Peloton has devalued 51%. Punishment for rich valuation.
I believe value is determined on a 20 year horizon.
I started a position in Peloton for the Patient Compounder portfolio in April 2021 and continued buying until July 2021. It forms 3% of the portfolio’s cost basis.
I have written about Peloton before. You can read it here. TLDR : I liked the company’s products and the high growth rate since 2017. I acknowledged the high risk that came with the company’s lofty valuation and stated that valuation would nosedive if they fail to continue executing.
And the company appears to be failing to execute. At least in the short term.
The company’s stock price has devalued from a peak of $162 to about $49. This appears to be caused by several factors :
Recall of the Tread+ treadmill & sales halt of it
Reduction of pricing for Bike and introduction of a lower cost Tread
Decelerating revenue growth in Q1 2022. A lot has been said about this so I won’t cover the details here. You can look it up on Peloton’s investor relations website.
It appears that Peloton is undergoing some execution issues at the moment. I do not know whether this is a short term problem or a long term one because of the following :
Peloton has an annual subscription churn of 2%. This is Netflix’s churn rate and is amazing.
Tread is a new product and has a 89% net promoter score. Customers love the product and the classes on the subscription
Peloton’s subscription revenue grew 94% Year on Year. Gross margin for this business also improved from about 40% in 2018 to 60% in 2021. This business has some serious operating leverage.
Peloton has just started expanding internationally. Latest market is Australia.
Lower priced hardware would allow more customers to get onto the Peloton subscription.
Peloton has a 10-20 year goal of having 100 million subscribers. They have about 2.3 million at the moment and need to 50x this. I do not know if they can reach this, but I did start the position because they were posting almost 100% YoY growth until of late.
What returns can we expect if Peloton hits 100 million subscribers in 20 years and only the subscription business has value?
First of all, please note that Peloton is a small 3% position in my portfolio because it isn’t clear how long it can keep up growth. It was also richly valued. That’s why I capped the position size relative to something like Alibaba (which I also own and is cheap by most valuation metrics).
Now, let’s attempt to value Peloton based on their 100 million subscriber target in 20 years time. We will ignore revenue and margins from the hardware business for this exercise.
Subscribers : 100 million
Annual revenue / subscriber : $360 ($30 a month - I assumed their subscription will decrease in price from $39 currently).
Subscription Gross Margin : 60% (it’s currently 62%. For the sake of being conservative, we assume they don’t achieve any more operating leverage from today and margins decline slightly)
Annual Gross Profit in 20 years time : $21.6 billion
Gross Profit multiple : 10x
Share dilution is zero. I assume they issue shares and do buy backs over 20 years resulting in roughly no change to outstanding shares.
Market Cap in 20 years time : $216 bn
At today’s market cap of $15 billion, if Peloton hits 100 million subscribers and does 60% gross margin on that business with a 10x gross profit multiple, one can expect an annual return of 14.2%.
I bought Peloton at a market cap of $30 bn. If Peloton hits 100 million subscribers in 20 years, I can expect an annual return of 10.3%.
Obviously, when I did my work on Peloton, I bought the stock on the assumption they’d hit 100 million subscribers in 10 years, not 20 years. That was the bet I made. I also didn’t buy more than 3% because there is a good chance they’d not hit this subscriber count resulting in underperformance.
The company could also go to zero. This is a real risk one should think about.
For now, I like my Peloton position despite the devaluation as the upside (10% a year) remains and it is a small position. I will be looking to add to it in the coming years if they demonstrated a resumption of growth.
Disclaimer : This article is not investment advice and merely for entertainment. I only give opinions, not advice and am not a certified financial advisor. I’m just some bloke on the internet possible shooting my mouth off.
Invest with caution and always do your own analysis. This devaluation in Peloton stock should be a cautionary tale for every investor. It highlights the risk of investing in richly valued companies.