• Brett Schafer

Not So Deep Dive: Peloton Stock (Ticker: PTON)




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  3. Apple Podcasts

Watch on YouTube



Show Notes


(Ryan) What they do: Peloton is an interactive fitness platform. So it’s workout equipment paired with interactive classes. The two big pieces of hardware that they currently offer are the bike and the tread, but they also sell apparel and some accessories. But the majority of revenue comes from the 2 big pieces of hardware and the sale of memberships.


A little bit more about the logistics behind these. When someone buys a bike or a tread, they almost always do so through either the website or mobile app. They can walk into one of the showrooms and go for a test ride, but the purchase is often made online. The manufacturing is then done by either Peloton themselves in Taiwan or by 3rd party contract manufacturers. Then within their major markets, they employ last-mile logistics teams. So a Peloton truck, or occasionally a 3rd party, will drive the bike to the end consumer and help install it.


As for the content side, they have 2 production studios. 1 in London and 1 in New York. Those studios employ 40 instructors with different workout specialties. Could be cycling, running, yoga, strength training, meditation, or any number of things. These workouts are stored in a library of content that members get access to, but there are also live classes.


Should also mention: Standard Bike costs $1,495, Bike + is $2,495, the Tread is $2,495, and a subscription is $40 a month. But they all come with 39 months, 0% APR financing, so it’s actually quite affordable for a household.


(Ryan) History: In 2012 a former Barnes & Noble executive named John Foley had the epiphany that instructor-led classes were better than just working out on your owl but he wanted to take the experience into the home. The rest of the year was spent bringing in some other team members and raising a $3.5M series A and by 2013 they had a working prototype. By 2014 they were selling to consumers and they even opened their Manhattan studio that year. All along the way, they were raising funding rounds to help expand manufacturing capacity, because this was pretty capital intensive early on. I’m curious to know how the instructors were paid early on.


But by 2019, they officially came public. Interesting note, John Foley did an interview with CNBC before coming public saying that they were “surprisingly profitable”, and they weren’t.


(Brett) Industry/Landscape/Competition:

  • Competitors: Bowflex, NordicTrack, Echelon, and gyms

  • Global fitness industry estimated at $87 billion, with 200k gyms/studios around the world

  • Possibly the most important stat to think about with Peloton: There are an estimated 174 million fitness club members worldwide

  • I think it is a slam dunk for the fitness industry to continue growing around the world if the quality of life continues to improve and manual labor decreases (this stuff is strictly a modern and rich person activity)


(Ian) Management and Ownership:

  • John Foley is the CEO

  • Another good How I built this episode

  • He worked at Mars

  • Went to HBS

  • Later worked for IAC and ran one of their small companies

  • Worked on the digital side at Barnes and Noble

  • Started Peloton when he was around 40 years old

  • He owns about 1.8% of the company

  • William J. Lynch is the President, former CEO at Barnes and Noble


(Brett) Valuation:

  • Market cap of $27 billion, ticker PTON

  • (numbers before Q3 results released)

  • P/S of 6.75

  • P/GP of 18.6

  • No profitability metrics that really matter yet

  • 57.9 million stock options outstanding vs. 303 million shares outstanding. Expect dilution to be a headwind


(Ryan) Earnings: Their earnings calendar is a bit strange. Last Q they reported was their Q4, so I’ll talk full-year numbers, but new earnings are about to come out.

  • For FY 2021 they had just over $4B in revenue, up 120% from 2020.

  • However, that includes a big drawback in Q4 of this year from the recall of the tread.

  • They ended the year with 2.33M connected fitness subscriptions, 114% more than a year ago

  • ~20 Monthly Workouts per connected fitness subscriber in Q4, that’s slightly down YoY. But that’s a really tough comp, and still not a bad number.

  • And then it’s probably best to break gross margin into 2 camps. They have connected fitness gross margin (hardware) and they have subscription gross margin (software).

  • Last Q connected fitness GM was 11.6% vs 45.3% a year prior. That included the costs from tread recall but the company also reduced the price of its standard bike.

