Why I reduced PTON (again)

Peloton grew to almost a 10% position for me by the end of September, but I cut it significantly throughout October as the price rose. By the end of October is was only a 3.4% position. After listening to Thursday’s earnings call, I’ve actually reduced it some more. Here’s why.

Not every company has to be SaaS, but we should realize why we like SaaS – and a lot of it boils down to recurring revenue and Dollar Based Net Retention Rate (DBNRR), which combine for almost certain growth each year. Growth rate may slow, but growth is almost inevitable. Because the recurring revenue gets you to where you were last year, the DBNRR adds to it, and then you target new customers. So perhaps you see something like:

Year 1: $100m revenue
Year 2: $200m (100% growth)
Year 3: $350m (75% growth)
Year 4: $550m (57% growth)
Year 5: $800m (45% growth)

With PTON, where about 80% of revenue is not recurring, you could very well see something like this:

Year 1: $1.8b
Year 2: $4.4b (144% growth)
Year 3: $6.5b (47% growth)
Year 4: $6.0b (negative 8% growth)
Year 5: could be up, could be down

The point is that without recurring revenue, at some point (who knows when) you’ll have less revenue than you had the year before. It could be year 20. It could be year 3. My simplistic thesis is that if for Peloton revenue grows year after year until year 20 (or something like that), it someday be worth a lot more than it is today. But if revenue tops out in the next year or two, I doubt it will. And I’m not smart enough to know which is more likely.

I’ve seen a few people say that their PTON position is among their largest, and I believe a couple people might even have a 20% or 25% allocation. I’m not going to try to tell you how to invest your money, but I urge you to take a hard and humble look at the numbers and ask yourself: how sure are you annual revenue will get to $10 billion? $20 billion? How many years can they grow it significantly before they top out? My point is not that Peloton can’t get there – it’s that I don’t think any of us can really have a clue what demand will be a year or two from now…much less 5 or 10 years from now. And unlike a SaaS company, with something like Peloton, you kind of need to.

In July PTON was around $62 and an $18b market cap when Rex posted this: https://discussion.fool.com/do-you-have-any-companies-that-you-f…

90 days ago when they reported a blowout quarter, he and I both made the case PTON should be worth $40b (it was his idea…I just agreed): https://discussion.fool.com/peloton-q4-report-34614564.aspx
https://discussion.fool.com/thanks-for-the-summary-rex-let39s-be…

And now PTON’s market cap has exceeded $40b (342.1m shares * 125.46 per share = about a $43 billion market cap). At $18b Peloton was a no brainer for me. Now that it has more than doubled, it’s no longer a no brainer.

Thank you so much for bringing this one to my attention, Rex! $62 to $125 in just a few months…that’s amazing, and much more than I expected!

For anyone who still has a large position, I hope Peloton grows into a huge company over the next several years. Predicting that just isn’t what I’m good at.

Bear

78 Likes

Bear, you make an interesting perspective.

I’m curious to learn whether people will buy a “newer” peloton bike every X months just like they buy a new iPhone. if so, recurring revenue for hardware is not going to be 0%

The installment plan on the website is 39 months, so I will probably assume that the upgrade happens every four years. If they can keep customers happy, it’s reasonable to assume some decent recurring revenue (but in a four-year period).

Some people may want to replace it every three years or five years. But a repurchase is expected unless(1) one finds a better choice, (2) one doesn’t exercise at home anymore. At this moment, I did not see any serious competitors that are superior. (a similar business case is iPhone) Given the advantage (community, technology, etc.) they accumulated today, they hold a first-mover advantage. Finding something that is better than their bikes is not going to be easy. To me, it likes making a better phone than the iPhone.

Their growth will eventually slow down because COVID is forcing them to burn their customer – all future customers (who should probably arrive in years) all come in the same year (20-21).

I believe they create a great product because even before the COVID, their quarterly Revenue YoY in 2019 is 122.40%, 123.59%, 105.11%.

