As a consumer goods company that integrates the features of Apple, Netflix, Costco, and Tesla, it faces a massive market with no real competitors. In addition, the current valuation presents a fair& cheap entry point with the potential of higher multiple into the holiday season. Most importantly, its product encourages the user to work out by actively overcoming laziness.
We believe that Peloton is a market disruptor in the fitness and health industry, using streaming and IoT to change the way people exercise. The fundamental reasons we like PTON are as follows.
1. There is no competitor of the same scale.
2. The entire industry has substantial growth opportunities.
3. Its great business model, long-term solid sustainable cash inflow.
Many people still question the actual demand post-pandemic environment. But we see Peloton as companies sell a great product that encourages users to overcome inherent laziness. The current stock price hasn’t counted in the potential of PTON becoming the long-term market winner. With such a cognitive gap, now is an excellent time to buy PTON.
The US is the largest fitness market globally, both in terms of average participation and average expenditure. The US fitness market values about $37 billion each year, with about $4 billion spent on various equipment. According to Statista, there are 36.7 million spin bikes and 52 million treadmills in the US. With the sales of 1.2 million equipment for PTON, there is still massive room for growth, where PTON’s penetration is less than 5% of the TAM. Compared to traditional fitness equipment companies, PTON uses streaming+IoT+subscription to access new markets and new customer groups. In the past, people going to the gym were mainly “serious” workout people committed to exercising. At-home fitness devices like PTON would not satisfy their need, yet it is an excellent option for people who exercise lightly and have no time for the gym. The recent fitness data is also reflecting this fact. More young people and more mid-to-low income people are working out. The Internet Generation is more willing to work out than any other generation.
Aside from its market scale, we like PTON because its business model integrates many current high-quality business models.
Apple: it controls the SKU counts, yet each product provides a great user experience.
Netflix: as a streaming service that focuses on library content, it enhances user experience by investing in massive content. The more content it accumulates, the greater the competitive advantage and the lower the marginal cost.
Costco: core earnings come from the long-term subscription revenue.
Tesla: integrating the supply chain of production, transportation, sales and assembly is favorable for creating brand premium targeting end-users.
PTON’s investment in streaming services forms an extremely high barrier to entry and grows a key competitive moat. PTON is seemingly a hardware sales company, yet its core earnings and future competitiveness come from the subscription. The PTON subscribers pay $39 every month to use the streaming service. The user could find the streaming courses with their desired length of time, exercise type and instructors. PTON spent more than $100 million on making various training videos. Users love such videos and their instructors. Some PTON instructors have already become internet celebrities, such as Robin Arzon, who has more than 800,000 followers on Instagram. Currently, the estimate of Instagram followers of all Peloton instructors exceeds 5 million. At the same time, Peloton only has 2 million paying subscribers. With the production team coming from a Hollywood background, the quality of the video is way better than those created by various Youtubers and low-input companies.
The longer it gets, the greater advantage Peloton enjoys. The company has 34 instructors, two studios and videos in various languages (English, German), with more variety in language options and exercise types available in the future. As the most similar competitor to Peloton, Echelon raised funding of $65 million with the most recent valuation of $1 billion, and its revenue is just over $100 million. The investment by Peloton in streaming in FY21 alone is over $130 million, let alone its scale advantage in hardware. Mass production could lower the cost. Like Netflix, massive content production forms a high barrier to entry, making it hard for start-ups and other competitors to enter the market. A considerable amount of videos and broader coverage of exercises would grow a more substantial competitive moat as time goes by.
PTON increases users’ participation and maintains users’ stickiness through high-quality content and interaction through streaming. Peloton subscribers almost have the highest stickiness in B2C subscription products. For example, 12 monthly churn rate is only 7% and retention of 80% after 36 months. Even AT&T and Costco can not reach the stickiness level of PTON subscriptions. With incredibly high stickiness, average exercise frequency also shows the users exercise a lot. The average exercise frequency increases from fewer than seven times per month in 2018 to more than 17 times per month today, where the gym already reopened. The exercises also expand from PTON Bike, running course to those exercises without PTON exclusive hardware, such as yoga, meditation, strength training. High user stickiness and increased average workout reflect users’ fondness for PTON products.
