Peloton reports its 2Q20 results after the market close on Wednesday Feb. 5. Consensus expects a loss per share of $.30. We are modeling an $.18 loss per share. When we made our call we said we are at the peak of adoption right now. We think FY 2020 is likely to be the peak in subscriber adds and new bike sales, and the quarter to be reported will be the peak in YY growth rate. A squeeze on this event is a real possibility.
The company is investing and building vertical infrastructure for a fitness empire that we simply think does not have a big enough addressable market to justify. Peloton owns a defendable core concept in its integrated and competitive at home cycling experience, and we think that if properly executed, that business could be worth $2-$4bn. The problem is today's market cap stands around $9bn. Competition vs that core business is rapidly accelerating while PTON invests heavily to grow outside of its core in search of TAM, but in businesses where its competitive moat is small to nil and profit potential is significantly smaller. Capital would be much better suited to maximizing share gain within that cycling core.
Fitness is a business subject to fads and cycles, and despite what management might make you think, this is a category that is very sensitive to macro forces. We think the company's vertical model in this space means outsized margin risk when revenues slow as the company hits its full potential much earlier than consensus expects.
This stock is not a short at all costs today, but we think the long term is very bearish at this valuation, and think the stock is a sell/short when we reach the lockup expiration currently scheduled for March 24th.
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Expectations for the Quarter
Our bias is to the upside, results likely exceed our estimates which are well ahead of consensus.
Revenue
- Consensus expects subscription growth of 90% to 686,000 members. Management guided to 680,000-685,000. That would represent a deceleration from 103% in FQ1.
- We expect net subscription growth of 100% to 737,700 members with an acceleration in gross subscription additions and churn.
- For the year management guided subscriptions to be between 885,000-895,000. We are modeling 920,000.
- Consensus expects revenue to grow 60% to $422mm. Management guided $410-420mm.
- We expect revenue to grow 106% (a slight sequential acceleration) to $543mm.
Margins
(Margins are less of a focus with the widening EBITDA losses.)
- Management guided gross margins to be between 39-40% vs. 44% last year.
- We are modeling flat gross margins thinking that management’s guidance is conservative. In follow up conversations management could not articulate why gross margins should contract as much as guided.
- We expect both connected fitness and subscription gross margins to be flattish.
- Management guided adj. EBITDA loss to be $65 to 70mm. We are modeling a loss of $40mm.
- We expect deleverage in R&D and G&A while sales and marketing spend is expected to decline as a percentage of sales.
Setup
Peloton shares are up a modest 10% since the IPO, but are up nearly 50% from the low. The Renaissance IPO ETF rose to a record last week. YTD shares of Beyond Meat are up 63%, Telsa shares are up 35%, and Uber shares are up 24%. The market this year is rewarding growth companies for top line growth.
The short interest is 68% of the float as of year-end, up 7% points from a month earlier. The bulls think a large beat could be a significant catalyst for the shares due to the short interest, but a large beat is what everyone expects.
Did it Peak Early?
Peloton like other exercise and diet companies tend to hit peak interest in January driven by New Year’s resolutions. Due to the significant social media coverage of the company’s controversial holiday TV commercials interest in the company spiked in January, but then resumed its seasonal decline as seen in the following chart. The spike likely pulled forward demand into FQ2 from Q3. So while we expect better growth in FQ2, it comes at the expense of FQ3.
The Market’s Focus
Investors are likely most closely tracking new subscriptions. We expect subscriptions to double in FQ2 driven by an increase in ad spending and the social media controversy around its holiday commercial. App downloads (as depicted in the following chart from our black book) suggest subscription trends are slowing which will lead to an acceleration in churn in the following quarters.
Customer churn rates are already worsening and will get worse based on consensus subscription estimates. Converting the company’s monthly churn rate into quarter results and then annualizing the churn rate as seen in the following table shows a continued increase in churn rate.
Biggest Concern
Our biggest concern for the company is the rapidly increasing competition in boutique fitness, connected fitness bikes, and connected devices while penetrating a market with think is small than the company believes. At the annual CES conference in January the number of new entrants into connected fitness clearly reflects a significant increase in the competitive intensity of the industry. It seems like every exercise equipment manufacturer is offering a connected device while there are a myriad of startups looking to add their innovation to the category.
The Peloton bulls seem to be most excited about some potential for the company’s dominance in the future in owning digital/streaming exercise. We think that is very premature with little currently to suggest that any one company will do that including Peloton. The following graphic highlights just a slice of recent competitive offerings.
Lockup Expiration
Management has timed the lockup expiration well to occur on March 24 before the Q3 earnings report. Q3 is typically the company’s largest quarter of the year, but due to the pull forward of demand likely sees more of a plateau in sales sequentially rather than a peak. The founders have been selling for years and we expect a number of employees to do the same when they are allowed to do so. Perhaps even more meaningfully there are also a number of investors during its startup phase that have significant gains that would also likely sell soon after the expiration. The significant increase in float will make it much easier to borrow the shares to short which has kept some skeptics on the sidelines. With profitability pushed off way into the future we expect there to be limited upside in the shares in the intermediate future, but considerable downside.
