Sometimes a company's product is on the market at just the right time, and it takes off and becomes a fad. That's the rough backstory for Peloton Interactive (PTON 4.29%). The problem is that such fads eventually end, often leading to a rude awakening for the company and its shareholders.
This is where Peloton is today, with the stock off by more than 90% from its 2021 highs. And it's not clear that it has what it takes to remain a stand-alone company.
Ups and downs
When the COVID-19 pandemic started to spread, governments around the world asked people to stay home and avoid social interactions. That's the perfect environment for an exercise bike that's sold online (for clarity, the company also has stores) and includes an interactive class component via a subscription service. In short, Peloton was perfectly positioned to benefit as the world went into hiding.
Image source: Getty Images.
But the pandemic restrictions eventually ended, and people started to venture back into the world. Peloton's business wasn't quite as sticky as it once seemed as people who like to work out actually went back to the gym. The company reported that the number of connected subscriptions increased from around 1.1 million at the start of fiscal 2022 to roughly 2.3 million at the end of that year.
However, there was an interesting trend: The fourth quarter saw a notable drop in the number of classes being taken even as subscriptions increased. On top of that, there was a 95% decline in net new fitness subscriptions on a year-over-year basis in the first quarter of fiscal 2023. That was followed up by a decline of 78% in the fiscal second quarter.
There appears to be something going on here, with a glass-half-empty view being that Peloton's popularity has peaked. That's highlighted by the company's shift from selling hardware with a subscription to selling just a fitness subscription service via an app.
There's nothing wrong with an app, noting that it is a very high-margin business. However, this is a major directional change for the company and one in which there are other formidable players, including Lululemon Athletica (LULU 1.31%) with its Studio product.
There's likely to be material overlap between these two customer sets, and Lululemon probably has the stronger brand name and image. And it's just one competitor in what is, essentially, a fairly low-barrier to entry product offering.
Not enough money in the bank
Here's the interesting thing about this comparison. Lululemon has a highly profitable clothing business that supported its purchase of the Mirror workout hardware. Like Peloton, the hardware side of things didn't work out so well, so Lululemon is now shifting to a subscription model, through which it hopes to build customer loyalty and sales.
Peloton doesn't have a highly profitable business to fall back on. In fact, the company has yet to turn a full-year profit.
That's not to suggest that Peloton can't be a profitable company -- only that it doesn't have the same backstop as some of its competitors. But if Lululemon sees and can extract value from operating a subscription workout service, it isn't far-fetched to believe that Peloton might be attractive to a buyer that might be looking to do the same thing.
This is conjecture, of course, but Peloton has a clock ticking in the form of zero-coupon convertible debt worth a total of roughly $1 billion. That fairly large sum has to be paid back in early 2026. The conversion price is over $230 per share, versus a current stock price of around $12, so it is highly unlikely anybody coverts.
In other words, lenders will probably want to be paid back in around three years. At the end of the fiscal second quarter, Peloton had around $870 million in cash on its balance sheet, so it really doesn't have the money to repay that loan.
Not for the faint of heart
Management's goal is to start making money, which would probably allow it to more easily roll over the debt (though it would probably be unable to get another 0% interest rate in the given interest rate environment and with its current business condition).
However, another solution would be to just stabilize the company and sell it. As the time until the 2026 convertible debt comes due gets shorter and shorter, that outcome could become more and more likely.
If Peloton can't turn sustainably profitable by shifting toward an app, meanwhile, it may end up shrinking its business until it is profitable or, worse, filing for court protections in a bankruptcy, potentially cleaving off the exercise equipment and leaving behind the app.
In the end, there's really no way to tell what happens from here (the company could turn a profit and go on to great business success), but there is a lot of execution risk to consider. Most investors will probably be better off watching from the sidelines as there is a very real chance that Peloton doesn't exist as it does today in five years' time.