Similar to iPhone where App Store creates a strong moat, Peloton is a similar story. Their content and community are going to be the secret sauce of a “better” exercise experience. NordicTrack, Precor, Nautilus, and SoulCycle will lose user experience unless they figure out a way to align with Apple Fitness closely. A similar story that almost all non-iPhone brands use Android (Google) system.

My point is that if they can continue to use their community and scale to create high-quality content and user experience, they are competing against the brick-and-mortar gym and traditional fitness hardware companies. I will seriously consider evaluating the threat only if Apple is making its only bikes, shooting for a similar price range.

Its 232% growth will “slow down” to 100% (or lower) since they already burn their future customers. They might one day becomes a growth/value-mix or even a value company. But I don’t think this is going to happen in the near future since the fitness market is huge and they are disrupting the current business models (subscription-based gym memberships).

I think they still have a good runway, and COVID is still a tailwind to them. If they can become the de facto #1 brand with high customer loyalty for the home exercise choice. Peloton to the need for exercise is iPhone for communication.

If so, at the time they are slowing down, they will be extremely profitable by then.

I won’t try to reason Peloton’s future against a SaaS company like DDOG. It’s a comparison of oranges to apples. I always feel all home-gym equipment suck and I’m glad to see some good products available. And some introverts like me appreciate and enjoy the opportunity to work out with others virtually (not physically). I guess somehow they find a niche even before the COVID.

In addition to Revenue YoY and other growth metrics, I will check:

  • Do they create a superior customer experience? – paying attention to their retention rate
  • Is there a better alternative? – paying attention to Apple Fitness for possible partnership with Fitness hardware companies.
  • Does Peloton increase its advantage (like market share) against gym and fitness hardware companies? – paying attention to observe whether people give up Peloton once COVID is over.
  • Do they build a moat through network effect? – paying attention to their community size (both coaches and users). I see a strong financial reason that if I’m a good coach, I want to teach where I can make the most $$. So, where are the best coaches teaching? (Are they joining or leaving Peloton)
  • Does their Profit Margin drop abruptly? What are the reasons? – paying attention to poor operation, leadership changes, or lowering the price to deal with strong competition.

So far, PTON is all green (positive) on the above five tests to me. But if any of the above five turn yellow or red, I will reduce my portion accordingly.

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Hi Bear,

Like you, I would generally prefer a true SaaS business over a non-SaaS business (or a business only partially based on recurring revenue like PTON). I do understand that a SaaS model naturally should lead to higher valuations than non-SaaS companies, all else being equal. But that’s where we differ. I don’t think all things are equal here. Consider again their 1Q report:

Connected fitness subs grew 137% (with 0.65% churn and a 92% retention rate) while digital subs grew 382%. They saw 20.7 workouts per connected user, showing a never-before-seen level of engagement on their platform. Revenue grew 232%. I haven’t heard a single person who doesn’t love the experience the company delivers. They have so much demand that they’re starting up new manufacturing facilities and accelerating delivery times. They are bringing new, highly anticipated equipment to market. They make money on competitor’s equipment with a lower cost digital subscription. They guided above the market’s expectations, despite being supply constrained. And all of this seems to have no end in sight with WFH continuing on.

I don’t consider valuations when I invest. And I don’t know what the future holds. But I’m pretty sure that PTON’s growth is not fizzling in the next quarter or two. And if that turns out to be true, I’m also pretty sure the company will continue to add to its gains. On the other hand, if growth starts to slow, it will get crushed. But that’s no different than some of our other companies. CRWD’s technology may be disrupted. ZM may slow down by normal life snapping back faster than we all think. If those scenarios happen, the elevated valuations of our stocks will cause them to take a major hit too, regardless of DBNRR. I just don’t see a difference here with a story like PTON.

Is there greater risk with PTON? Maybe. Does their valuation imply greater volatility considering their non-SaaS growth story? I don’t know. What I do know is that their story is simply too good for me to pass up for now (my allocation is 14%). But I’m also watching carefully. If things change, I’m out.

