Here's What We Know About the Peloton IPO

Connected fitness company Peloton pioneered a business model that a lot of would-be rivals are starting to replicate -- its stationary bikes sell for $2,200 and up, after which, customers can pay an additional $39 a month to get access to digital workouts and live classes. Based on its impressive retention rates and profitable status, that's working pretty well for them. But is this company public market material?

On this week's Industry Focus: Consumer Goods show, host Dylan Lewis and Motley Fool analyst Dan Kline look into it. Learn more about Peloton's brand power and niche, its competition, market dynamics, and more, and what it all says about this company's long-term investment potential.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on July 16, 2019.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, July 16, and we're going to be putting Peloton through the IF boot camp. I'm your host, Dylan Lewis, and I've got fool.com's Dan Kline with me on Skype. Dan, what's going on, man?

Dan Kline: Oh, not too much! As you can tell, coming to you from my den today because a little bit of a parenting conundrum this week.

Lewis: I always like to see the setups that our remote contributors have with their taping. Some people have the very nice, elegant libraries behind them with all of the must-read business books. You've got kind of a simple layup behind you.

Kline: I generally tape from my co-working space. But my wife had to fly to Connecticut abruptly, so I'm stuck in the house, in and around. I apologize for the very casual set up.

Lewis: [laughs] No worries, Dan! Our listeners can't tell. I think they hear you just the same, no matter what the setting is. 

Kline: Well, we appreciate that!

Lewis: On today's show, we want to talk about a company that will be going public at some point soon. We do not have a public filing for this business. That is Peloton. They have filed confidentially with the SEC, so there's some intent here to go public. We don't have a ton of specifics because we don't have the filing yet. But this was such an interesting story and it tapped into such a big trend that you and I have both been following for quite some time that we wanted to discuss it, Dan. 

Kline: Yeah. It's really interesting that this is a company that would seem to be one of these huge investments, you're going to look at the numbers and find out they're losing all sorts of money in attaining customers. The reality is, they say they're profitable. They're raising money to fend off competition, not because they need the money. And they've created a business model that we're just starting to see others latch onto.

Lewis: Yeah, it's kind of a new idea. For the people that are not familiar, Peloton is probably best known for their stationary bike product. They also have a treadmill product, and they're working on a digital offering as well. But their basic product offering is, they have a package. The low-level one runs about $2,200 for their stationary bike. That gets you the hardware, and then you have membership payments of $39 a month. The treadmill costs about $4,300 and has a same membership model. The idea here is, you have this fitness equipment that you can put in your home, or perhaps in a shared space like a hotel, and then the membership payments get you access to this entire digital library of workouts.

Kline: Yeah. They've created a market that's now called connected fitness. What this does is, it brings some of the communal spirit of taking a spin class. When you go to a gym, there's some encouragement from the teacher, from seeing students around you. With Peloton, obviously, you can do taped classes, but you can also do live classes from their studios. And you're getting that interaction, and it makes it more communal. In theory, it makes you want to do it more than just the traditional exercise bike that's a very one-on-one experience.

Lewis: Yeah, they're trying to build that community and take advantage of the digital abilities that are out there. There are some that are likening it a little bit to the Netflix of fitness. We like using that type of catch-all so much, it's so tempting for us. They've decided to dive a little bit more into digital recently. They really started out with the stationary bikes back in 2014, and are now giving an all-digital product as well. It's a Peloton app. I think for about $20 a month, you can access their full library of workouts, so, if you have an iPad or something like that at home, you can have these curated and specific workouts targeting a lot of the stuff that you want to be working on.

Kline: It's worth noting that that's a very crowded space. There are a lot of workout apps. I actually in the gym today saw someone following along on their phone and doing an app. There's a lot of services for that. But with Peloton, their goal is, that's almost like an add-on. If you've already paid for the gym and their services, that's a way to use it when you're traveling, when you're not at your physical bike, because the negative of having your Peloton bike or treadmill is that it's not all that portable. You're probably not going to bring it with you on vacation. 

Lewis: No, it is a fairly large piece of fitness equipment. I don't think anyone's bringing that to the beach house for the summer if they're only there for two weeks. It's the kind of thing that tends to stay in one spot in the house.

Kline: For any of you who are thinking, this doesn't look all that different from the exercise bike in your gym, except instead of the screen being a television, or maybe even something that shows you a little bit of terrain, or gives you some numbers on your workout, it's a live class where you can see the teacher, or a taped class where you can see the teacher.

Lewis: Yeah, it's definitely worth looking at some of the promotional videos to get a better sense of what this looks like, for anyone that has not attended a fitness class before or hasn't seen one online. There is this jazz to it. There's this excitement to it, that I think is probably really motivating for people that are using Peloton devices.

Kline: Yeah. If you want to check one out, there's a pretty strong retail presence. We joked about this a little bit on Slack, but look around your area. Whichever one the nice mall is, the mall that has all the fancier stores, Peloton often has, they're kind of pop-up kiosks, but they're almost like pop-up exercise studios, where you could get one, you could try it out, you could get some of the excitement of how this would work. Forgetting the price and the competition, it is a pretty cool product.

Lewis: Let's dive into some of the numbers that we do have. Like I said, we're a little limited here because we don't have their financials yet. But we do know that since beginning selling bikes in 2014, the company has sold more than 400,000 bikes, and they have over 500,000 subscribers for its memberships. Based on some comments from management, we know they're profitable, seemingly, and that 2018 revenue was somewhere north of $700 million, which was up from about $400 million in 2017. Obviously, a lot of growth going on here, Dan.

Kline: There's one number that's absolutely huge to me: They say they've retained 96% of their customers. That tells me a couple of things. One, when you watch the commercials for this, it's the beautiful people, and their Peloton is always in some amazing place, like a vista behind them. It seems to me that the early adopters of this would be people who are already pretty good about their fitness routine. If they can hold onto those people, as it gets down to, I don't want to say regular people, but people who are not as committed to fitness, who do this and see it as the miracle cure, I'm going to guess that retention rates are going to stay pretty high. Once you've invested $2,200, $2,400 in buying the bike, it's hard to say, "I'm going to cancel my $39 subscription, which turns this bike into effectively a coat rack."

Lewis: Yeah, there has to be some element there of the sunk cost incentivizing you to be more active.

Kline: Yeah. And, $39 -- I'm actually very surprised the number was that low. I never looked into the cost before. When you look at your gym membership, if you cancel your gym membership, you might as well put on social media, "I've given up," while you're eating a tub of ice cream or squirting cookie dough directly into your mouth. You're going to get a little bit of that, like gym logic of, "I know I didn't use the Peloton last month, but I'm really going to use it every day next month." And that will work for them if they can continue to get the next level of people into the product. What I don't think they're going to do is, the replacement cycle on these is going to be very, very long. Bike technology does not change that much.

Lewis: No, it does not. And, so we aren't shaming anybody, and so we're being candid here and giving a good feel for our perspectives on the fitness world, maybe we should talk a little bit about where we're coming from here, Dan. I truly love putting a bunch of cookie dough and ice cream in my mouth.

Kline: We've talked about this before -- Dylan is much younger than me, and in dramatically better shape. He's getting, like, fan mail from screaming teenagers. I am not. 

Lewis: [laughs] That's all too flattering, Dan! I'm not the Beatles!

Kline: [laughs] I know. But Dylan's a fit, good-looking younger guy. I am 45, and last year, decided I was going to get back into running, and super messed up my knees. Six months of physical therapy, a lot of sedentary-by-force behavior. And then, about three months ago, I went back to the gym, and I realized I work well with appointments. That's good for me at work. It's good for me in fitness. So, I pay a trainer to come to my home gym. I live in a building that has a nice gym. And three times a week, we do a very hard -- didn't start hard, but it's hard now -- hour workout. And then he holds me accountable. We text back and forth on days we're not working out. And it's been very good to make me go to the gym when I'm not with him, and also, when I'm on vacation -- I was on a cruise ship last week, and instead of at midnight having a pizza, I had a piece of grilled chicken. [laughs]

Lewis: There you go, Dan! That's true strength right there!

Kline: I'm putting an effort in to get back to palatable. I was joking to one of our colleagues today that I'm trying to look more Hulk and less Endgame Thor. That's a bit of a spoiler if you haven't seen that, but Thor has let himself go a bit out of depression in that movie. I'm working very hard. But my habits are more regimented and expensive than the way you're doing it.

Lewis: Yeah. For the summer, I've been biking about 20 miles each day to work to make up for the fact that the Metro is closed. And, I usually play soccer about once a week in a D.C. rec league. I'm biking a good amount, I play some sports. I'll occasionally get down to the gym, but I'm not someone who's spending a ton of money on fitness products. 

I think there are elements of both of our fitness tendencies that play into what someone at Peloton would be targeting, but neither of us are necessarily the ideal target market for this product.

Kline: No. If my building had a Peloton, I would probably use it twice a month to shake things up. But, when you go to a class and you're not physically there, there's no real accountability for it. If I have an appointment with my trainer and I cancel, it costs me money. If he shows up and I don't put in a full effort, I've wasted time and money. Whereas if I'm doing it remotely, there's only so much encouragement -- again, there's people in my family, my aunt is super fit, and she was always the one that had the old NordicTrack ski machine, and she'd use it all winter when you can't go outside. Peloton would be perfect for her because she goes to classes but she's time constrained. For someone like me, for someone like you, I'm not entirely sure at the price point it's a very logical product.

Lewis: Yeah. There are definitely some internet memes about the stereotypical Peloton customer, and the place that it sits, maybe, in the home or in the home gym or something like that. There was this tweet thread that went viral a little while ago and it was from a Twitter handle @ClueHeywood, and Clue said, "Love putting my Peloton bike in the most striking area of my ultra-modern $3 million house." 

Kline: Right. That's a brand lifestyle piece of this. When you market exercise, you can do one of two things. You can be like -- and I mean this jokingly -- "Hey, fat lazy slob! We're just like you! Try it, it's easy! You'll get in! Here are the amazing results you can have!" And I'm teasing a little bit, because that's certainly could be how you market toward me at various points. Then there's the person who looks like they don't need to work out because they just spent 19 hours at the gym, and they go to an all-you-can-eat buffet and eat water. [laughs] That's the Peloton lifestyle. Everyone is super good-looking, they're models. It's aspirational. You're supposed to believe that if you buy a Peloton, three months from now, you're going to be a supermodel living in a mansion. Rationally, I think you understand that's probably not going to happen, but that's where they're going. It's how a lot of the high-end gyms market themselves. This is a gym you're going to come to that costs $200 a month where you put makeup on before you go.

Lewis: Yeah, this positioning is not limited to Peloton. You look at a lot of the boutique gyms out there. I'm thinking about Orangetheory, I'm thinking about some of the other big ones, SoulCycle for example, a lot of those are scenes into themselves, and they are a place to be seen and it's a cultural community in addition to being a place where you work out. I think Peloton plays on that a little bit, except it is in the comfort of your home.

Kline: Yeah, and I think that is a little intimidating. But I will point out that Peloton does have entry-level classes. If you have never been on a bike before -- I went to a Peloton at the mall, I think I sent you a picture of me doing that. And I asked them questions about, can my middle-60s mom, who's never been on an exercise bike, or at least hasn't since the 1980s, do this? And there's absolutely classes for all levels. So, they're not actually as exclusionary as their marketing would be. But they definitely want the marketing to be upscale. I do think -- we'll talk about this in the second half of the show -- that leaves them vulnerable on a certain level.

Lewis: Actually, there are some tools that the company makes available that almost play into this "visualize your future self" mode. If you're on their site, and you're on mobile, at least on iPhone, and you're checking out one of their products, you can use AR to place it in your home. You can literally have the Peloton sitting in front of you in your corner or out in front of your windows as they are in these advertisements. There is this element to the way that they are trying to market to people of, "Hey, picture this, and picture your future self," a little bit.

