Peloton: What's Priced In?
What do you get for $5.1 billion? And what might it actually be worth?
“Stock prices are the clearest and most reliable signal of the market’s expectations about a company’s future financial performance. The key to successful investing is to estimate the level of expected performance embedded in the current stock price and then assess the likelihood of a revision in expectations.” - Michael Mauboussin
At $13.25 per share, Peloton’s share price is up 99% from its low in October. Clearly, the long-term expectations implied by the stock price are higher than they were then. And they are still far lower than they were during the height of the pandemic. But that’s about all we can conclude about what’s priced in before diving deeper.
The market is saying the equity is worth $4.6 billion and the whole business including net debt is worth about $5.4 billion. That’s excluding the exercisable options from the share count and likewise the cash proceeds from exercising them because the weighted average exercise price is higher than the current share price. Including them, the market cap is $5.1 billion and the enterprise value is $5.3 billion.
So what do you get for that? The subscription business should do about $1.7 billion of revenue over the next 12 months. That includes about 3.1 million Connected Fitness (“CF”) subscribers paying $44 per month and about 0.8 million digital app subscribers who appear to be paying about $6 per month on average. The CF business has an ultra-low average monthly churn rate of 1.14%, which is up from around 0.6%-0.8% during the pandemic, and looks on pace to grow its sub base by perhaps 130,000 this fiscal year (ending June).
You also get the Connected Fitness hardware business, which includes the apparel and accessories business and Precor. Over the last four quarters, this business has reported negative gross margins due to a variety of factors mostly stemming from the aftermath of the pandemic, the previously vertically-integrated business model, and excessive inventory ordering. As the higher cost inventory is sold through making way for lower cost inventory and overall inventory levels come down, reducing excess storage costs, this business should begin to approach normalized gross margins in the 20%-30% range. Around current volumes, this business should do something like $1.2 billion of revenue over the next 12 months.
The big wild card at this point is growth. When the stock price was collapsing, the narrative was Peloton’s growth was over, this was a broken business, former subscribers were returning to gyms while struggling to sell their bikes and treads. Yet that was never the case. People assumed a plunging stock price meant these things, but in reality it was caused by the massive fixed cost deleveraging when the business failed to grow into the enormous cost structure built out by prior management. The business was not dying, but its cost structure and cash burn were emergencies. Today, those fires have been largely put out, churn is still very low, and the business continues to grow its subscriber base quarter after quarter.
Lately, growth has picked up during the seasonally stronger half of the fiscal year. Net CF adds nicely beat guidance last quarter (60k versus 27k guidance) and had already matched management’s current quarter guidance (47k-57k) as of February 1, only one month into the quarter. New alternative selling channels and go-to-market strategies like the rental program, the certified pre-owned program, and third-party retail partners Amazon and Dick’s were responsible for 19% of Connected Fitness unit sales last quarter.
Is this going to be a business that adds 1.2 million CF subs annually like it did in fiscal 2021? No. Will it have no growth at all? I don’t think so. My current base case is about 132k this fiscal year and an average of 159k net adds annually over the long term. This fiscal year’s 132k is arguably still depressed from the pull-forward effects of the pandemic and certainly from management’s pull back on advertising spending as it prioritized near-term cash flow. There’s also the Row that was just released, the likely return of the Tread+ at some point, as well as the growth of the rental, CPO, and third-party retail programs that should boost results. It is also only a matter of time before the company expands beyond just five countries.
The other wild card is what management can do with the digital app business. The content is the company’s secret sauce. Barry even called the digital app “the path to the promised land” on the last call because it can grow without requiring a hardware sale and it can leverage the largely fixed cost content. The company plans to have a multi-tiered freemium offering to both get people in the door and give them a taste of what Peloton is while upselling those who value the whole content library. I expect this offering to be revealed within the coming months. Barry’s goal is to have at least 1 million new people trial the digital app in his second year as CEO, which starts this month.
In the remainder of this post, I’ll discuss:
a reverse DCF and one set of expectations that backs into the current share price,
the assumptions behind my revised base case scenario and how that values the business.
I also include a PDF showing the long-term assumptions behind six possible outcomes for the business, including the two mentioned above, and how those assumptions translate into current equity values. Essentially, you’ll understand my take on “what’s baked in” at a wide range of different price points. Let’s begin.
Reverse DCF
What do I have to believe about Peloton’s future for the equity to be worth $5.1 billion or $13.25 per share?
One plausible scenario that backs into the current share price includes the following: