Share prices of Peloton Interactive (PTON 4.29%) are down roughly 55% over the past year and 95% from their 2021 highs. Basically, investors have soured on the connected exercise equipment idea now that the world is moving past the emergency phase of coronavirus pandemic. Peloton is looking to move on, too, shifting to an app-based model. Is it worth buying on the hope that this reinvention works?
There are moving parts in Peloton's operations
During the early days of the coronavirus pandemic, when people were socially distancing and working from home, having an exercise bike that connected to the internet was great. It basically simulated the feel of being in a gym without actually having to go to a gym. Investors pushed Peloton stock up to massive heights, along with a lot of other coronavirus-related names (Clorox and its cleaning products are an example).
Image source: Getty Images.
When the world opened up again, most of the stocks that rallied because of the health scare plummeted back to earth. Peloton was among the hardest hit, at least partly thanks to the fact that the business isn't profitable and hasn't yet been profitable in any year of its public life. Even a great product that can't find its way into the black won't survive for very long.
Which is why Peloton is shifting its business model. Instead of focusing on selling high-priced equipment that leads to a subscription customer, it is going to reorient around an app. The goal appears to be to start the customer funnel from the other direction. Lure people in with a low-cost app and then step them up to higher-priced subscriptions and hardware.
It's not a bad plan, noting that nearly 60% of the company's workouts were not cycling-related. Around 60% of active members participate in non-bike workouts like yoga and strength training. And nearly 40% of the company's workouts don't involve a Peloton-branded hardware item of any kind. Clearly, there's demand for something beyond connected hardware.
Services are more profitable, but...
What's really interesting, however, is when you compare the profitability of the hardware business versus the subscription side. Connected fitness products had a gross margin of negative 5.4% in the fiscal 2023 third quarter (ended March 31). The subscription service had a gross margin of 67.8%. It is way more profitable to operate the company's subscription business than sell connected hardware. That makes sense, but it highlights why the company wants to shift its focus.
The problem is that Peloton still hasn't figured out how to turn a profit. The company lost $0.79 per share in the fiscal third quarter, which was down from a loss of $2.27, but still not good. There were some one-time items in the mix, so future results could look better. But earnings need to get consistently into the black before most investors should consider this stock.
Then there's the cash burn. The company has around $870 million of cash, but the cushion here is dwindling. A year ago that number was $1.25 billion. In the fiscal third quarter it used $55 million of cash. Eventually, the money will run out, noting that it has a nearly $1 billion zero-coupon convertible bond outstanding that comes due in early 2026. That's less than three years away and dealing with the maturity could be difficult if the company's business model shift doesn't work out as hoped or is slow to take off in a meaningful way.
Another troubling number
Which brings up one last number, the 13% year-over-year drop in app subscriptions. Sure, the company highlighted the 5% increase in connected equipment subscriptions, but that's the old model, not the new one. With a massively higher profit margin, it may not be a problem if there are fewer app subscribers. But this is a new business shift, and it seems like the company would be having more success. Most investors will probably be better off watching Peloton from the sidelines, noting that it is in the process of relaunching the brand to highlight the app. If that works out well, it might be worth a second look. If it doesn't, well, the company's 2016 convertible maturity will look increasingly like an insurmountable wall.
