Peloton Interactive Inc. (PTON, Financial) has taken the exercise world by storm, selling its proprietary exercise bikes and treadmills to high-end customers and keeping them hooked with extensive interactive and on-demand workout content.
Like many high-growth unicorn companies that have gone public in recent years, Peloton has failed to become profitable. According to the company’s management, this is by choice. Last month, CEO Jon Foley insisted that lack of profitability was due to Peloton’s reinvestment in growth. On Dec. 4, CFO Jill Woodworth told attendees at a UBS investor conference they “haven’t set a formalized post on when [they] will be profitable.”
These losses might not worry investors who are used to the Silicon Valley model of “growth at all costs,” yet Peloton may find it harder in practice than in theory to shift from the red to the black.
Lack of profit is a problem
Growth companies are often expected to show losses as they expand. However, in the world of fitness hardware, there is clear evidence that profitability tends to peak when adoption rates are highest (called the "peak of the phenomenon" trend). Legendary short-seller Jim Chanos (Trades, Portfolio) made this exact point in a series of tweets on Nov. 5:
“This is the point in the fitness equipment/class curve where PTON should be most profitable. It only gets tougher going forward. Their product/software line is quite expensive for what it is...And if we are doing our math right, PTON’s inventory is up over 300% Y/Y, with DSI at 209 days vs 110 days at Sept 2018.”
Chanos has not let this point go. Indeed, he hammered on it once again on Dec. 4:
“Peak profit margins for fitness hardware and/or classes needs to be at the peak (rate-of-change) of the phenomenon, not five years out. Ask Nordic Track, Reebok Step, Zumba, CrossFit, Bowflex, Taebo and now, SoulCycle about that.”
Overall, rising inventory and persistent lack of profitability is not a particularly appetizing recipe for investor enthusiasm, esecially for a non-tech stock. Peloton, which is experiencing almost unheard of levels of hype at present, is still struggling to make a profit. The profitability function for fitness hardware is tied to the “peak of the phenomenon” trend, which is not a great sign for Peloton’s future prospects.
Where’s the demand?
Last week, Peloton announced that it had struck a deal with Amazon.com Inc. (AMZN, Financial) that will see its exercise videos become available to owners of the online retail giant’s Fire TV products. While this will undoubtedly help boost subscriptions for a time, Peloton still evidently felt it necessary to reduce its digital subscription price at the same time, as the Verge reported on Dec. 4:
“Fire TV users can also download a new Peloton app to access workout classes on their TVs. Previously, users would have to cast classes from their mobile apps or from Peloton equipment to a device that supports Miracast. The ability to stream classes on TV is likely to help users who currently subscribe to Peloton’s digital membership, which now costs $12.99 a month compared to $39 a month to use with a Peloton bike or treadmill. (Previously, Peloton charged $19.49 a month for its digital-only subscription.) With the Fire TV app, users can use their own gym equipment with the classes or opt to see it on a larger screen. It’s also helpful for those who want to take Peloton’s off-equipment classes, like yoga, meditation, or strength training, without having to watch it from the screens on their bike or treadmill.”
The decision to cut price so soon after going public is an ominous sign for future growth. After all, if you are already cutting prices to boost demand, how massive can your addressable market really be? Jim Chanos (Trades, Portfolio) took to Twitter on Dec. 4 to dissect the move:
“Wow, that was quick! A digital sub drops to $12.99/month vs $19.99/month previously...bike owners must still pay $39/month, however. Price cutting this early? Peloton only added 3,856 net digital subs last quarter. They probably didn’t want to see that metric decline so soon after going public. But makes you wonder about the software/class demand away from hardware sales...Peloton only added 3,856 net digital subs last quarter. They probably didn’t want to see that metric decline so soon after going public. But makes you wonder about the software/class demand away from hardware sales.”
Any sign of flagging demand should be a serious worry for investors hoping that Peloton can turn its losses into profits through the miracle of volume.
Verdict
Peloton is not profitable, though it promises it will be one day. However, its path to profitability is far from clear, especially when considering the economics of fitness hardware and services. Signs of slowing demand growth appear set to further weaken Peloton’s narrative. Peloton’s stock has taken quite a beating since its public debut, but the pain is likely far from over.
Disclosure: No positions.
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