-Dave.

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Hi Bear,

All great points.

How many years can they grow it significantly before they top out? My point is not that Peloton can’t get there – it’s that I don’t think any of us can really have a clue what demand will be a year or two from now…much less 5 or 10 years from now. And unlike a SaaS company, with something like Peloton, you kind of need to.

Over the next two years I think you’re discounting:

  1. New products: They have a treadmill that is coming at a lower price point next year. Plus rowing machines and other nice products are on the drawing boards.

  2. Upgrade cycle: My wife is already looking at the new model and wants to upgrade. She views it as a car payment and will just extend out her contract for the new system and keep paying the monthly fee.

  3. Low penetration rate: This one is probably the best argument for growth in the near term (1 to 2 years). They still have a huge market opportunity in both the US and internationally. Germany is the only non-English market they currently support. They can expand this initiative to Switzerland, and Austria easily where it is cold and fitness is popular.

  4. Pandemic is accelerating: There is no sign is the crisis slowing. Infection rates are at an all-time high around the world. Exercise at a gym or fitness club is not an option for most for at least a year. Many gyms are still going to fail (sad). This will reduce the options available in the market as a whole.

But hey, don’t listen to me. Everyone should make their own decisions. And if you sold and moved into something else, that’s great. I may do the very same at any point in the future if I lose confidence in PTON or find a better opportunity.

Cheers,
Golf Caddy for Peter Lynch

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I think I need to clarify some things:

  1. I do not think that Peloton done growing! As has been pointed out, they’ve got new products coming, and the current products are selling like crazy. In fact, they’re going to have their biggest quarter ever in December with revenue over $1 billion! Then for the fiscal year ending in June 2021, annual revenue will be over $4 billion! Here’s my challenge: What do you think revenue will be for the fiscal year that spans July 2021 through June 2022? None of us can offer a very good guess, I don’t think. That was the entire point of my first post. Since we can’t do that, we shouldn’t be overconfident in PTON.

  2. There actually were a few cracks this quarter. The supply issues, the sequential drop in EPS although revenue was way up, heck even a thing as minute as the drop in workouts per connected user. (It was actually down from last quarter, Dave.) Anyway, none of these things are death, but the problem is that my baseline confidence is lower for this company than for a SaaS company, so it is more easily shaken.

  3. I said in my original post that not all businesses have to be SaaS. That’s true. Software companies can have troubles too, of course. But on the whole, SaaS has been the most predictable business model I’ve ever seen. And with more upside than the market has been able to price in heretofore.

  4. Most of this is just experience talking. I don’t know what the valuation “should” be. I don’t know how much growth will slow or when. PTON might keep right on growing through fiscal 2022 and beyond…but just a slower growth rate might be enough for the stock to go nowhere, a potentially huge opportunity cost when you could invest in other things that are going up. Experience tells me to plead ignorance and preach caution. Personally I think the low hanging fruit has been plucked, and I may be wrong by a lot, but I’d rather be early than late on this one.

All this is a reaction to seeing how much confidence some are placing in PTON. Experience just tells me that this one isn’t going to be very predictable. For me, that means it will be a small position if I keep it.

Bear

PS - If anyone else responds, I’d appreciate if you answer my challenge in #1. It’s not that I don’t foresee growth for fiscal 2022. It’s that I don’t think we can predict how much.

23 Likes

Over the next two years I think you’re discounting:

1. New products: They have a treadmill that is coming at a lower price point next year. Plus rowing machines and other nice products are on the drawing boards.

2. Upgrade cycle: My wife is already looking at the new model and wants to upgrade. She views it as a car payment and will just extend out her contract for the new system and keep paying the monthly fee.

3. Low penetration rate: This one is probably the best argument for growth in the near term (1 to 2 years). They still have a huge market opportunity in both the US and internationally. Germany is the only non-English market they currently support. They can expand this initiative to Switzerland, and Austria easily where it is cold and fitness is popular.