  • The subscription gross margin was 63.3% which is up from 56.8%

  • FY operating income would have been positive if it weren’t for the recall, but they reported an operating loss of about $188M

  • And OCF was -$240M, but inventory was down last year. So the spend on inventory decreased that number.

  • SBC was $194M for the year. A little unnecessary.


(Ian) Balance sheet and liquidity:

  • About $1.6B in cash and short-term investments

  • About $1.5B in debt

  • ~$830mm is convertible notes, 0%

  • The conversion price is $240/share, good for Peloton

  • Inventory is ramping up significantly, something to watch

  • Management says it is related to the launch of new products and prep for the biggest holiday season ever


Anecdotal Evidence:

  • (Ryan) Several family members have them and still use them frequently. It’s more convenient.

  • (Brett) I just joined a gym and didn’t think at all about buying a Peloton. I think the easiest anecdotal evidence is just looking at their workouts chart in the shareholder letter. That tells you whether people are still using the product.

  • (Ian)


Future growth opportunities:

  • (Ryan) Corporate wellness programs. They launched this program in June and it allows employers, insurers, and other partners the ability to offer their employees and members subsidized access to peloton digital subscriptions, all-access memberships, and/or connected fitness products. They signed a few big corporations, but CFO Jill Woodworth said they’re more than willing to reduce gross margin percentage to increase gross profit dollars and I think that’s what you get here.

  • (Brett) strength workouts. If they really want to get more people from gyms they need to go after more workout verticals. Strength workouts increased 256% in FY 2021 and are now 18% of the workout mix. This also increases the value of a subscription.

  • (Ian) Wearables. I know, it has not been historically a good category, but Peloton and Apple might be the only companies that can do it effectively. Peloton is reportedly working on a digital heart rate armband. It acquired Atlas wearables in late 2020.


Highlights and lowlights:

  • (Ryan) Highlights: Seems like they’ve got the manufacturing/backlog issues solved and they’re building out a big facility in Ohio to help with that. Good that they have this done before Xmas. Received approval on the repair remedy for the tread. I also like the business model. It scales really well. Lowlights: I’m not overly fond of the management team. And I can’t really put my finger on why.

  • (Brett) Highlights: The margin profile of the subscription business looks good, and if there is going to be a winner in connected fitness, I would bet it will be Peloton. Lowlights: Acquisition of Precor, churn creeping up. Looks like they may be stuffing COR into S&M (store leases, payment processing, digital app costs, and property depreciation are all included in S&M, which makes no sense). I do not like that the founder’s wife has a large role in the business. Here’s a quote that scared me: “We did not have any undisclosed off-balance sheet arrangements as of June 30, 2021”. Material weakness as of June 30 on the valuation of inventory.

  • (Ian) Highlights: 92% retention rate. Very impressive, studios/health clubs typically have rates between 70-80%. Cult following. A most similar company to Apple with a cult following, hardware, and software. Lowlights: Lots of acquisitions. Uncertainty about the future. Safety, peloton tread. Is it sticky?



Bull case:

  • (Ryan) The name of the game is connected fitness subscriptions. You can increase LTV in other ways, but that’s the most important. Based on their current guidance for FY 2022, they’d be generating a little over $1.1B in gross profit from subscriptions. I think you need to get at least 10 million subscribers. Seems possible, especially with new product lines.

  • (Brett) Subscription gross profit gets to $5 billion, which comes from a 10x in connected fitness subs and stabilized churn. I don’t know if anything else matters unless they move into new business lines.

  • (Ian) Peloton is not just a COVID company. It continues to grow its subscriber base, and people relate to the brand for more than just spin classes. Need to grow revenue at 25-30% for the next 4+ years. If additional product lines catch on


Bear case:

  • (Ryan) I think TAM really is the biggest concern here. Maybe subscriber count is closer to saturation than the market thinks. I could probably argue the other side of that, but if it is, this would probably make for an underperforming investment. I think the idea of this being one of those temporary workout gimmicks is behind us.

  • (Brett) Churn creeps up and the addressable market is not as large as investors expect.

  • (Ian) Peloton wastes money on acquisitions, looking to grab the next big product innovation in connected fitness, but fails.



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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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