and Unity collects and analyses the data and takes a share of the advertising revenue for its input.
• Internal issues as well as a data problem from a big customer hit the accuracy of its targeting and hence its ability to charge for the advertisements its serves.
• Unity is adamant that this is a short-term execution problem that will be fixed by Q4 2022 and that things should be back to normal by FY 2023.
• Here, the company hinted that it should be able to sustain growth rates of 30% or more and that the market opportunity should remain unaffected.
• On this basis and after a 30% decline in the shares to $34, Unity has a market cap of $10bn and an enterprise value of $9.9bn.
• This means that the shares are still on 2022 EV / sales of 6.6x and 4.7x in 2023.
• This remains far from value territory and in this climate, there is plenty of space for the shares to fall further.
• If this internal issue turns out to be temporary and the valuation further unwinds to something representing normality, then it will be time to have a serious look at Unity.
• I like Unity as it could end up as one of the pioneers of the Metaverse, but this is so far away that one has to invest in the business case of the next 5 years which remains games platforms.
• On that basis, there is still plenty of air in the bubble to deflate the shares further before a bottom is found.
• The contrast with Peloton could not be clearer.