Kline: Jason Moser and I talked about augmented reality a few weeks ago. One of the things we talked about is how valuable would it be for trying on outfits. "Gee, I wonder what I would look like in that hat or that pair of glasses." Now, you sent me an augmented reality picture of a Peloton in our office. I'm familiar with that spot in the office. And I had to look at it and go, "Wow, did you get one of these to test out? Is this just a coincidence that we're doing a show and they dropped one off?" It was 100% believable.

That said, I don't need augmented reality to picture how an exercise bike might look like in my house. It's not something that requires a fit, like a pair of glasses, where you might like it, and it might not look good. I know what an exercise bike looks like. I know what my house looks like. I have the level of imagination it takes to figure this out. This isn't Pokémon Go, where they're blowing your mind. But it was a cool piece of technology.

Lewis: [laughs] Dan, I guess I will just cut out one that I've printed and send it to you in the mail so you can hold it up, and then immediately be able to place it within your house.

Kline: [laughs] Yes, I'll give you my fax number later.

Lewis: All right, Dan. Like so many of the unicorns that have gone public in 2019, there is some serious demand for shares of Peloton. I've heard and read that there are a lot of people that are pretty excited to see this company go public. What has you excited about this business?

Kline: They've carved out a brand, and that does mean something, but I'm not that excited about this business, only because they are hitting one piece of the market. Call it the SoulCycle crowd, the pricey, the fancy, the good-looking fitness people, the wealthy. And when you look at where the market is going, every existing fitness brand has the ability to move into connected fitness, and they might have the ability to do it by offering an add-on for products that are already out there. If you look at who's going into it now, brands you've heard of, really, the name brand is NordicTrack. NordicTrack has always done infomercials and advertising. They've been a very public-facing brand. They sell direct to consumers with financing. They have some stores. And they're offering Peloton-like products of all the different cardio machines they make. For your average consumer, that might be more appealing than Peloton. There's also some, let's call them sports-specific. There's one called Hydrow. It's a rowing machine. Same sort of premise as the bike. There's one for boxing where you can take virtual boxing classes. There's another one that's called MIRROR, which is a mirror you put on your wall where you have access to gym workouts. You might take a yoga class, you might take a strength training class. This space is going to become very, very crowded, and that's without, what if Planet Fitness starts offering at-home classes to members? What if any of the other studios make things available? There's just a lot of potential competition, and I'm not sure what the advantage they have is other than branding.

Lewis: What we've seen far with Peloton is that most of their ads seem to be targeting the individual buyer, the consumer. They are not saying, "Go to this hotel and use it," or "Go to this gym and use it" -- at least for most of the spots I've seen out there. It's much more, "This is something that is in your home." I wonder, though, at the price point for these products, is this something where more of the customers might ultimately be people that are enabling a ton of people to use it instead of it being a device that sits in one person's home?

Kline: I mean, health clubs are about 40% of the connected fitness market. I think there's obviously an ability to bring this into everyday gyms, where maybe there isn't always a class going. Even the fancy gyms might have classes from the main hub in New York or wherever it happens to be. The reality is, Peloton would be working against fitness companies that already have a sales rep network that sells to your national chain gyms. if you're Peloton, one, you have to create a commercial product, which is going to be a higher grade of steel, a more durable bike than a home bike which gets used an average of 13 times a month. Even if you have two or three people in the house that use it, that is not the equivalent being in a gym, where it's going to be used hour after hour and need a maintenance program. So, yeah, I think those are all markets for Peloton, but it's going to be hard for them to get in. Even something like selling to my home gym or your home gym in our building, the companies that already sell to those places have an advantage. Do they have to take on reps? Do they have to be sold by a third party? They're going to be fighting an uphill battle. 

Lewis: The flip side of that, I will say, is by creating this aspirational brand, they are able to create some pull for their own products, or create cachet for places that would be putting their products there. If you were trying to be the hip apartment building in Columbia Heights in D.C., you might have a Peloton instead of your average stationary bike.