The users are encouraged to work out not just because of high-quality videos but also the payment mode. On the psychological level, PTON has the advantage in the bet against laziness. Whether it is the gym or fitness device, the biggest enemy is inherent laziness. Lack of persistence is the key reason that turns fitness devices into clothes rack. The monthly payment plan of PTON brilliantly wins this psychological battle with the user. Every PTON user already has a device at home with multiple family members. If the user decides to unsubscribe PTON product, it means
1. I admit I don’t want to exercise anymore. I want to be lazy, no more workout.
2. I need to admit to my family that I made a mistake in purchasing this expensive device.
At the same time, canceling the subscription requires acknowledgment or permission from the family members. And the typical response would be: “I’d rather spend a bit of money every month than you be a couch potato every day.”
Once the PTON hardware is installed at home, the users would not unsubscribe due to their family roles, personal pride and the sunk cost. In terms of product category, PTON subscription and Netflix subscription are fundamentally different. Canceling Netflix subscription this month due to lack of good content would be deemed an intelligent decision to save money. With the PTON subscription, customers need to use their product more often to yield returns on their investment. The more I use the product, the more money I can save. The thinking process of many users is relatively straightforward “since I spent so much already, I need to use it more to make my money worth.”
Because PTON users subscribe to the streaming courses, the long-term earnings almost all come from subscribers. Based on the 80% retention rate after three years, the long-term net income margin of PTON is around 18%(see calculation below). From the LTV perspective, the long-term margin of PTON could exceed 33%. In the current growth period, PTON should sell as much hardware as possible and acquire as many users as possible. There is no significant competitor at the moment. Europe and the US will soon witness the first shopping season after the recovery. The. Factors mentioned earlier are the fundamental reasons PTON could sell well in the shopping season this year. As time goes by, the subscription revenue and profit would be the keys to the earnings growth of PTON. It is what the company has been doing since August. The price of PTON Bike dropped by $400 to $1459, which further enhanced the demand. Compared to competitors like Echelon and other connected bike brands, PTON is more affordable and cost-effective than before. The company is on the right track towards the holiday season.
PTON has already made plans for the shopping season in 2021. The production and transportation problems will not recur this year. People had high demand to work out at home back in 2020 due to the pandemic. However, the annual production of PTON at the time was only 200,000~300,000. It was impossible to produce enough hardware to meet demand at that time. Many users had to wait for 2-4 months for the product they ordered to be delivered. In the past year, Peloton prepared by acquiring Precore, expanding factory in Taiwan, and investing in transportation channel. Now Peloton’s annual production can reach around 1.3 million devices. We believe the production bottom neck should not be a big issue this year.e
In addition to the production scale-up, some of Peloton`s business strategy also shows confidence for great sales this holiday season. First, the company stocks up inventory worth more than $1 billion. Second, PTON has also expanded the transportation and installation team for quick delivery. Third, during the last earnings call, the company said it would increase S&M spending in this holiday season. Furthermore, the Peloton Treadmill recalled in the past due to safety issues was launched in the market recently. All the arrangements made in the past six months lay the foundation for the shopping season this year. However, the current stock price hardly reflects the possibility that Peloton could sell well by that time. Therefore, we believe now is the perfect time to buy PTON.
In terms of valuation, the PTON price is already low with a sufficient safety margin. We separation PTON hardware and software in terms of valuation. Our valuation for PTON hardware is 3XPS based on electronic hardware company peers` multiple. As for the subscription business, we use 11.8X PS, which is closer to the SaaS industry average and live streaming/companies multiple. Based on the 2023 revenue structure, the PTON target price is $145. The current market price of around $100 is equivalent to a market valuation of PTON software subscription at 6XPS in 2023. The overall valuation is just at 65% of that in the past. There is doubt about how well Peloton could achieve for this first un-covid Hollyday season. That is why the current valuation is low. But once the market sees signs of good demand or sales performance. The market will realize that PTON’s potential lies far beyond the current level. As a result, the stock& multiple would go much higher.
Many WFH benefited companies such as Zoom facing the challenge of pulling forward 3-5 years of growth and reaching market maturity too quickly. Despised Pelton is also a WFH benefited name. Still, there is no way PTON can satisfy everyone’s demands like Zoom by resizing with AWS. PTON needs time to build factories to manufacture, open showrooms worldwide, and introduce this brand to the public through advertisement. Even though PTON and Zoom share a similar trend in the short term, these two are fundamentally different. Zoom has almost reached saturation in one year. PTON only has two million subscribers worldwide, with a penetration of less than 5%. Large market opportunity combines with a great product and aggressive holiday season business strategy. It is highly likely to see a blowout of holiday sales. With a reasonable valuation, now is the perfect opportunity to plan the investment.
For we also prepared a 37-page long deep dive and financial model. you may download those files here: