Peloton Prioritizes Access And Acquisition Over Profits

Peloton Incorporated hasn’t had a profitable year since going public in 2019 (and was not profitable in 2018 or 2017). The company’s strategy, as stated in the first quarter shareholder letter, is to prioritize accessibility and household acquisition over near-term profitability. The brand has amassed 2.5 million connected subscribers over the past three years, up from only 511,000 subscribers in 2019. Peloton has a cult following that some companies can only dream of, and that should eventually provide a road to a profitable future. 

The company sells connected fitness products like bikes and treadmills and also offers subscriptions through connected Peloton products (alternatively, consumers can buy just the digital content from Peloton to use on existing fitness equipment). In 2021, 22% of revenue generated by the company came from selling subscriptions. 

While the number of subscriptions has grown, the majority of Peloton revenue comes from selling its connected products. Both revenue channels have their own challenges and neither one seems to be the quick answer to bailing Peloton out of its current hot seat as an activist investor demands the CEO be fired and the company be put up for sale.  

Peloton’s price reductions for connected equipment impacted margins

The company’s gross margin of 36% for the year ending June 2021 was significantly below 2020 at 46%. Peloton’s connected products gross margin dropped to 29% compared to 43% the year prior. The performance continued to spiral downward for the first quarter (Q1) 2022. Gross margin continued its fall to 32.6% with connected products dropping to 12% in the quarter, with an intentional price reduction as a key contributor. As stated in the quarterly report, a strategy of the company was to lower its price for connected products to provide better access to younger and less affluent consumers who are the fastest growing demographic. The company stated, “We continue to believe price remains a barrier to purchase for many consumers and this is our latest step to improve the accessibility of our platform. We are pleased with the consumer response to our new price, which quickly converted many consumers already in our purchase funnel and is helping to generate a significant number of new leads.” While subscription margins were improved from 57% to 62%, the revenue represents only 22% of total sales.

Operating expenses for Q1 hit 77% of total revenue with significant increases in sales, marketing and SG&A (selling, general and administration). The overall performance for the quarter showed a loss of $376 million following a $189 million loss for the last fiscal year. 

Peloton revenues remain a substantial growth factor

While margins and profits have been a challenge, revenues have doubled or more than doubled year over year since 2018. Annual revenue for 2021 was up 120% compared to 2020, reaching over $4 billion. The positive revenue growth is demonstrative of the highly engaged customer base that Peloton continues to grow and may be what is needed to fill in the profit gaps. Adam Levinter, CEO and founder of Scriberbase, said, “High growth tech stocks, particularly in recent years, show that profitability can be kicked well into the future so long as top line growth remains.” Levinter discussed how other businesses can learn from Peloton as a use case, in terms of building a business model that is more community driven, with sticky predictable recurring revenue coming from subscriptions rather than one-off sales.

The subscription model is driving profits and high customer lifetime value

Peloton’s ability to sell connected devices (that are a gateway to subscription services with recurring revenue) provides high customer lifetime value (LTV). Levinter discussed how Peloton, despite recent criticism, has a tremendously valuable hybrid business model, with stationary bike hardware sales that act as a gateway to its engaging, community-driven classes accessible via paid subscriptions. “While critics point out the stock’s recent slide, among slowing growth and escalating costs, Peloton’s business model, particularly on the subscription side, remains powerful.” The Peloton model, according to Levinter, is among the stickiest of its kind with an average net monthly connected fitness churn of only 0.82%, and a 12-month retention rate of 92%. “This kind of retention among subscribers is indicative of strong consumer LTV and commitment to the brand itself.” 

What happened on the way to the pandemic to fool investors

Peloton rode the pandemic wave that put excess cash in the hands of consumers from stimulus payments and brought newfound popularity of at-home gyms. Consumer demand rose significantly across all home categories including home fitness and well being. Investors wanting to take advantage of this booming trend may have invested in Peloton or other similar fitness/exercise home equipment and services companies. Many of those companies have experienced similar recent declines in stock price after steep rises. Levinter said, “As average retail investors looked to capitalize on some of these trends, companies like Peloton saw extraordinary increases in stock prices, soon trading at multiples well beyond business fundamentals.”

Activist investor Blackwells Capital LLC is said to be calling on Peloton to fire its CEO, John Foley, and put itself up for sale after its stock plummeted 80% from its pandemic high. The business model has not changed since the company started, and the strategy of the company remains intact; build a community of followers which it has done for the past five years. Blackwells owns 5% of Peloton stock while the CEO and his team hold more than 80% of the voting power. As Michael Wiggins De Oliveira stated, “Why would they want to fire themselves out of their jobs? It’s ludicrous to assume that this activist will have any power to affect change.”