Kline: The building across the street from me in West Palm Beach is a hip, fairly expensive rental building connected to the brand-new, ultra high speed train. I could see a place like that advertising as an amenity, "We have Peloton machines." There's absolutely that piece of it. That's a nice market, but what I don't see this brand becoming is eight or nine times bigger. Can it become a $2 billion brand? Maybe. But at some point, does it hit a life cycle where, yes, it's hit all the places it can go, and there's not that many new customers coming in? Again, how many people are buying, how many businesses are buying, a $2,400 -- or a commercial one, say a $4,000 or $5,000 -- bike? And how often are they replacing it? It's not going to be that often. Now, is your commercial subscription going to be higher? They don't have a lot of added costs for more subscribers. This isn't Netflix, where they have to make exercise classes that appeal to an incredibly vast array of people. There's somewhat of a limit to it. If you're doing one studio with three different gyms that has live classes every 20 minutes, that's probably going to cover your bases pretty well. And then your taped archive becomes enormous very quickly.

Lewis: One thing I do think is pretty smart with how they've set this business up is, we talked about the difficulties of the hardware business. Those difficulties are there whether you're selling iPhones, TVs, or these incredibly specialized fitness devices. The upgrade cycles are very hard to anticipate. The inventory decisions that you have to make are really difficult. And you need to keep coming out with hit products and expanding your portfolio. What they have done well is say, "You need the hardware to really be in this. You can access it elsewhere, but if you have it in your home, then you're like you're hardcore, you're in this. But, we have this recurring, super high-margin revenue coming in from memberships." And I imagine those content costs scale over time and it all becomes incremental for every user they're able to add.

Kline: Yeah. Look, if this was a private company that I was having a chance to get a piece of, I think it's an amazing business. They already make money. I see no reason in the next three years they couldn't triple their user base, which has almost no incremental cost, in terms of added content. So, that $39 a month per another 1.5 million people is really highly profit. 

That said, there is a pressure as a public company to show growth quarter over quarter, month over month, year over year. And I do think this tops out, and the ability to have a next product -- if I already have an exercise bike, and that gets me into shape, am I going to want a rowing machine, a climbing machine, a Peloton, I don't know, slow cooker? I'm not sure what the next angle would be. In a lot of ways, this to me is like a GoPro-like play, where you can be very successful and still not be a good publicly traded company.

Lewis: Yeah, I think the services or the software ambitions for them -- in this case, content -- are much further along than GoPro was and Fitbit has been. Both of those companies were hardware companies trying to say, "Hey, we're platform businesses." I think that Peloton has the money to back it up. They have the built-out subscriber base, that's there. 

We threw out some pretty big numbers when it comes to the cost of running one of these things over the course of the year, if you were to buy it and then use it every single month. They are big. That is not an inexpensive amount of money to lay out. I will say, if you are someone that is in that market and you are regularly going to a SoulCycle class every couple of days, I ran the numbers. [laughs] I couldn't help myself, Dan. Flywheel offers a package that lets you do 12 classes a month for about $225. If you use that as a benchmark, you would be breaking even on buying a Peloton in a year, and you'd have the benefit of taking more than 12 classes each month and being able to do it from home. So, there is a market where I think this makes sense.

Kline: Yeah, absolutely. When I lived in Connecticut, I was a member of a gigantic yoga studio. It was, let's call it $140 a month, somewhere in that range. There were two studios, so there were classes every hour, every 90 minutes, there was a lot of choice. But even then, there wasn't always choice. There wasn't endless choice. If I had the ability at home to start almost whenever I wanted or whenever I wanted with taped stuff, that's an advantage for Peloton. And clearly, an average CrossFit gym is going to cost you over $100 or close to $200 a month. There's absolutely people spending this for fitness. I'm spending dramatically more than this for fitness, and hopefully I get in good enough shape that eventually I don't have to do that and could consider some of these alternatives. 

But even when you look at what an Orangetheory costs, which is much cheaper per class, if you're going regularly, once you've paid for the bike, the $39 a month is a mid-level gym membership.

