Connected fitness company Peloton’s (NASDAQ: PTON) stock is up almost 4x this year, trading at levels of about $115 or about 8x projected FY’21 Revenues. Peloton’s recent growth partly justifies these valuations – it has effectively at least doubled Revenues each year over the last three years and is on track to double Revenues again in FY’21 (fiscal years end in June). However, as the early phase of growth dies down and Covid-19 related demand declines, could the company’s success be a flash in the pan? Or is Peloton building a sustainable competitive advantage? While it’s still too early to tell, we think that Peloton’s business model has a lot going for it.
High Switching Costs: Peloton’s business model focuses on building commitment via its pricey, but high-quality exercise bikes and treadmills. Once customers invest in its high-cost hardware, it’s likely that they will continue to pay for the monthly connected fitness subscription service (about $39 per month) to get the most out of their equipment. This is evident from the fact that churn rates stood at just 0.65% in Q1 FY’21 – well below most subscription-based digital services.  The company is also looking to significantly broaden its reach, by launching slightly lower-priced equipment and indicating that it could eventually sell pre-owned bikes.
Favorable Experience For Users: The overall experience of spin classes and fitness lessons are highly dependent on the quality of instruction, and Peloton’s team of instructors have obtained celebrity-like fame. This is a big positive, as Peloton’s model scales well compared to physical fitness classes. The economics of owning a Peloton also compare favorably with gym memberships and spin classes. The average monthly cost of just a gym membership was about $58 in the U.S. in 2018, while Peloton’s connected program costs $39 a month and can also be shared among family members.
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Brand Buzz, Social Features: Being one of the first movers in the connected fitness space, Peloton has built significant brand value. The company is also building social features which could help to engage users and build a sense of community around its platform. This network effect could also help to prevent customers from churning out of its platform. Peloton is also counting on its lower-priced digital fitness subscription ($13 per month) as an acquisition channel for its pricier equipment and connected fitness offering. The company said that Digital Subscriptions grew 382% to over 510,000 over Q1.
[9/11/2020] Peloton’s Valuation
Peloton (NASDAQ: PTON) is an at-home fitness company that sells connected exercise bikes and treadmills and related fitness subscriptions. The stock is up over 4x year-to-date, as the Covid-19 pandemic and related lockdowns caused people to stop going to gyms and fitness centers and work out from home, causing demand for the company’s products and services to soar. Peloton now trades at about 8x projected FY’21 revenues, ahead of Apple (NASDAQ:AAPL) which trades at about 6.5x. Does this make sense? We think it does. In this analysis, we take a look at the company’s financials, future prospects, and valuation. See our interactive analysis Peloton (PTON) Valuation: Expensive Or Cheap? for more details. Parts of the analysis are summarized below.
An Overview of Peloton’s Business
Peloton Interactive sells connected fitness equipment including bikes (starting at about $1,900) and treadmills (starting at about $2500) with a monthly Connected Fitness Subscriptions ($39 per month), which streams and syncs instructor-led boutique classes to users bikes and the Peloton Digital Membership ($13 per month) which streams classes to mobile devices and smart TVs. The company’s Product and Service bundle are positioned as an alternative to not just other exercise equipment, but to gyms and fitness center memberships. Although the company’s products are priced at a premium, the ecosystem – which combines hardware, software, and content – compares quite favorably in terms of price versus fitness classes and subscriptions. For perspective, the average monthly cost of just a gym membership was about $58 in the U.S. in 2018.  While Peloton sells primarily to individuals, it also has some exposure to the commercial and hospitality markets.
Peloton has been growing quickly. Revenues rose from about $440 million in FY’18 (fiscal year ends June) to about $1.83 billion in FY’20, – an annual rate of over 100%. Equipment sales rose from about $350 million in FY’18 to $1.46 billion in FY’20, with the company delivering 626k Bikes and Treads over 2020 alone. Subscription Revenues grew from about $80 million to $360 million, as the company’s base of connected fitness subscribers rose from 246k in FY’18 to about 1.09 million in FY’20. Peloton’s total membership base rose to 3.1 million as of the end of FY’20, including users who only pay for its digital subscription (not connected to its equipment). Over FY’21, we expect Peloton’s Revenues to grow to almost $3.6 billion, driven by continued growth in equipment sales and a growing base of subscribers.
While Peloton remained loss-making as of last year, the economics of its business look favorable. Overall Gross Margins are thick at about 47% in FY’20 with hardware margins standing at 43%. In comparison, even Apple – an icon of hardware profitability – posted Gross Margins of less than that at 40% over its last fiscal. While Peloton’s Operating Costs have been trending higher, they have been growing slower than Revenue. With Revenue projected to double this year, Peloton appears to be on track to turn profitable.
Peloton stock currently trades at levels of close to $130 per share, valued at about 8x projected FY’21 revenues. While the valuation multiple might appear rich, considering that Apple – the most established hardware/software/services play – trades at about 6.5x – we think it is largely justified. Peloton’s Growth has been solid – with Revenues doubling each year over the last two years and sales are likely to double in FY’21 as well. Margins also have scope to improve meaningfully, considering the company’s high gross margins and low customer acquisition costs. Moreover, the company’s lucrative connected fitness subscription revenues are likely to be very sticky, as users who have invested in high-cost hardware are less likely to stop paying for its monthly service. Given the buzz surrounding the company’s brand, there may also be scope to double down on lifestyle and apparel products, taking on the likes of Lululemon and Nike.
That said, there are risks as well. Firstly, Peloton faces significant supply constraints at the moment. While a new manufacturing facility in Taiwan is likely to begin production at the end of the year, the company is still likely to miss out on some potential holiday demand. Secondly, as the Covid-19 pandemic eventually ends, investors could re-think the valuation of “at-home” stocks and this could at least temporarily impact Peloton’s valuation. Separately, tech giants – with their deep pockets and software ecosystems – could play a bigger role in the connected fitness space, challenging Peloton. For instance, Apple recently launched its at-home workout app, Fitness Plus, that provides guided workouts and connects with Apple devices such as the Apple Watch.
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