What a difference a year can make.
Almost exactly one year ago, Lululemon Athletica (LULU 1.21%) and Peloton Interactive (PTON +0.74%) were settling a lawsuit in which the yoga apparel maker had accused the exercise-bike specialist of patent infringement over its Peloton-branded line of women's apparel.
Late Wednesday, the two companies announced a new five-year strategic global partnership. Shares of Peloton surged as much as 35% in after-hours trading on the news, then opened Thursday up around 10%. Lululemon stock is up around 1%.
A win-win deal
On its face, the agreement makes perfect sense, as it leverages each company's obvious respective strengths.
Starting Nov. 1, Peloton will become the exclusive provider of digital fitness content to members of both Lululemon's paid Studio App subscription service and its free Essential membership program (which has over 13 million members). Lululemon will become the primary athletic apparel partner to Peloton, offering co-branded apparel at Peloton stores and online.
Lululemon also announced it will discontinue selling its fledgling Studio Mirror product before the end of the year -- though it will continue providing ongoing service and support for existing Mirror devices. This shouldn't be entirely surprising, however: Lululemon previously spent $500 million to acquire Mirror in 2020, wrote down most of the value of the acquisition by the end of 2022 amid weak sales, and reportedly considered divesting the business earlier this year.
Peloton, for its part, has also shifted attention away from its core hardware sales of bikes and treadmills. Shares even briefly rallied in May after it unveiled an ambitious brand relaunch trying to reframe itself as not just a maker of in-home exercise bikes, but rather a holistic connected fitness company for everyone.
Why Peloton still isn't a buy
So where does that leave investors in each company? I think Lululemon remains a buy while Peloton remains firmly in the "avoid" category.
Perhaps I'm biased, as a shareholder of Lululemon for almost exactly a decade now. But I couldn't be more pleased with its decision to focus on what it does best, while simultaneously winding down its struggling Mirror business and delegating digital fitness content to Peloton. Lululemon has achieved extraordinary success with enviable margins and top-line growth in the apparel space, and it has nothing to lose by making nice and offering co-branded apparel through Peloton's commerce outlets.
Meanwhile, this is definitely a validating win for Peloton in the thick of its turnaround efforts. But the company is still reeling from costly recalls, as well as a separate patent-infringement settlement last quarter with Dish Network. So Peloton's disparate after-hours pop is indicative of just how badly the company needed an incremental win: It's working to recapture sustained sales growth (revenue fell 14% year over year last quarter), cash-flow positivity (quarterly free cash flow was negative $74 million), and bottom-line profitability (the latest quarterly net loss was $241.8 million).
Without specific partnership terms being disclosed, it remains to be seen whether the Lululemon partnership will have a meaningful positive impact on Peloton's operating results. I suspect we're unlikely to see Peloton replicate this arrangement with any other well-funded athletic apparel frenemies such as Nike or Adidas.
So what does Peloton need to do in order to prove itself worthy of a spot in my portfolio? It could start by delivering a blockbuster holiday quarter to close out this calendar year. Management has already told investors that Peloton expects to incur negative free cash flow in each of the next two fiscal quarters (its first and second quarter of fiscal 2024, respectively); this is due to a combination of seasonality of hardware sales, inventory payments, recall costs, and marketing spend leading up to the holiday period. Only after that -- starting in the second half of fiscal 2024 -- does the company anticipate returning to sustained cash-flow positivity.
Until then, however, I'm afraid Peloton's partnership-induced pop could prove to be short-lived.
