Peloton (PTON 4.29%) is widely recognized for its exercise bikes, which were a huge hit during the pandemic lockdowns, when stuck-at-home people were searching for ways to work out. The demand surge has since faded, and shares have cratered, down 97% from their record high (as of Jan. 18).
The company is trying to fix the situation with a new strategic priority, though. While most people think that this exercise stock makes money from selling fitness equipment, a whopping 70% of its revenue comes from something else entirely. Let's take a closer look at Peloton's business.
Focusing on recurring revenue
In the most recent fiscal quarter (first-quarter 2024 ended Sept. 30, 2023), $415 million of Peloton's $595.5 million in total sales was derived from subscription revenue. This is a much higher figure than hardware revenue, which came in at $180.6 million. The subscription revenue consists of the money Peloton makes from its digital fitness apps that offer a wide variety of workout classes.
This revenue split differs greatly from the situation just three years ago. During Q1 2021, Peloton generated a whopping 79% of sales from its connected-fitness products, as the business benefited from strong demand during the pandemic.
The change in sales mix is what CEO Barry McCarthy wants to see. He was hired in February 2022 to initiate a turnaround strategy, with one of his main goals being to get Peloton to produce more recurring revenue. The fact that McCarthy had prior stints at Netflix and Spotify points to his experience in successful subscription-based businesses.
Last summer, Peloton revamped its digital app strategy to offer different tiers. After the free option was quickly eliminated, because the company wasn't successful in converting those customers to paid subscribers, there are now just two tiers at different monthly price points.
The subscription segment, which carries an incredible gross margin of 67.4%, only increased revenue by 1% last quarter. Even more disappointing, digital app membership declined 8% quarter over quarter.
McCarthy wants to drive growth by making Peloton's offerings available in more places, meeting people where they are. Recent partnerships with Lululemon and TikTok show how management is trying to boost distribution capabilities to get more people to eventually sign up for the digital app.
Hardware is still important
Based on recent trends, it's likely that software and services will continue to be the key business driver for Peloton going forward. But investors can't ignore the company's hardware products, particularly the stationary bikes, which helped Peloton become a well-known fitness brand several years ago and throughout the pandemic's height.
To be fair, equipment sales have fallen off a cliff. The latest quarter's revenue of $180.6 million was down 70% from three years ago. And currently, they face a softer macro environment that discourages people from wanting to pay high prices for them.
But by still selling hardware products, Peloton receives some benefits. Most importantly, I think they drive customer stickiness and loyalty. Once someone commits to spending a four-figure sum on an exercise bike, they might be inclined to stay a Peloton member, whereas a digital app subscriber has almost no friction to cancel.
Hardware that's differentiated by software is a smart business strategy when successful. This is exactly the playbook that Apple operates from. Of course, Peloton needs to figure out ways to drive growth and improved profitability when selling its exercise equipment. The latter also won't be an easy task, given the measly 3.1% gross margin of the connected-fitness products segment.
At the end of the day, Peloton is still a struggling enterprise that has a lot of work to do to right the ship. Investors should think twice before buying the stock.