4. Pandemic is accelerating: There is no sign is the crisis slowing. Infection rates are at an all-time high around the world. Exercise at a gym or fitness club is not an option for most for at least a year. Many gyms are still going to fail (sad). This will reduce the options available in the market as a whole.

I would add apparel as an area of possible expansion:

https://www.wsj.com/articles/how-peloton-could-beat-nike-and…

PTON’s building a brand with increasing market opportunities.

Dave

4 Likes

Good discussion, Bear.

What do you think revenue will be for the fiscal year that spans July 2021 through June 2022? None of us can offer a very good guess, I don’t think. That was the entire point of my first post. Since we can’t do that, we shouldn’t be overconfident in PTON.

I have nothing new to offer by way of revenue predictions other than what has already been shared. But that doesn’t automatically limit portfolio allocation for me. Two reasons:

SaaS companies deserve a “baseline confidence” level (I like the way you phrased that). But not if valuations rise to meet the expectations of built-in growth.. Now I don’t pretend to know what “proper” valuation levels are for a SaaS vs. non-SaaS companies, but this just makes sense. While SaaS companies should be valued higher (as Saul has demonstrated multiple times), what happens once they are? The risk of growth slowing approaches (equals?) the risk of a non-SaaS company. For example, if ZM growth slows (a post-COVID world? MSFT competition? Poor execution? Something else?) do you think their stock will be crushed any less than PTON? They’ll both take a 30% haircut overnight. I just don’t see the justification for basing investment allocation on the basis of a SaaS/non-SaaS model.

Therefore, any highly valued high growth company requires constant scrutiny. I’m a LTBH guy at heart. But I’ve had to come to grips with the fact that high growth stocks, especially in a targeted portfolio, just require constant verification of growth and the investment thesis. This has proven true of my SaaS as well as non-SaaS companies.

So here’s PTON, a fitness Gorilla that could possibly (probably?) have multiple S-curves to ride for extraordinary gains, yet it lacks our preferred SaaS model. What’s one to do? Assuming one believes in the PTON story (and that’s a big assumption), I think it’s very reasonable to allow a larger allocation, proportional to one’s confidence level, while staying vigilant. For me, that’s about 15%.

-Dave.

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Great post Bear and subsequent contributions.

You are definitely right, its no longer a “no brainer” like it was in the Summer. Any other ideas of no brainers from you or Rex then I’m all ears! : )

However, its ticking many of my boxes (not the SaaS one clearly!) to justify the spot of my current highest conviction. I guess my founder led, long term disrupter roots are more evident here with Peloton, which I’m trying to blend my portfolio with alongside the magic of the Saul & Bear strategy.

This is very early innings, we’re seeing their FaaS model starting to evolve (Fitness as a service) ala Roku’s switch from hardware to software, the brand/community is off the charts, they’ve barely marketed their core products and John Foley is a visionary founder/CEO. And that’s just the story, the financial metrics are humming. From what I can currently see, there is plenty of evidence for Peloton to be throwing down 10b in revenue in the future.

I will be watching them like a hawk though for any warning signs as you would expect for top tier positions and will very much scale back this position (or exit Saul style) if the future doesn’t look as rosy. Positive vaccine news in 2021 and the winding down of lockdowns could be its real test next year.

Until then I can only see continued momentum on all levels for Peloton.

I know Zoom & Crowdstrike are SaaS, but I’d love to get yours or any other posters thoughts on your top reasons for why they remain top tier holdings?

Thank you for raising this, its certainly got me thinking of how to keep punching holes in our companies.

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I’m curious to learn whether people will buy a “newer” peloton bike every X months just like they buy a new iPhone. if so, recurring revenue for hardware is not going to be 0%

In one of the interviews I listened to, PTON execs were talking about their great build quality and how they want the product to last years and years. This is part of their commitment to being environmentally friendly and sustainable. Now, perhaps trade-in and resale will support continued revenue growth.

I think clothing is a great area of growth.

Long PTON but it’s not a top holding.

