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Perhaps you can relate to John Foley, the founder of Peloton (NASDAQ:PTON), when it comes to getting up early in the morning to make it to your fitness class. Sometimes, it's just not gonna happen.

In 2012, Foley saw the trend of team-fitness boutiques such as yoga classes, cycling classes, and other related group fitness classes. Team fitness was a growing trend as people prefer working out with others over going to the gym by yourself or running outside alone. But these fitness boutiques had limited capacity which meant that, if you wanted to get in the class, you had to sign up early or arrive before spots run out. What if this idea could be scaled to reach 5 million, 10 million, or 50 million people worldwide, with no limits on the size of the class? This sparked the idea to bring the intensity and motivation of cycling into everyone's home. Problem solved!

The Peloton logo on one of its bikes

Image source: Unsplash.

Peloton is a fitness company in North America that offers virtual interactive in-home fitness equipment with connectivity to some of the world's top fitness instructors. Its signature product, the Peloton Bike, has made it to over 400,000 users who enjoy the luxury of a world-class fitness bike with access to live classes with top fitness instructors through its touchscreen technology. In 2018, Peloton also released its interactive treadmill product.

Peloton went public on Sept. 26 with a guide price of $29 per share, giving it a valuation of about $8 billion. However, the stock opened $2 below this price, and, as of the market close at the end of the week of its IPO, it was trading at $25.24 per share. Peloton CEO John Foley said it was "some slight disappointment" that the share price closed below the guide price.

So, is Peloton a good choice for buying into the in-home fitness trend, or will it be in the near future?

Here's a few highlights of Peloton's IPO as a potential investment for the growth investor.

An overview of Peloton as an investment

What is Peloton's business model? According to Foley, "Peloton sells happiness," but in reality, the company makes the majority of its income through its subscription service to live fitness classes.

As of June 30, 2019, Peloton has sold approximately 577,000 Connected Fitness Products and counts 1.4 million members who've downloaded the Peloton app. Peloton has two subscription options: the Peloton Membership at $39 per month and the Digital Membership at $19.49 per month. The company has over 500,000 paying subscribers across these subscription packages. 

Not only does Peloton sell fitness bikes, but it now offers treadmills as well. As of this writing, the fitness bikes sell for about $2,200 and the treadmills for about $4,295.  In addition, those without Peloton fitness equipment can subscribe to generic fitness classes such as yoga, walking, and running.

From an investment standpoint, the subscription model is a highly attractive and sustainable setup. It automates the income stream while reducing the number of lost clients and increasing retention overall. Think about it -- how many subscription services are you currently being charged for, but perhaps you're "on the fence" with the product or not yet convinced that you should yet cancel? Not that Peloton is a subpar product, but the point is that building a subscription service around a great product has a notable benefit from an investment standpoint -- namely, probable sustainability.

Many say that Peloton is actually a tech company, not a retail fitness company, because its attraction is the interactive virtual fitness classes provided through modern technology. The growth of similar companies hinges heavily on the data obtained, how that data is interpreted, and how the company uses the data.  

The high-priced products that Peloton sells are an added benefit to the company's bottom line. As of its recent S-1 filing, Peloton's gross margin for subscriptions is currently 42.7%, up from 9.7% in 2017. For their connected fitness products (Peloton Bikes and Treadmills), gross margin is at 42.9%, up from 38.1% in 2017.

The past, present, and future growth of Peloton

In the fitness industry, gym memberships alone command a market of approximately $30 billion per year. Add fitness equipment, personal training, nutrition and -- more recently -- virtual fitness apps and live fitness classes to this, and that number becomes quite a bit bigger. This presents a great opportunity for growth for Peloton as it enters the public markets.  

Subscriptions and workouts per month

Since 2017, Peloton's subscriber base has grown from 108,000 total subscribers to 511,000 subscribers currently, over 100% subscriber growth year over year. Its average number of workouts during the same time frame went from 7.5 workouts per month per subscriber to 11.5 workouts per month per subscriber in 2019, a clear sign of increased user engagement. Peloton currently reports a 95% 12-month subscriber retention rate, a number that would make any investor happy.

Revenue sources and revenue growth

According to recent fiscal reports, Peloton has quadrupled its revenue numbers since 2017. As of its fiscal report for 2019, Peloton reported $915 million in revenue, up from $218.6 million in 2017 and $435 million in 2018. Peloton has clear indications of continued growth and positive market reactions.

Income

While its revenue and subscriptions continue to trend sharply upward, its net losses have increased too. In 2017, Peloton reported a net loss of $71.1 million, which followed a $47.9 million net loss in 2018 and a $195.6 million net loss in 2019. What does this mean? It means that its fast growth is most likely the result of costly marketing and customer acquisition. Peloton's fiscal year-end reports show a total of $585.8 million in operating expenses, of which $324 million are sales and marketing expenses.

In other words, approximately 55% of operating costs are related to sales and marketing expenses. For a company still in its rapid growth phase, this isn't hugely uncommon. 

What investors should watch for is how these numbers play out as Peloton penetrates the market and grows its brand. As its brand and platform expand and the Peloton name becomes more popular, costs related to marketing and customer acquisition are likely to taper off. Take a look at Uber, for example, which is currently experiencing challenges in reducing its cost of revenue.

Balance sheet

As of this writing, Peloton has $378.1 million in cash with no long-term debt. Its total cash equates to about $14.94 per share. With a current share price of about $25, some could argue that you're really paying just over $10 per share seeing that you're getting an additional $14.94 in cash per share purchased. If you believe Peloton is on to something big, now could be a great time to buy in as the high amounts of cash on hand and zero long-term debt both suggest a healthy balance sheet.

Indicators to watch for as Peloton enters the public market

With strong sales growth and a healthy balance sheet, Peloton might be a promising investment for the growth investor. That is, of course, if it can lower the cost of such growth over time.

Growth investors seeking to decide whether Peloton is worthy of their portfolio may wish to keep the following indicators in mind: 

  • Can Peloton maintain a strong balance sheet?
  • Will Peloton build trust and a strong reputation through predictable growth forecasts? This allows investors to more accurately predict its growth and thus make a better investment decision.
  • Can Peloton continue its current sales growth trend?
  • Will Peloton expand into new markets such as additional subscription services, fitness products, and fitness equipment?

A positive response to the above questions may indicate a major opportunity to invest in Peloton for the long term.

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