The stock price for Peloton Interactive (PTON 3.67%) is down more than 70% from its all-time high following a disastrous earnings report last week.

Revenue in its fiscal 2022 first quarter grew just 6% to $805.2 million as hardware sales suddenly declined, a sign the company is struggling to attract new customers at the same pace even as it lowered prices for its bikes and treadmills. It also slashed its guidance for the full year to between $4.4 billion and $4.8 billion from $5.4 billion.

Even worse, Peloton was clearly spending money at an unsustainable rate with sales and marketing up 149% in the quarter against just single-digit revenue growth. As a result, the company announced a hiring freeze the day after the earnings report, showing a company in disarray with its full-year guidance well below the analyst consensus.

A woman riding a Peloton bike in her living room

Image source: Peloton.

Some investors, including some of my Motley Fool colleagues, see the sell-off as a buying opportunity. After all, the stock looks cheap in some ways. It's down sharply from its all-time highs; it trades at a price-to-sales ratio of less than 4, and the core subscription business, which many bulls see as the company's biggest competitive advantage, is still intact.

Its subscriber base continued to grow in the recent quarter to 2.49 million, up 161,000 from the previous quarter, and while average monthly workouts per household slipped to 16.6, they remained above pre-pandemic levels.

Peloton's current challenge isn't that the business is broken or even that it's a pandemic fad. It's the same problem the stock has faced before. It's still overpriced.

Stretching for subscriptions

The subscription business model is a great means of leveraging fixed operating costs across a wide audience. It's worked in the software-as-a-service industry and for consumer-facing streaming services like Netflix (NFLX 0.96%) and Spotify (SPOT -0.57%)

But as much attention as Peloton's subscription business has gotten, the majority of its revenue still comes from hardware, even since sales fell in the most recent quarter. Connected Fitness sales, the segment mostly made up of hardware like bikes and treadmills, dipped 17% to $501 million, and the decline was even worse than it looks, as it includes the acquisition of bike manufacturer Precor.

Subscription revenue, on the other hand, nearly doubled to $304.1 million. Most of the company's gross profit comes from the subscription segment, which totaled $202.7 million, but sales and marketing costs easily exceeded that in the quarter at $284.3 million. The company has spent lavishly to acquire the customers it has so far, and it's no longer benefiting from the pandemic.

Based on connected fitness subscription additions of 161,000 in Q1 and $284.3 million in sales and marketing costs, it paid $1,766 to acquire each of those customers. The company charges connected fitness members, who must own a Peloton Bike or Tread, a monthly subscription fee of $39, and it claimed a contribution margin of 70% in Q1. That means the company keeps $27 a month from each of those subscriptions after paying the direct costs to serve them, like recording classes. Assuming it loses 8% of those customers each year, as its current churn rate indicates, it would take seven years to recoup those marketing costs. Factoring in the time value of money and today's high inflation rates, the payback period is even longer.

Peer review

Peloton has no pure-play connected fitness peer on the market, but there are a number of other subscription businesses that serve as useful comparisons. Ignoring the hardware segment, which is mostly a hook for the subscription business due to its low gross margins, Peloton is valued at roughly $6,000 per connected fitness subscriber with a market cap of $15 billion. Netflix, which is still growing briskly, is valued at just $1,340 per subscriber, while Spotify, another growth stock, is valued at just $290 per subscriber. The New York Times, which is seeing strong growth in its digital business, is valued at just about $1,000 per subscriber.

Those business models aren't the same -- Netflix and Spotify rely on outside content while Peloton doesn't -- but they still serve as a useful comparison.

A bet on Peloton at this point is a bet that connected fitness will come to dominate the fitness industry the way streaming now dominates video entertainment. But the numbers show that Peloton is still a niche product with just 2.5 million connected fitness subscribers, despite a once-in-a-lifetime crisis that gave the brand a huge boost, and fitness is a much more fragmented industry than entertainment has ever been.

Peloton's current valuation still has high expectations for the company baked in, especially considering the headwinds in its hardware sales, the hiring freeze, and the wide losses it's expecting this year with a forecast of an adjusted EBITDA loss of $425 million to $475 million.

At this point, Peloton could fall a lot further before it bottoms out.