The market is clearly less than thrilled with Peloton Interactive's (PTON 4.07%) fiscal third-quarter results and fourth-quarter outlook if Thursday's 14% post-earnings plunge is any indication. That's understandable. Subscriber growth was anemic, and the fitness equipment company believes its subscriber base is poised to shrink during the quarter currently underway.
Matters may not be quite as dire as they seem to be on the surface, however. Peloton is arguably moving in the right direction. It just needs to tweak the numbers.
Revenue mix is evolving for the better
Don't misunderstand. Peloton Interactive's future as a stand-alone company/brand is hardly guaranteed. It remains in the red, and competitors like Nautilus (NLS) and NordicTrack are moving into Peloton's connected fitness equipment turf.
There is a light at the end of Peloton's proverbial tunnel, however. The key is simply figuring out the right balance between its costs and its pricing -- for its equipment as well as its guided fitness sessions available to paying subscribers.
But, first things first.
Is Peloton Interactive a manufacturer of gym equipment like treadmills, stationary bikes, and rowing machines that also offers subscription-based access to trainer-led workouts? Or is it a subscription-based fitness outfit that sells gym equipment as a means to an end?
It's an important philosophical question, although not exactly a new one.
The answer is both, or neither. The two go hand in hand, to be sure; one fuels demand for the other. The trick is just keeping people paying for guided workouts once they've made the initial, sizable investment in Peloton's relatively expensive at-home fitness equipment.
As it turns out, though, the appropriate, sustainable pricing of its goods and services isn't clear-cut.
Take a look at the graphic below. It's not nearly as complicated as it seems to be at first glance. It's simply a comparison of Peloton's equipment revenue and subscription revenue, compared to its equipment profits (losses of late, in this case) and subscription operating profits. It's the trajectory of the data that makes the image well worth seeing.
Data source: Peloton Interactive. Chart by author. All figures are in millions of dollars.
You're seeing that right. As Peloton's revenue shrinks, it's becoming more profitable. That's because high-margin subscription revenue is making up an ever-bigger piece of the revenue pie, while fitness equipment -- sold at a loss since early last year -- is a shrinking part of total revenue. Look for this trend to persist going forward as consumers who have already purchased their equipment continue to pay for access to workout sessions.
Slower but better
Don't misread the message. The company's still got plenty of stuff to figure out. At the top of its to-do list is finding a way of producing net profits (remember, gross profits don't reflect costs like marketing, administration, and research and development). Peloton lost a total of $276 million last quarter. These net losses are apt to persist even if gross profits are positive.
There's also the not-so-small matter of slowing subscriber growth. Indeed, the organization expects to lose (net) connected fitness subscriptions during the three-month stretch now underway -- the core cause of Thursday's tumble. It's going to have to find a way of reigniting interest in its training sessions and/or its app.
Data source: Peloton Interactive. Chart by author. All figures are in millions.
Take a step back and look at the bigger picture, however. As the company grows its subscription business and deprioritizes equipment as a profit center, it's getting better. More to the point, it's moving toward more sustainable profitability.
To this end, know that the company will soon unveil multi-tiered paid membership options available through the app. As CEO Barry McCarthy explained in his Q3 letter to shareholders, "Our goal in relaunching the app is to engage new categories of customers, drive top-of-the-funnel awareness for Peloton, and become a meaningful contributor of revenue for our business." The initiative will hurt overall revenue growth rates, to be sure. But as its digital subscription ecosystem adds scale, look for Peloton's profit margins to widen.
It's still not for everyone's portfolio. In fact, it's probably not a great fit for most investors' portfolios. There are just too many lingering unknowns, like whether or not its competitors can replicate Peloton's premium products and services.
But with Thursday's stumble dragging shares to less than half of February's peak price -- and more than 95% below 2020's high -- there's a speculative bullish case to be made here. The market's not pricing in how the company's evolving business model is already starting to change its fortune for the better.
