Imagine if I told you there was a company that has not only persuaded more than half a million people to spend over $2,000 on an exercise bike, but has also convinced most of those people to shell out as much as $39 per month for video content. Total revenue is expected to be as much as $1.5 billion in 2020, up more than 60%.

"This company must be printing cash," you would think to yourself. "This company must be the perfect company."

But this company is not the perfect company. This company is Peloton Interactive (NASDAQ:PTON). Instead of printing cash, Peloton is lighting it on fire. The fitness company lost nearly $200 million in fiscal 2019, and it will probab0ly lose more than that in 2020.

A man on a Peloton bike.

Image source: Peloton.

Spending big to make sales

The problem, not surprisingly, is that all the convincing Peloton has done to find homes for its expensive equipment has been exceedingly expensive. It turns out that selling a $2,250 exercise bike, or a $4,300 treadmill, is not an easy thing to do. The profit Peloton makes selling a piece of equipment is mostly erased by the sales and marketing spending required to make that sale.

In the fiscal first quarter of 2020, Peloton generated $157.6 million of revenue from its connected fitness products. The rest of the company's revenue came from subscriptions, other than a few million dollars from branded apparel.

Peloton realized a gross profit of $89.8 million on its connected fitness products. But the company spent $77.6 million on sales and marketing, wiping out most of that gross profit. Not all this spending is pure advertising -- Peloton operates 81 showrooms globally. But a lot of it is. In fiscal 2019, sales and marketing spending increased by $172.6 million to $324.0 million. Of that increase, $117.4 was due to increased spending on advertising and marketing programs.

Sales and marketing ate up 34% of total revenue in the first quarter, leaving very little for other expenses. The company posted a net loss of $49.8 million.

To put this spending in perspective: If we assume all of Peloton's connected fitness products revenue came from the bike, and assume an average selling price of $2,250, the company spent about $1,100 on sales and marketing per bike in the first quarter. This is a ballpark number, to be sure, but it's really something.

Peloton's advertising spending isn't going to slow down anytime soon. From the company's S-1 filing: "Our growth strategy contemplates a significant increase in our advertising and other marketing spending and expanding our retail showroom presence."

Overestimating the growth opportunity

Peloton believes its total addressable market includes 67 million households. That estimate is a fantasy. Eventually, Peloton is going to run out of people willing or able to buy $2,250 bikes and $4,300 treadmills.

Peloton sells niche products. It's the meal kit of the exercise equipment industry. There's a market for them, but it's not all that big, and overreaching by hurling cash into marketing is going to end badly.

Competition is also a problem. NordicTrack makes nearly identical products and already has a somewhat well-known brand. NordicTrack, known for its once-popular ski machine, was the Peloton of the 1990s, enjoying booming sales until the winds shifted and its products fell out of favor. The fitness world follows fads, and Peloton is just the latest one.

Peloton CEO John Foley argued during the first-quarter earnings call that the big losses are the result of investments the company is making in growth. "I believe if we pull back on growth, we could be profitable tomorrow, but that is not what the Board and the leadership at Peloton believes we should do," Foley said.

That's an easy thing to say when you have no intention of doing it. Peloton has never turned an operating profit, even in the years before this heavy spending on new products, international expansion, and physical stores. If the growth opportunity isn't as big as the company seems to believe, and it almost certainly isn't, these investments are going to backfire.

Peloton is spending big to sell bikes and treadmills to gain users for its subscription products. This is a razor-and-blade model, except the razor costs thousands of dollars, many times more than basic exercise bikes and more than double the price of similar products like the EX1 bike from Echelon.

That's fine in the high end of the market, where a few thousand dollars doesn't mean much. But it won't work in the mainstream fitness market, no matter how much cash Peloton spends on advertising.