I have held a tiny position (about 2% of my total portfolio) in PTON for around the past 12 months or so. Out of curiosity, I just now looked at the PTON website:

https://www.onepeloton.com/shop/bike

To my pleasant surprise, my stock gains in PTON alone would buy me 12 Peloton bikes including shoes, bike weights and headphones for each bike!

That, my friends, is the tremendous power we have in common stock investing.

Jim

https://www.onepeloton.com/shop/bike

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…and sure enough both ZM and PTON getting hammered just as hard today. Both down around 16% as I write due to vaccine results, regardless of SaaS / non-SaaS model. Just sayin’…

FWIW, I added a little to both positions, but I’m keeping dry power on the side. Major sector rotations like we are seeing rarely complete in 1 day. But the sale is a little too good to for me to ignore for now.

-Dave.

4 Likes

Here’s my challenge: What do you think revenue will be for the fiscal year that spans July 2021 through June 2022? None of us can offer a very good guess, I don’t think…If anyone else responds, I’d appreciate if you answer my challenge

Hi again, Bear! Allow me to take a stab at this.

No, none of us can offer a very good guess, but it won’t stop me from trying :slight_smile: I will focus my forecast for fiscal year 2022 on the subscription revenue as this will be far more predictable.

Peloton has grown subscription revenue every single quarter without fail. Regardless of the vaccine news/COVID impact, I feel confident this will continue for at least the next seven quarters (through fiscal 2022). One of the biggest reasons why I feel so confident is thanks to the growth of their digital subscription. Earlier this year, Peloton reduced the price to $12.99/mo and saw growth explode. Last quarter digital subscriptions grew 210% and this quarter it grew a whopping 382% YoY to over 510,000 subs. This would equate to an additional $80M in revenue for the year if that number stayed flat (which it obviously will not). A quick anecdote to add, this is the subscription my wife currently has and she loves it. She no longer attends the gym she did pre-COVID and now wants to buy the treadmill. I began using the app and love it as well and now I want the bike. It is quite a powerful tool to drive more growth for Peloton hardware.

Anyways, with all that being said, I feel confident forecasting out subscription revenue for Peloton. This is my best attempt at what that might look like for the next seven quarters. In my opinion, this forecast is on the conservative side. The italicized numbers indicate my forecast.

 
Sub Revenue ($M)					
2018	 $14 	 $17 	 $23 	 $27 	 $80 
2019	 $32 	 $37 	 $51 	 $61 	 $181 
2020	 $67 	 $77 	 $98 	 $121 	 $364 
2021	 $157 *$188 	 $225 	 $270 	 $840* 
*2022	 $297 	 $327 	 $360 	 $396 	 $1,381*  

The reason I feel good about this is because sub revenue is not going to suddenly drop off a cliff. Their monthly church and retention rates are too consistent. I feel confident the subscription growth will continue to climb steadily each quarter, by at least 20% this year and then 10% next year. I expect it to grow faster than 131% this year thanks to all the new hardware sales but it pays to be cautious. The 2022 growth forecast would be far lower than anything Peloton has every reported. Here would be the QoQ and YoY growth numbers.


QoQ Change %			
2018		15.4%	36.4%	20.0%
2019	17.4%	17.7%	37.0%	19.4%
2020	10.2%	14.7%	27.4%	23.4%
2021	29.1%	20.0%	20.0%	20.0%
2022	10.0%	10.0%	10.0%	10.0%

YoY Change %									
2019	121.7%	126.1%	127.1%	125.9%	125.5%
2020	112.0%	106.7%	92.2%	98.7%	100.8%
2021	132.9%	143.6%	129.5%	123.1%	131.0%
2022	90.1%	74.2%	59.7%	46.4%	64.3% 

The real kicker is trying to predict the hardware revenue. As many people have mentioned, how many customers did they pull forward this year? Your guess is as good as mine but I do not expect Peloton to report negative growth YoY for fitness revenue. With all the demand they are seeing for the bike+, current backorders, lack of members returning their old bikes after buying the new one, and the new supply factory, I think it is safe to assume growth will not go negative in fiscal 2022. It is much easier to forecast the next three quarters thanks to their guidance they gave last week. Take 2022 with a very big grain of salt, but I will go ahead and throw a dart at the wall.


