An (Almost) Completely Non-Financial Analysis of the Peloton IPO
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February 9th, 2022

Disclaimer: Peloton has been a polarizing company ever since announcing it’s IPO, with profitability concerns on one side and the potential for leading a brand new luxury home-fitness category on the other. This piece is the result of digging deeply into the merits of both sides and is not financial advice.

Just over 1 year since Peloton raised a monster $550 million Series F, led by TCV and joined by giants like Kleiner Perkins, the fitness (and more!) company is looking to IPO.

Targeting a valuation of $7.6 billion, they are betting big that the public markets will buy into their vision of the future of fitness — one that is connected via devices ranging from $2,000 — $4,000 providing streamed lessons to anyone who can afford it.

Peloton’s financials have already been thoroughly dissected and discussed by analysts looking at its S-1 (which is a highly recommended read and includes the prospectus, financial statements, risk factors, and more), so this piece attempts to take a more holistic look at the company.

We’re going to cover:

  • The management team
  • The product itself
  • The ecosystem the products occupy (including having some fun with a potential acquisition target)
  • The users
  • How it can achieve its full upside, and
  • Where it could potentially falter

When we do delve into financials, it will be mostly to provide context around statements regarding business model feasibility.

Introduction, or What’s In a Name?

Best known (and well-lampooned) for its costly bikes and treadmills, Peloton immediately attempted to identify itself as anything but a hardware company. This makes sense, given that hardware is really hard and the few IPOs in recent memory have failed to live up to expectations. Exhibit A, from page 1 of the prospectus:

So… what don’t you do?

The fact that they are trying to project an image of expertise across so many domains is worrisome. Is Sears a tech & logistics company because they have an app and do deliveries?

A cynic would say it dilutes focus to try to be all the things Peloton claims.

A supporter would say that possessing so many core competencies creates a deep moat for any potential competitors to cross.

A reader with common sense would point out that Peloton’s key business drivers are connected device sales and subscriptions, underpinned by a content network that gives people access to a wide range of workouts. Everything else is incidental. Despite the two most plausible narratives here being fitness and media, they are chasing a valuation as a technology company. Hopefully you will have your own opinions by the end of this piece. For now, let’s take a look at the management team responsible for leading this Peloton into the future.

Management team

Assessing company health by reviewing key executives is a delicate task, as past accomplishments aren’t always indicative of future performance. However, the executives below have led Peloton to its current state and will be the ones responsible for creating shareholder value post-IPO, so knowing where they come from is useful. These profiles and more are available on the company’s Team page.

John Foley, Founder/CEO**: **The guy in charge of vision, evangelism, fundraising, and general company solvency is John Foley. A tech executive who most recently the eCommerce division of Barnes & Noble, including its digital storefronts and the NOOK launch. While we all know how that turned out, it probably left him more than capable of handling the complex supply chains and online media portion of the Peloton business.

Yony Feng, Cofounder/CTO: Yony seems like a very qualified individual who joined at the earliest stages and was able to grow his management capabilities as Peloton scaled. His background in low latency streaming at Cisco/Skype before joining in 2012 was likely instrumental in launching the early products. According to LinkedIn, he assumed the “CIO” role in April 2019; presumably so the team could tell investors that they totally have someone in charge of data security.

Tom Cortese, Cofounder/COO: Looks like a straight operator in the product space. He navigated the sale of a company he founded with Foley in 2011, though there is very little information available online.

William Lynch, President: William was the CEO of B&N at the same time Foley was there and appears to have had a heavy hand in the eCommerce initiative as well. He went on to helm Savant, a luxury home automation service provider. I’d guess the Venn diagram between Savant customers and people who would enjoy Peloton is basically a circle. His current role is as president of Peloton Interactive, but it is unclear what that means.

Jill Woodworth, CFO: Joined in 2018 from JP Morgan, and JP Morgan promptly became a key bookrunner for the deal. I’m not sure how common this arrangement is, but in addition to the financier connection, she certainly has the track record to be a fine CFO.

All in all, a brief review of key personnel didn’t bring up any individual concerns. However, buried deep inside the S-1 is a risk factor that stating “We have grown rapidly in recent years and have limited operating experience at our current scale of operations”. This is likely something every S-1 contains from a legal coverage standpoint, but it still bears mentioning. In 2012 when both Foley and Lynch were there, Barnes & Noble was doing over $7 billion in revenue, or over 7x Peloton’s current revenue. What “scale of operations” is the S-1 referring to?

