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1 Question Peloton Has to Answer

By Jon Quast - Updated Jun 1, 2021 at 9:06AM

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The answer will determine how successful the company is long term in two important areas.

On April 1, nine-year-old company Peloton Interactive (PTON -5.48%) completed its acquisition of 40-year-old company Precor for $420 million. Both companies deliver a connected-fitness experience to their customers. However, Peloton's focus is undoubtedly at the consumer level whereas Precor excels in commercial-fitness applications like gyms, hotels, and apartment complexes.  

With the acquisition now complete, Peloton needs to answer the following question: How quickly and effectively can it integrate Precor into the business? It's a question that can only be answered with results over time. But make no mistake, the success of this acquisition is a big part of a bullish thesis moving forward for Peloton shareholders. Here's why. 

A person does yoga at home while watching video content from Peloton on TV.

Image source: Peloton Interactive.

Fixing a supply problem

One of Peloton's biggest ongoing problems is struggling to meet the incredible demand for its products with enough supply. There's multiple reasons for its supply problem. First, demand over the past year outpaced management's expectations. But also, the COVID-19 pandemic disrupted supply chains, resulting in a growing backlog of orders. 

To address this problem, Peloton is investing heavily in its own U.S.-based manufacturing facility. The company is spending $400 million to build a facility in Ohio it's calling Peloton Output Park. Starting in 2023, it expects all of its orders for North America will be fulfilled from this facility.

By taking greater control over its manufacturing, Peloton hopes to speed deliveries and gain operating leverage with scale. However, the company's experience is more in delivering a great consumer experience, not manufacturing. By contrast, Precor's team does have manufacturing expertise.

On the conference call to discuss results for the second quarter of fiscal 2021, CEO John Foley said, "Precor has deep manufacturing and R&D [research and development] expertise, which will help us bring new hardware products to market more quickly and better positioned us to serve our North American member base over time."

At the recent J.P. Morgan Global Technology, Media, and Communication Conference, Peloton CFO Jill Woodworth said Peloton Output Park is designed to meet the company's growth needs for decades. Therefore, it's easy to see the importance of this aspect of the Precor acquisition. Peloton will need to quickly integrate and rely on Precor in various areas related to manufacturing. The success of its supply chain is relying on it.

A person touches the screen on a Peloton exercise bike.

Image source: Peloton Interactive.

The potential flywheel

For companies, a flywheel is when success with one part of the business drives more success in other parts of the business. For an example unrelated to Peloton, some companies provide a marketplace for buyers and sellers. If they can attract sellers to the platform, those products will attract buyers. And as more buyers come on board, that attracts more sellers still. And so the flywheel spins.

It may seem odd for Peloton to acquire a commercial-application business in Precor, but Woodworth clued investors in on an overlooked flywheel the commercial business can provide. Consumers who use Peloton's hardware at a commercial location essentially get an in-depth trial of the product. If they like it, they may buy one for their home. Indeed, at the aforementioned conference, Woodworth said, "I think the latest stat I saw was that for every bike we place in a hotel, we sold at least seven bikes to a consumer as a result of that."

Woodworth didn't elaborate on how Peloton tracks this metric. However, the implication is huge. By acquiring Precor, the company expanded its addressable market to include commercial locations. And by doing so, it's developing a flywheel that could improve its new user-acquisition strategy.

The stakes

To put Peloton's efforts in financial perspective, it had about $2 billion in cash and cash equivalents on the balance sheet as of the most recent quarter. It's generated almost $3.7 billion in trailing-12-month revenue. And its market capitalization is around $33 billion. With this context, we can see that the $820 million it's spent to acquire Precor and build Peloton Output Park is a very large investment.

The speed and success of integrating Precor into Peloton will be hard for shareholders to measure. In the most recent quarter, Foley said, "The integration process with Precor is advancing according to plan." But that's something you expect a management team to say. 

The completion of Peloton Output Park is still years away, so it will be hard to know how well it's going in the short term. For this reason, I'll be focusing more on the flywheel effect that Woodworth recently talked about. In coming quarters, I would expect management to elaborate more on how the commercial business is doing. And if Peloton maintains strong user growth in coming quarters, it could be a sign that the flywheel is working. This would be a great development for long-term investors.

JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Jon Quast owns shares of Peloton Interactive. The Motley Fool owns shares of and recommends Peloton Interactive. The Motley Fool has a disclosure policy.

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