Fitness Revenue ($M)					
2018	 $41 	 $112 	 $118 	 $78 	 $349 
2019	 $78 	 $221 	 $262 	 $158 	 $719 
2020	 $158 	 $381 	 $420 	 $486 	 $1,445 
2021	 $601 *$900 	 $1,000  $700 	 $3,201* 
*2022	 $700 	 $1,000  $1,100  $800 	 $3,600* 

Again, attempting to be conservative, the YoY growth would then look like this (no sense to look at QoQ figures given their seasonality).


YoY Change %								
2019	89.5%	98.1%	121.5%	104.1%	106.4%
2020	102.3%	72.2%	60.7%	206.8%	100.9%
2021	281.6%	136.2%	137.9%	44.1%	121.6%
2022	16.4%	11.1%	10.0%	14.3%	12.5% 

This forecast would give us about $4B in revenue in 2021 and $5B in 2022 thanks to the growth of subscription revenue. With a larger percentage of revenue coming from subscriptions, the gross margins would improve dramatically. Let’s go ahead and assume this forecast is spot on (it won’t be) and try to assign a multiple at the end of fiscal 2021.

– $4B in revenue, trades at 10x TTM → $40B market cap
– $4B in revenue, trades at 15x TTM → $60B market cap
– $5B revenue forecast, trades at 10x NTM → $50B market cap

After dropping by 20% to $100 per share today, Peloton now has a market cap of less than $28B. It currently trades at about 15x TTM sales after dropping from 20x. I do not think it is the bargain it was at a market cap of $18B, but I think there remains significant upside potential over the next couple years.

This obviously includes a ton of guessing, but my point is that Peloton remains a compelling opportunity, especially after todays drop. People are not going to stop working out from home given the incredible convenience. As Bob Dylan once said, the times they are a-changin’ and things are not going back to the way they were before. Although Peloton is already one of my top positions, I could not help but add to it today and I will add more if it continues to drop. How long will they continue to grow for? I do not know but I do feel confident that just as we are in the early stages of the shift to the cloud/digital transformation, I believe we are also at the beginning of a big shift with regards to digital fitness. This company is the leader in a very exiting category and is absolutely crushing it, that is all I can say for certain.

Thank you so much for bringing this one to my attention, Rex!

You are most welcome. I am glad I could contribute something back to this board after having gained so much from yourself and others who post here. I am so grateful for this community on this board.

Rex

P.S. With today’s insane sell off, it is not just PTON that is compelling. I also added to ZM, CRWD, and ROKU. What a gift today was!

31 Likes

Argh… I realized I made a calculation mistake in my post above. PTON currently trades at a multiple of closer to 12x TTM sales, not 15x. My calculation did not include Peloton’s latest quarter. My apologies for adding to the board but I wanted to correct this mistake.

4 Likes

Discussion, so far, has been about Peloton’s organic growth.
Peloton is looking at M&A possibilities, see LinkedIn job posting:

Senior Director, M&A Technical Diligence
Peloton is looking for a passionate Senior Director, M&A Technical Diligence to help us vet and evaluate opportunities for growth through acquisitions, strategic investments, and partnerships.

Responsibilities

  • Assess engineering personnel at M&A target companies for talent, capabilities, technical expertise and acumen, and culture fit
  • Evaluate system architecture (e.g., cloud architecture, application architecture, enterprise architecture) and facilitate high level code reviews
  • Assess M&A target Intellectual Property, algorithms and tradecraft
  • Evaluate scalability of technology platforms and adaptability for Peloton’s needs
  • Assess (or engage specialists to assess) M&A target software, APIs, hardware specifications, firmware, electronics, etc.

https://www.linkedin.com/jobs/view/2191500947

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