Whether it be from an infamous 2019 commercial or from your favorite celebrities' social media accounts, you've probably heard of Peloton Interactive (PTON 4.00%) by now. The company sells high-end, tech-focused stationary bikes and treadmills that come equipped with connected monitors for streaming fitness classes from the comfort of your home. For those of us who do not want to shell out $2,245 for a bike or $4,295 for a treadmill, there's a stand-alone membership for $12.99 per month that provides access to thousands of on-demand workouts. The company also sells various workout accessories and apparel.
Peloton went public in Sept. 2019, and since then, the stock has soared over 60% to reach a market capitalization north of $13 billion. For comparison's sake, that's more than double the market value of Planet Fitness, which is the most popular low-cost fitness center chain in the U.S. This valuation could be justified by the fact that Peloton generated revenue greater than four times that of Planet Fitness in the quarter ended March 31. Peloton is also growing at a tremendous rate with revenue up 66% and connected fitness subscribers (those who own a bike or treadmill) up 94% year over year in the most recent quarter. Is this just another fitness fad or something more sustainable?
It's time to compete
Even before the coronavirus outbreak, Peloton was benefiting from the increased desire for convenience when it comes to working out. There's a large demographic out there that has every intention of getting and staying fit, but they just can't find the time. It has become even more important to be able to exercise at home at the time of your choosing, particularly as the pandemic has spread. Even as gyms begin reopening their doors, members are still hesitant to go. These factors play heavily in Peloton's favor.
The company offers a truly differentiated product, as evidenced by its gross margins. In the fiscal 2020 third quarter, Peloton's bikes and treadmills had a 45.3% gross margin. During the same period, Apple's products segment generated gross margin of 30.3%. This is remarkable, and it demonstrates the value-add that Peloton delivers.
While critics point to the high price points of the company's products, I think there are three obvious signs that Peloton is building a significant competitive advantage for its business.
The company has mastered the customer experience. Average monthly workouts in the third quarter were 17.7, compared to 13.9 in the prior-year period. Average monthly churn during the period was 0.46%, the company's lowest level in four years. Additionally, the 12-month retention rate was 93%. It seems that once a new member tries a Peloton device for the first time, he or she becomes hooked. Bolstering the user experience is the social and community aspect of being able to share workouts and interact with others in class.
Peloton is also building a platform business model with strong network effects. The company attracts some of the best fitness instructors in the industry to exclusive deals by paying them much more than competitors. As these sought-after instructors join Peloton's platform, it attracts more subscribers. Consequently, as more subscribers join and begin taking classes, top fitness instructors gravitate toward Peloton. As the network grows, it becomes more valuable to all participants.
The company's intangible assets make it difficult for competitors to replicate its business. With a Net Promoter Score of 86, brand recognition and likability are through the roof. Peloton's focus on technological innovation is also a huge strength as it has led to the creation of a powerful community of supporters from which the company collects valuable data that it can use to continually enhance the user experience.
Are you ready to ride?
An unprofitable business like Peloton cannot be analyzed using traditional valuation methodologies. Instead, it would be fruitful to utilize the perspective of a venture capital investor and focus on other key metrics. As previously touched on, user numbers are skyrocketing and churn is at extremely low levels. Furthermore, the company's monthly subscription generates recurring revenue, which is always a positive characteristic to have.
An astute investor should assess Peloton's realistic growth runway before contemplating the purchase of shares. However, there is one rule of thumb that I believe every investor should follow -- don't ever bet against a company with a great product.