Ride the Bike

Peloton (PTON) represents the top of the heap in terms of home fitness. Their stationary bike is the best but they have gone to great expense to make it so – including building their own touchscreens, software systems, content development studio, retail locations, special music software, even their own clothing. Their bike costs over $2000 and comes with white glove home delivery and setup.

Of course, Peloton wants to be positioned more as a technology company than a maker of exercise equipment. The part of their business that is a little like a technology or content company is the subscription business. The bike costs $2K+ but then you pay $40/month for access to the content library, tracking tools, leaderboards, and live classes. The “Tread” is over $4K. We have yet to experience that one but it certainly looks nice.

Most investors question the market potential given the high price points and competition. We’ll get to that but as a change of pace let’s start with valuation.

Looking at Numbers

First of all, they do break out products versus subscriptions. For the year ended June 2019, they did $915M comprised of $719M product and $181M subscriptions. Both are growing just above 100% YoY.  Using a back-of-the-envelop approach and thinking about the proposed valuation of $7.8B one can get there by putting a 5x sales multiple on the “hardware” business and a 20x multiple on subscriptions. That’s not unreasonable. That puts the P/S ratio for the whole company at about 9x sales. We’ve also included our PFV here another point of reference.

Some other numbers to consider are those of some potential comparable companies. Lululemon (LULU) has TTM revenue of $3.6B, is growing 22% and is valued at 7x sales and 47x trailing earnings. Planet Fitness (PLNT) has revenues of $641M, is growing 30% and is valued at 8x sales and 51x trailing earnings.

Peloton’s growth has been outstanding but of course, it’s fueled by expensive up-front purchases. The subscription business is 20% of total revenue.

The company provides some of its own estimates of total market opportunity and suggests they have 12-14M targets who are likely to become customers. We’ve seen some credible analysis of these numbers and they are not wildly optimistic. Most tweak the income assumption a bit and end up with a true available market for them of about 10M customers.

We’ve been though all the numbers on gym memberships and all that but we are really talking about here is a special demographic. These 10M people have plenty of money and care deeply about their health and fitness, enoough to make room for it in their homes and in their budgets.

A few examples we know well are tennis and personal training. If you are avid tennis player you spend somewhere between $200-400/month at your club. That’s a combination of membership fees, clinic fees, court-time rental. If you are a gym type and seeing a personal trainer 2x per week you’re spending $400-800/month for that. Sure these numbers vary a lot and you can find other examples but the math is prettty basic. Other classes like yoga, spin or pilates tend to run around $20 so if you do that 2x per week you’re still at $160/month.

Peloton offers 0% APR financing on the bike which comes to $58/month for 39 months. So with the subscription you’re talking $100/month. If anything I think Peloton has the ability to increase prices based on their market position. We’ll cover some direct competitors but they are basically lower-cost alternatives.

When you think about this as really a $100/month subscription market with the bike rolled in the serviceable market size is about $10B in annual revenues. If Peloton can capture a third of that market they can be doing over $3B/year in recurring reveunes.

Direct Competition

We’re going to focus here on the in-home bike. There are of course innumerable competitors due to all the choices one has about getting fit. A friend of mine walks the few miles back and forth to work everyday and uses the stairs instead of the elevator (he lives on the 9th floor) and he fit as a fiddle. And many gyms now have spin classes and there are specialty spin studios like SoulCycle (now owned by Equinox).

Before I get to the copycats it’s worth mentioning that most serious cyclists (I was one once) have a trainer already. This is a unit which you attach your (typically very expensive) bike to inside and then use your own gears to vary resistance. They have some drawbacks in terms of comfort, stability, and noise but they are more than adequate. There’s been innovation in this space as well with much improved hardware (costing around $1K) and software and content to support training. Avid cyclists tend towards these systems because they provide the a “feel” that is more like riding a real bike on the road. If you’re interested in this kind of thing you might check out Zwift.

Turning to the direct Peloton competitors there are a few but two stand out – Nordic Track and Echelon. Nordic comes right out with a head-to-head comparision of their bike with the Peloton. The prices are fairly even so it’s not clear why one would go with the Nordic over the Peloton. But it’s a choice nonetheless.

Echelon offers a range of bikes that start at $840 (for the EX-1) and go up to $1,640 (for the EX5-s). Their monthly subscription is a bit lower at $79 and they emphasize lower costs by annual purchases. If you compare the EX5-S to the Peloton over a two year period the EX5-s will cost you $2,200 while the Peloton will run $3,200. The EX-1 is still a very good machine and is only $1,400 with the two year membership.

What is clear from these and other offerings is that now that Peloton has done it many others can do – at least in terms of building a high quality “connected” bike that comes close to matching what they offer. They can also do it a lower price in many cases. So for Peloton the brand and the retail stores will be all important. The company might also consider increasing prices and further differentiating their membership rather than trying to compete with any of these companies on price or value.

The question is how well they will do at building this “lifestyle brand” over time. They’ve made some good moves so far like getting the Peloton bike in the gym at luxury hotels, the types of places their typical customer would be. But they still have a long way to go there with only smattering so far. Doing some big deals with outfits like the Ritz Carleton and Four Seasons should be at the top of their list.

Stock Conclusion

Syndicate commentary has been all over the map this week and based on how the market has been acting and how deals like SmileDirectClub (SDC) performed out of the box we think investors should take a “watch and see” posture on this deal.

At the mid-point of the $26-29 range it’s a $1.1B offering. There are 20 banks on the cover to flog it so it’ll get done. Right now market conditions don’t feel like investors are going to chase the stock to higher levels. Given the pricing relative to our PFV there’s more risk than reward at the mid-point.

If the proposed price were to be lower than the range we might get more interested but it seems like there is some pressure for the underwriters to demonstrate that there is high demand for the shares so will probably price it too high.

 

 

 

 

 

 

 

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