A couple of interesting takeaways from perusing this page:

1. Yony’s LinkedIn link was broken. Broken links are a bad look for any page on a “tech” company’s site.

2. Half the team doesn’t even have Peloton profiles listed. For a luxury product that probably relies heavily on word of mouth referrals, it isn’t particularly encouraging to see that not even the leadership buys into the product.

Product

For full disclosure, I have never used one of these products and don’t know anyone who** **has. Everything in this section is from publicly available information.

There appear to be three core products: Bike, Tread, and App. The Bike and Tread are referred to as “connected fitness devices” and are $2k and $4k, respectively. The App is split into a “Peleton Membership” priced at $39/month which requires the Bike or Tread, and the “Digital Membership” priced $20/month which doesn’t. Both give you access to the course catalog, but the pricier one provides live workout metrics, interactive courses, and a performance dashboard.

As far as I can tell, the connected fitness devices are bikes and treadmills with TVs attached. From a physical experience perspective, I don’t know how much better they are than their nearest (more reasonably priced) competitors, but Peloton’s sales pitch revolves largely around the live classes and performance tracking.

For this reason, I am led to believe that the course catalog is the beating heart and soul of Peloton. By providing guided lessons and performance statistics, it provides a more convenient delivery of the cycling boutique experience in the comfort of one’s own home. They claim to have 20+ live courses per day and thousands on-demand.

There is also to be a social media aspect to the product. While it feels shoehorned in, it probably helped them justify a tech valuation with early investors. Perhaps it is useful for keeping yourself and your social circle accountable, but for now it’s more of a fun toy to see how much the CEO works out.

Only 5 workouts in the month of September, John? Pre-IPO stress is a real thing.

Tech Company Valuation — Justified?

The sleek contours and the instructor-led training appears to be resonating with a certain community: they claim to have sold over 400k bikes and boast 1.4 million subscribers. But does that justify the valuation expectations?

Full Consolidated Statements of Operations and Comprehensive Loss available in the S-1

Let’s look at the numbers: a top line revenue of $915 million after costs of revenue and operating expenses means Peloton operates at a $132 million deficit. They have yet to turn a profit.

Their target market cap is 8.3x revenue ($7.6 billion on $915 million). This lines up with technology company valuations, but the “Cost of Revenue” section contains insights which suggest it may be more of a media company.

The “Cost of Revenue” section contains some fascinating insights. The CoR for the connected devices is 61%, 56%, and 57% in 2017, 2018, and 2019, suggesting that Peloton has the manufacturing and logistics processes controlled pretty well. But the subscription side raises some questions. In a typical SaaS model, the CoR should shrink as a percentage of revenue. This is because the incremental cost of distributing software to a new customer is nearly zero, while the incremental revenue is still 100%. The problem lies in the fact that Subscription CoR is inextricably tied to content creation. Content, unlike software, does not scale. It is for this reason that media giant Viacom has a market cap of $10 billion despite revenues of $12 billion (0.83x multiple) and arguably one of the most entrenched distribution networks in the world.

Peloton calls themselves a tech company and a media company interchangeably, but the two are quite different in terms of investor demand. If they push the media narrative too hard, they still remove the stigma of being a hardware company, but may find it challenging to raise at software company multiples.

Regardless, Subscription revenue is making up a steadily larger portion of their business. Up to 25% in 2019 versus 22% and 17% in 2018 and 2017 respectively, they appear to be consciously prioritizing it. Content creation and distribution is a tricky game, as we will explore further on.

Where does Peloton fall in relation to other high-profile IPOs? Their expected market cap to revenue ratio is significantly higher than FitBit’s, which was 5.5x ($4.1 billion on $745 million). FitBit was operating with $131.7 million in profit the calendar year prior to the IPO, as opposed to Peleton’s $132 million deficit. Peloton will likely face challenges similar to FitBit as they try to introduce new products to market, but at least will have reliable subscription revenue.

How it could win

Despite having never turned a profit, Peloton has certain market-leading qualities that they can continue to entrench themselves in.

A major win for them, which they can conceivably parlay into higher market share and lower marketing spend, would be if they maintained their position as the premier location for fitness content producers. Their platform draws a uniquely fitness-focused, middle to upper class audience that content producers can become celebrities on. Indeed, current instructors have become famous in their own rights, amassing huge Instagram followings. Combining the audience with the visual nature of the medium and the sustained attention the instructors receive, there should be immense competition to supply lessons. While this would drive content production costs down, it would also work to bring more users to the platform as instructors become ambassadors for their own classes, which would of course be available exclusively through the App.

To my knowledge, no other company has created a content library this large, this high quality, and this focused.

Acquiring a wearables company would improve their visibility by orders of magnitude, and would also put them on the path to sustainability by producing more data and diversifying their product offering.

Although there was no acquisition strategy listed in the prospectus, acquisitions should absolutely be on their radar. They could use an acquisition to address one of their most glaring weaknesses: visibility. The price points of Peloton’s connected devices sit squarely in the “luxury” bracket, but rarely (if ever) can be seen ‘in the wild’ due to their in-home nature. This is a problem because luxury items tend to derive their value from social proof, and owners of luxury items like to be seen using them. So Peloton devices occupy a luxury limbo: they are expensive, but cannot be appreciated by anyone but the owners.

Acquiring a wearables company would improve their visibility by orders of magnitude, and would also put them on the path to sustainability by producing more data and diversifying their product offering.

By setting up a wearables line, they would be able to give their most valuable category of customers — the Bike and Tread owners — something to leave home with to show that they are, in fact, Peloton product users. In the same way that Apple created AirPods and Apple Watches to convey a certain level of sophistication, Peloton can use accessories as free and ubiquitous marketing. Customers spending $4,000 on a treadmill likely wouldn’t be price sensitive, and in fact would likely jump at the opportunity to obtain something highly visible that was made exclusive to them.

Below the owner-only tier of wearables would be a less exclusive, yet still highly functional accessory. This could either be used as a gateway to the Subscription service (i.e. 12 months of free Digital Subscription on purchase) or vice versa (i.e. sign up for 24 months of the Digital Subscription and receive a free wearable). In both cases, more new users would be incentivized to join.

A side effect of wearables is the veritable trove of data they produce. If Peloton could upsell even their existing 1.4 million subscriber base, they would be sitting on biometric, location, and intent data from a fitness-focused, middle-upper class cohort that would be immensely valuable.

Somebody should tell them that FitBit is exploring a sale.

How it could lose

Removing the rose-tinted glasses from above, the Peloton IPO is fraught with risks the management team will need to handle deftly.

The most pressing question remains: will the company ever be profitable? Their losses have compounded year over year, and the fact that they are looking for a fresh cash infusion just one year after raising $550 million is troubling at best. Their current activities are unsustainable, with the S-1 stating bluntly that they “expect to incur net losses for the foreseeable future”. If there is an absolute cap on the audience that accepts the product at this price point, or if growth slows, or if competitors emerge, Peloton is in danger. Profitability concerns will follow this company as long as the business model remains unchanged.

Looming large in the profitability equation is how they decide to proceed with regards to content. While content is distributable and can be offered at a lower price per user, creating and licensing it is incredibly expensive. Just ask Netflix. However, their content is an integral piece of their value proposition and without it, their flagship hardware is just expensive exercise equipment. When acting as both a creator and distributor, a disruption in either is catastrophic to the business as a whole. If competitors drive up the price of content creation, for example, users suffer by needing to absorb the higher cost. If users leave the platform, content becomes more difficult to produce because there is less revenue to fund it with.

They also had a lawsuit to the tune (haha) of $150 million by the music publishing industry for knowingly using unlicensed music. Peloton denies the allegations, but their mere existence is worrisome. If they were knowingly using the music without licensing it, there would be potential for other moral and legal lapses to come to light in the future. If they weren’t, there would be serious concern around their internal control processes and how such a glaring oversight was allowed to happen for years.

Other risk factors are explored in depth in their S-1. They include the fact that they rely on a limited number of suppliers, derive most of their sales from the Bike, and are more susceptible than most companies to the effects of an economic downturn.

Conclusion

Peloton is best known for their stationary bikes, but is a market leader in the connected home fitness category because of the content engine that unifies all their products. They are well positioned to expand their footprint as a premier luxury product with the right partnerships and acquisitions.

However, the questions that arise about their current model’s sustainability are underlined by the fact that they have never been profitable and, by their own admission, don’t expect to be in the foreseeable future. Additional management decisions that led to a high-profile lawsuit and a market cap target that would be high even for a pure software company lead to concerns that the $26–29 per share are overvalued.

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