Peloton has been a public company for less than 3 years and its share price has been all over the place. It is now down over 90% since its all-time high back at the end of December 2022 and the volatility has been crazy.
The goal of this post is to analyze the company's fundamentals, lay down some assumptions about the future, and value the company as a whole.
Feedback is always welcomed!
What is Peloton?
In a nutshell, it is a company that's making money by offering:
– Connected fitness products – Exercise equipment (bikes, treads, and soon rowing machines)
– Subscriptions – Media content related to fitness (pilates, strength training, stretching, yoga, meditation)
– Fitness apparel (insignificant in terms of revenue at this very moment)
The hype
As we all know, the pandemic caused this company's share price to go through the roof. The demand for their products skyrocketed thanks to the lockdown and the media coverage of their products.
Connected fitness products
The revenue of their connected fitness products grew from $734m in 2019 to $1,5b in 2020 (99% growth) to $3,2b in 2021 (115% growth).
Note – Their fiscal year ends 30 June, hence, 2021 is the year starting July 1st, 2020 to June 30th, 2021.*
However, these products are generally considered more premium/luxury. For the same amount of money, one can subscribe to a budget-level gym for roughly 10 years and have access to a lot more equipment.
During this period, the gross margin that they had on these products was around 40%, which is quite high for a company in this industry, but the increased demand did its job well.
Until 2022 started and the growth was nowhere to be found. The revenue declined to $2,2b (-31%) and the decline was over 50% if the last quarter was to be compared year over year.
Not only that, but the gross margin was -11%. No, it is not a typo, they lost money on the sale of these products.
When there's a huge decline in the level of demand, it has a huge impact on the prices (Economics 101). Of course, the tough part was to estimate the level of demand for the coming period with all the uncertainty.
In 2022, the management put a lot of capital into inventory to meet the demand, which wasn't as high as before. So, at the end of 2022 (As of June 30th), there's roughly $1.1b in inventory. That's roughly 50% of all the sales they made in the entire last year. As the prices decline, they had to take impairment for some of these products.
Subscriptions
This, in my opinion, is their cash cow segment. It has been growing from $181m in 2019 to $364m in 2020 (101%) to $872m in 2021 (140%) to $1,4b in 2022 (60%).
The gross margin improved from 43% to 68% during the same period.
It seems that the company is more focused on selling connected fitness products as a way to reach out to its target customers and actually make money on the subscriptions.
The other operating costs
If we combine both revenue sources together, the total revenue for the last 12 months was $3,6b with a thin gross margin of 19% (gross margin of close to $700m).
Every young company is known for incurring losses due to heavy spending on Research & Development and Sales & Marketing that would allow them to grow fast. In that respect, Peloton is no different.
In 2022, the spendings were as follows:
- Sales & Marketing – $1b
- General & Administrative – $1b
- Research & Development – $360m
It is quite clear that the gross profit of $700m is not sufficient to cover these main operating expenses. Peloton lost over $1.6b from its operations (-46% operating margin). This is not that surprising as the majority of the high-growth companies are losing money due to the higher than average spending on Sales & Marketing and Research & Development. However, when the growth is no longer there, that's when it becomes ugly. In addition, I was not impressed by the level of R&D spending as Peloton's long-term success is highly dependent on its innovation.
But that's not all. They had 3 “one-time expenses” during the year:
- Impairments – $562m – Mainly related to goodwill, part as mentioned above to inventories
- Supplier settlements – $338m – Based on the information available, it relates to the settlement of litigation with iFIT
- Restructuring – $181m – As the demand falls, the number of employees is reduced
It could be argued that these are one-time expenses (as they were non-existent in the past), however, as the demand is falling and their inventory levels are high, it would not be surprising if there are further impairments, further restructuring, and who knows whether there will be further supplier settlements. If we take all of this into account, the operating loss of the company was -2,7b (-76% operating margin).
The balance sheet
On the balance sheet, apart from the high inventory levels mentioned above, there's around $1.3b in cash. Although on its own is a big number, it doesn't seem so big when we take into account the last year's losses company had. If the margins don't improve dramatically, they will be raising capital during the next 6-12 months.
They already have a debt of $2,4b (for comparison purposes, their market cap is $3,6b) so they're in a tough position.
Striking deal with Amazon
In the last 7 days, there were 2 huge headlines. The first one was the deal that Peloton announced that part of their products will be available for purchase in Amazon US stores.
The share price went up around 20%.
Only a few days later, they shared the 2022 earnings and the share price returned to the same levels.
This is a great example of how short-sighted the market can be at times. The deal with Amazon could be a great way to dispose of a large portion of the inventory that's just sitting there, but Amazon will take its share. That means Peloton's margins are not going to be as high (let's not forget, they're already losing money on their connected fitness products).
The more important question is, is there going to be increased demand for their products, regardless of whether they're being sold through Amazon or direct to the final consumer?
The key assumptions about the future & valuation
If we take a look at the analysts' expectations regarding next year's revenue, it ranges from $2,29b for the entire year (-36% compared to 2022) to $5,82b (+63% compared to 2022). This huge expectations gap shows the uncertainty around the company.
My personal views are that the Amazon deal will help their connected fitness products to not have a significant revenue decline, while the subscription revenue is still growing strong. However, I don't expect their operating margin to improve significantly in the next year.
Hence, my assumptions are as follows:
| 2023 | 2024 to 2027 | 2028 to 2032 | |
|---|---|---|---|
| Revenue | -5% decline | 5% growth / year | 3% growth / year |
| Operating margin | -20% | slowly improve to 5% | slowly improve to 15% |
My expectations are that the company has to focus more on cost-cutting and less on significantly growing revenue (other than their subscription revenue)
Discount rate: 8% today, increasing to 8.8% in 10 years
Based on those assumptions, the fair value of the company is close to $1,2b ($3.48/share)
The current market cap is $3,58b ($10,61/share)
Note: I have taken into account the cash, debt, and deferred taxes on their balance sheet as well as the outstanding equity options.
What if my assumptions are significantly wrong?
Based on the assumptions above, the revenue will grow by 39% in 10 years and the operating margin will be 15%.
I am aware that my assumptions could be significantly wrong. So, let's take a look at how the value of the company (per share) will change based on different assumptions regarding the revenue 10 years from now and the operating margin:
| Revenue / Op. margin | 10% | 15% | 20% |
|---|---|---|---|
| 24% ($4,4b) | -$1.9 | $2.7 | $7.2 |
| 39% ($5,0) | -$1.6 | $3.5 | $8.5 |
| 192% ($10,5b) | $1.3 | $11.3 | $21.4 |
| 300% ($14,3b) | $3.2 | $16.7 | $30.3 |
This table illustrates well how important it is for Peloton to cut costs and improve margin. In some cases, the fair value of the company is even negative, meaning it's not worth anything! Of course, one can argue that those assumptions are too pessimistic, but there is a chance that it plays out.
Of course, if they manage to grow 300% in the next 10 years (which is the assumption of the most optimistic analyst) and on top they improve the operating margin to 20%, there's 3x upside.
However, that means Peloton will need to bring $14,3b in revenue in 10 years. Just for comparison purposes, the total gym revenue in the US is $32b/year. This is a mature market, so growth is not expected.
Let's not forget that the share price at the peak of the hype was over $160/share. If that seems crazy, it is only because it was crazy! To justify a price of $160/share, Peloton needs to bring in 2x the revenue of all US gyms combined and have a higher operating margin than 25%.
What are your thoughts on Peloton as a company?
Also, feel free to provide feedback regarding the analysis, that is always appreciated!
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