Life’s a drag at Peloton
peloton is the main group of riders in a cycling race, staying together to save energy and reduce drag. Sadly, nothing seems to fix the drag on the Peloton share price, with the market continuing to punish anyone with a speculative long position.
Peloton Interactive’s share price once traded at more than $160. Today, it’s under $3. If you draw a five-year chart of the price, it looks like an incredibly tough mountain bike climb with a rewarding downhill at the end that goes on and on. If ever there was a poster child for craziness in the market, this is it.
Despite achieving positive free cash flow this quarter (albeit only just), the CEO of Peloton is stepping down. Barry McCarthy wasn’t even on the earnings call, even though he’ll continue to serve as a strategic adviser to the group.
The company is restructuring its workforce to such an extent that 15% of employees will be let go.
A business that traded on a revenue multiple of 21.6 (!) at its peak is now languishing at 0.4, despite having been touted as a platform business that deserved to trade at software-as-a-service multiples. Yes, connected fitness was at one point a buzz phrase. Now it’s just an embarrassment, with revenue far below the stayhome-and-stay-safe
Alevels of 2021. Shock, horror: most people would rather be outdoors or around other people than exercise alone at home on a glorified bicycle and iPad combo. It’s clearly panic stations now at Peloton, with major debt maturities on the horizon and a business model with a patchy track record. If you hardly ever make positive free cash flow, you will battle to find supportive lenders. This lack of financial success is despite the group having more than 3-million paid connected fitness subscriptions, which sounds excellent in theory.
Gross margin in the connected fitness segment was just 4.2% in this quarter, doing an excellent job of diluting the gross margin of 68.1% in the subscription segment. We know from Apple that combining hardware and software can be powerful. The difference is that Apple made a gross margin of 39.4% on its devices in the latest quarter and 72.8% on its services, in both cases higher than the equivalent segments at Peloton.
The funny thing is that the blended margin at both groups doesn’t end up far apart, with Apple at 45.9% and Peloton at 43.1%. This is because Apple is still selling plenty of devices, whereas Peloton is struggling to move inventory and is more reliant on services. This is why it is so important to drill down into the key metrics, because
Like so many other listed startups, Peloton has a scale problem. The unit economics might not be as strong as Apple’s, but a blended gross margin of 43.1% is nothing to get upset about. Overheads are just far too high relative to revenue, which is why Peloton has achieved positive free cash flow only in the latest of 13 quarters.
The problem isn’t going away, with revenue guidance for the year being decreased in response to consumer trends.
To preserve cash, Peloton will scale back on media activities (there will be less advertising). This gives midpoint earnings before interest, tax, depreciation and amortisation (ebitda) guidance of a loss of $13m for the year, $37m better than previous guidance. Imagine cutting back on growth spend so that you can settle happily on an ebitda loss of $13m, all while staring down the barrel of debt refinancing and planning to cut 15% of employees.
What went wrong here? Simply, far too many tech companies ramped up expenses in line with revenue during the pandemic, encouraged by growth investors and venture capital types alike. Sadly, this is the same issue that has plagued so many tech companies, with the difference being that Alphabet and Meta, for example, had strong-enough core operations so that they could pull back substantially on expenses to sort out the trajectory, whereas Peloton has had to navigate sharp drops in revenue in the post-pandemic world.
In the 2021 financial year, the golden year at Peloton, revenue was $2.2bn higher year on year. Gross profit was only $617m higher, as margin was diluted by equipment sales. Operating expenses were $685m higher. Spot the problem?
It’s easy to add expenses when revenue increases. It’s very hard to take them away when revenue drops. The net result is painful.