This quarter was no doubt bullish for PTON, we highlighted it to be so in our note on Monday PTON | 3Q Print Not a Short Catalyst. We should have perhaps gotten off the short over the near term around the increased interest, but we couldn’t tell how much interest was real vs free trialing (after all 1.1mm digital free trailers will make usage data look quite solid while resulting in net costs to the company). In addition we’re still not sure how much the long term value of this business model has changed. The long term addressable market has surely gotten larger, some people won’t ever return to gym workouts and will want to exercise at home, but we think it’s something like 25% larger, not 200% or 300%. At the same time management gave some validation to a key part of our bear thesis, that digital only has zero long term profit opportunity saying “We haven't seen the type of explosive unit economics in that business that would lead us to believe that it's going to be a meaningful driver of the bottom line for Peloton in the next couple of years”. There is not enough differentiation vs competition in the digital offering, YouTube has plenty of content for free, many competitors have growing content portfolios at varying price points with nearly all less than Peloton’s. So we think the focus has to be on connected fitness, and the accelerations here were definitely bullish this quarter and the market sniffed it out. Though the timing was very opportunistic here for PTON. A hyped IPO (however mis executed), controversial holiday ad taking awareness to the max, a strong January new year’s resolution selling period, then a once in a generation demand driver in gym closures and people confined to their homes. We suspect even some of those people who denounced Peloton on the holiday ad actually bought a bike when they realized they could not go to their own spin classes indefinitely. But we think the jury is still out on whether this is a game changing fitness business model/brand or a good idea that’s turned into a well-funded, budding business currently seeing outsized growth with opportunistic timing and convincing investors its worth 3x to 5x what will prove to be its underlying value. We’d caution people on the CEO’s closing statement that Peloton is a “recession proof” business, he also said it's “covid proof” (not even sure what that means) but can you really say that growth and demand would look anything like this without Covid19, let alone if we were in a recession without social distancing and gym closures? The other part of his statement was interesting, saying he “can't wait to wait to go to a buzzing, fun-packed New York City restaurant with good friends in the not-too-distant future, God willing. So we want to get back to normal like everybody”. There are probably a lot of new Peloton owners thankful to have a cool way to workout when stuck at home, but are also thinking they can’t wait to go back to their live yoga classes, crossfit WODs, bootcamp classes, and gym workouts. Maybe they will keep the Peloton subscription for the occasional home ride, but maybe they won’t and there is a churn risk on the horizon.
There is a lot of interesting things we saw within numbers and commentary, here are some of the key bull and bear points we’d highlight.
Bull Puts
- Churn might be the most bullish data point for 3Q as another sequential improvement brought monthly churn to 0.46% the lowest seen in 4 years. Virus concerns likely played an important role in reducing churn in March, but it’s still bullish especially in the context of macro/financial concerns for consumers.
- The guided acceleration in subs is the next big bull point. We care about rate of change at Hedgeye and the expected acceleration should get bulls excited about long term targets as the street tends to ‘over model’ the near-term changes in trend. Covid-19 certainly flipped this Q from slowing to accelerating, but given guidance implies only a 1000bps acceleration when competitors are talking about 3-5x lifts in demand, should the growth actually be much higher? Maybe it’s a sandbagged guide by the CFO for a beat, or it’s the supply constraints, but you would think the sub additions with this demand would be more than the number added in 3Q. Again maybe this just means a low beatable bar.
- Profits are rapidly inflecting and the company is actually expecting positive adjusted EBITDA for the year. That’s the power of “free” demand even turning off marketing spend. I mean right now many of the tools Peloton uses for driving demand and awareness (stores, commercials, etc) aren’t needed and the company can’t keep up with orders. That's how you can get positive EBITDA rapidly. It won’t last forever, but its definitely a positive and gives legitimacy to the massive marketing spending Peloton deployed in the past.
- The elongated delivery times cited by management are both a blessing and a curse. First it clearly indicates continued strong demand. You aren’t able to get product to customers fast, but the good thing is nobody can, and industry-wide commentary indicates people are just being patient and not cancelling order. That means the sales impact of the demand can last a long time on the Peloton P&L and we don’t expect demand to drop materially as long as the virus is around (maybe til we lap next March).
- Engagement in terms of workouts continues to rise now at 17.7 workouts per month per connected fitness sub (note a CF sub has 2.7 users by our math). These numbers are slightly skewed since more and more content and types of workouts are added (ie it’s not more and more bike riding), but still more working out means a stickier consumer, and any drop would clearly be a negative so the engagement rising is definitely bullish.
Bear Takes
- Digital-only as of the mid March trial change is only up to 177k subs. That’s just not good enough given the price drop and trial launched in Dec, awareness and price aren’t an excuse since a marketing campaign was launched in Dec as well. That tells us the consumer doesn’t value this product enough to pay for it, and management acknowledged this. We have said all along that digital-only wouldn’t work. So If your bull case is a ‘Netflix like’ tens of millions of digital-only subs paying $12.99 a month you should think twice. The company has already reduced that trial back to 30days as of May 1, probably done when it realized the music streaming cost of free users was significantly outweighing profit opportunity.
- Churn in 3Q was bullish, but guidance sounded bearish implying a rise. The CFO stated “connected fitness churn to be below 0.75% reflecting recent trends and an expectation that we will revert to more normalized levels by the end of the quarter” That sounds like its headed higher which would be a bad sign given the growth in subs and high engagement. However the company has also beat the churn expectation materially the last couple Qs, so maybe the CFO is just once again managing expectations.
- PTON management continues to talk about the investments in workouts outside of the bike, and highlighted the rapid growth in strength and ground-based workouts. We think it’s a risk as Peloton has less of a competitive differentiation here, the bike experience is special with a moat, the rest is not. It's much like how digital-only isn’t gaining steam and faces too much competition we think PTON will struggle to see a good ROIC outside of the bike. If you are just trying to add some value to subs, that’s fine, but you don’t want cyclers to shift to other kinds of workouts and deploying too much capital here we think is questionable. A simple thought on how the markets are different, try sleeping in a room next door to a person riding a high end spin bike, then try sleeping in a room next to that person doing a boot camp workout on a treadmill.
- Perhaps management’s focus on other workouts is because fitness has always been an industry susceptible to staleness and fads. Management likely feels it needs to keep innovating and evolving. But we think it can’t be doing what others are doing just on its platform. It needs to create new things, new workout styles, new products, or other innovations that can be as unique, competitive and engaging as the bike. Management promises a pipeline of equipment and content. We need to see more than a low priced treadmill and a rower.
- Management highlighted that the new purchasers of the Peloton bike saw a spike in younger users. We can’t help but think this is higher attrition risk as these people will be more comfortable to return to gyms when open since they are the low risk group for the virus, and its likely only got the bike because of their gym/fitness center closure.
Hedgeye Survey | April 19, 2020 N=500