Lewis: Yeah. I think it makes sense for the hardcore users. I worry a little bit about how deep the market is for those people. I think we've also seen the rise of things like ClassPass, where people like the class atmosphere of fitness but they don't want to do the same thing all the time. Sometimes it's a barre studio, sometimes it's yoga. Sometimes it's more of like a Barry's Bootcamp type of thing, which my roommates do at 06:30 in the morning while I'm sleeping. [laughs] Everyone has their shtick.

Kline: I do worry about the repetitiveness of it. If I had a Peloton, well, there's only so much you can do with a bike. You can't turn a bike into a rowing machine, you can't turn a bike into a strength training workout. There are limitations. What else could they sell you that changes that up? I'm not sure that, if I was a hardcore exercise enthusiast, would it be worth it for me to spend $2,400 and $39 a month for something that was only part of my workout routine? 

But I do think, for some people, the answer will absolutely be yes. They've shown, with 400,000 bikes, 500,000 subscribers, clearly there's an audience for it. The question is, how big is that audience? And, can they fend off the competition?

Lewis: Yeah. We will definitely be digging into the filing once we have full access to it. In the meantime, there's an interesting business here. What it really comes down to is, can they set up some of those really great relationships with people that would be footing the bill so that other people can use them -- the hotels, the fitness centers, that kind of stuff? I think the business gets a lot more interesting there. I'd love to see some more metrics on retention. We saw that 96%. I worry that's a little bit early adopter focused. I want to see what some later cohorts of customers look like.

Kline: Right. The other question is, can they come up with things like their digital-only product and attract a new audience? You have a bike. Can they come up with a $250 dock your bike sits in that gives you Peloton-like access that doesn't undercut their regular market, because the average person who's exercising maybe isn't also a cycling enthusiast? Can they come up with programming that's maybe not exercise-based? Maybe they're going to take me through a tour of the countryside, and use some of the AR technology and do other things with it. Can they fend off the fact that Best Buy has opened up connected fitness as a category, and is representing a lot of other brands, but not Peloton? There's going to be a lot of competition here. They are very well set up. This is going to be a successful company. The question is, will it be a successful public company?

Lewis: Absolutely. I think those are the kinds of things that take it from what is now roughly a $4 billion business to something multiples of that. Of course, the road there won't necessarily be easy. 

This is certainly a topic that I would love to hear from some of our listeners on. If anyone wants to write in with some of their fitness habits, whether or not they have their eyes on a Peloton bike, maybe considering checking out their app, or if there's any other dedicated fitness programs or devices out there you think we should check out, I would love to hear from you. Obviously, Dan and I are somewhat in this market, but not totally in this market. I mention this because we've gotten some awesome boots-on-the-ground reports from listeners recently. A couple in particular -- James from Ireland, who gave us the lowdown on his experience at Luckin Coffee in China; and from Lisa, who spotted some Uber bikes over in Europe. Always fun to get those messages, Dan.

Kline: And if anyone wants to commiserate about trying to get back into shape as a 45-year-old father -- or mother, or, frankly, anyone -- I am more than happy to share war stories and be supportive of anyone out there.

Lewis: You are @worstideas on Twitter, right, Dan?

Kline: I am!

Lewis: All right. If you want to reach out to Dan, you can catch him @worstideas. And he has a lot of great ideas, that just happens to be the title of the book that he wrote.

Kline: [laughs] I was going to say, I kept the handle because it was the title of my book, and it's kind of funny given that, obviously, I'm trying to give you good ideas when I appear on these shows or write for Motley Fool.

Lewis: I always think you bring plenty of good ideas to the table. Thanks for joining us today, Dan!

Kline: I appreciate that!

Lewis: Thanks for listening, folks! That does it for this episode! If you have any questions or you want to reach out and say hey, you can catch us @MFIndustryFocus on Twitter, or [email protected] via email. If you want more of our stuff, subscribe on iTunes, or you can catch the videos from the podcast on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass today! For Dan Kline, I'm Dylan Lewis. Thanks for listening and Fool on!