Viral Spot is Just Short-Term Noise for Peloton, But the Company Faces Real Headwinds

JohnWallStreet

Peloton Interactive released a television advertisement on November 21st that widely missed the mark. In the now viral spot, a man surprises his significant other with a fitness bike for the holidays. The actress, who goes on to document her progress over the next twelve months, ends the spot proclaiming ‘I didn’t realize how much this would change me’. Those easily offended jumped on the opportunity to cry ‘sexism’, which resulted in a social media firestorm that contributed to a -15% slide for PTON last week (to $31.31 at the close on 12.5). The company is standing by the controversial advertisement stating, “while we're disappointed in how some have misinterpreted this commercial, we are encouraged by—and grateful for—the outpouring of support we've received from those who understand what we were trying to communicate.”

Howie Long-Short: TheStreet’s Katherine Ross says that there is no reason to believe the negative sentiment surrounding the commercial will have a lasting impact on Peloton's business. “[The media outrage is] short-term noise. Next week, something else will make headlines and [the company] will be out of the news again.” Raymond James’ analysts agreed saying they did not expect the ad to “adversely affect holiday demand.” It appears as if cooler heads have already begun to prevail amongst investors. PTON shares rose +4% (to $32.63) on Friday 12.6.

Ross says that PTON’s “path to profitability” is a far greater long-term concern for investors. Despite beating analyst forecasts on both total revenue (+103% YoY to $228 million) and high-margin subscription sales (+103% YoY to 1.6 million) during the most recent quarter, the company posted wider-than-expected losses ($49.8 million). CEO John Foley insists that the customer loyalty his company enjoys will be their ticket to success and with a 94% 12-month retention rate on connected fitness subscriptions and user engagement climbing (+31% YoY to 11.7 classes/mo.), there is seemingly evidence to support the notion. But early adopters are likely to be the most fitness obsessed and thus the most likely to stick with the program. Ross wonders “will a [less motivated individual] continue to pay for classes if they stop using the bike after a few months?” In other words, while the company’s subscription business looks to be a strength today, she questions how many users will still be paying a monthly fee several years down the line. Of course, one could certainly argue that anyone willing to spend $2,000+ on a piece of fitness equipment is in it for the long-haul.

Historically speaking, fitness trends have come and gone (see: Jazzercise, Tae Bo), so while in-home cycling classes are popular today, there’s no reason to believe that a new fad isn’t on the horizon. Ross notes that while “more and more people are looking for little set-ups that they can put in their home in place of a gym”, traditional gym business “have done a really good job of fighting (see: low pricing, class options) to retain market share – they are here to stay.

Peloton isn’t profitable because it has been focused on building out its product line. While the company has been hesitant to disclose those plans in detail, a less expensive bike, a treadmill and a rowing machine are all rumored to be in the works for 2020. Diversifying products should lead to growth in hardware sales (think: will reach different demographics) and keep Peloton loyalists from burning out on a single discipline (see: good news for their subscription business).

Mounting losses and historical precedent has had little impact on investors eagerly buying up Peloton (shares are +35% over the last 30 days), but investors should be wary about another threat to the business - the possibility that company will face additional music-related lawsuits (or simply be forced to cut down on music library). Remember, Peloton is selling themselves as a premium product (and charging a premium price). Users aren’t going to tolerate playlists that are missing more than a few of their favorite songs.

Peloton trades at a significantly higher multiple (more than 10x 2019 revenues) than other connected fitness products (which trade at less than 2x), but Ross says to avoid the comparisons; unlike companies like FitBit and GoPro, PTON offers classes that bring in recurring revenue (with or without buying the hardware). The company’s business model seemingly has more in common with the budget-friendly gym chain Planet Fitness, including the multiple Wall Street has assigned to it (+/- 10x 2019's projected revenues).

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