Peloton (PTON +6.51%) continues to be a major source of pain for investors. The once flourishing company is having trouble boosting demand for its expensive products, while at the same time it sits in a precarious financial position. Shares currently trade at 98% below their all-time high.
The company's previous CEO, Barry McCarthy, is out after just over two years at the helm. But he leaves Peloton in a different state than when he found it, now with a greater focus on its subscription segment. Perhaps bigger changes are in order.
Should this struggling fitness enterprise forget where it came from and stop making its own exercise equipment?
The financial case
A few years ago, during strict pandemic lockdowns, Peloton's business was registering monster growth. And its exercise equipment posted a gross margin in excess of 45% in the first six months of calendar 2020. That rivaled the gross margin of 37% that Apple puts up with its hardware sales.
But now, demand has fallen off a cliff. Peloton has had to tinker with its pricing model and distribution strategy to try to get its equipment into more households. As a result, the connected-fitness gross margin has contracted significantly, to just 4.2% in third-quarter 2024 (ended March 31). It was actually negative in the year-ago period.
If Peloton stopped making and selling this equipment, perhaps its financial situation would improve drastically. During the latest quarter, 61% of revenue came from the subscription segment, which reports a stellar gross margin of 68.1%. That makes sense, given that it's a digital product.
Because Peloton posted a cumulative net loss of $4.9 billion in the past 12 quarters, its executive team should be willing to try anything to turn things around. If the entire business model was subscription-based, Peloton wouldn't need to tie up capital in developing, manufacturing, and marketing its bikes, treadmills, and rowing machines, and could seriously reduce costs.
NASDAQ: PTON
Key Data Points
Strategic thinking
However, this asset-light strategy might not work. Peloton's founding in 2012 was centered on creating a great connected-fitness experience, and a critical part of this is the exercise equipment.
Peloton's ultimate goal is probably to be as successful as the iPhone maker in terms of selling beautifully designed hardware differentiated by internally developed software. In Apple's case, if it stopped selling the iPhone, for example, I think it would totally undermine the company's powerful competitive position.
Consequently, if Peloton only offered a digital app, it wouldn't really be much different from all the other workout content out there. People can even find free workout classes on Alphabet's YouTube.
McCarthy's main focus when he took the top job was to drive more recurring revenue, so I think he fully understands what's being discussed here. To his credit, he revamped the digital app strategy, which now has two tiers.
Peloton ended Q3 with 6.6 million digital members, up 3% quarter over quarter, but down 1% year over year. The issue, though, is that the monthly churn is very high, at 9.2%. That's up 200 basis points from just three months ago.
This tells me that there is not much customer loyalty or stickiness when it comes to fitness content. In other words, whereas buying expensive equipment somewhat locks customers into the Peloton ecosystem because they made the four-figure-dollar investment, there is zero friction when canceling the digital subscription.
No way out
I don't believe Peloton will completely exit the exercise business. Despite its drag on the company's financial results, it remains a vital part of how customers view the brand.
I guess this means the company will remain in a difficult position for the foreseeable future, particularly as it tries to grow the subscriber base, boost sales, and get to profitability.
Investors should avoid this mess altogether, no matter how cheap the shares look.
