Shares of the connected fitness company dropped by roughly a third last week after the company reported a larger-than-expected loss as well as issuing disappointing future guidance. The question for the company going forward, however, isn’t whether it can get through a bad quarter (or even a few). Instead, there’s a real question as to whether a large enough market exists for its products to make Peloton a good investment. And, even if the potential exists, can the company claim enough market share to be more than a niche player given how many competitors (including Apple after a fashion) compete for those same customers.

Transcript

Sam Bailey  0:08  Welcome to 7Investing Now, a show that teaches you how to take a long term view on investing by better understanding what’s happening in the market now.

Dan Kline  0:16  Good afternoon or really, who knows what time it is. I am Dan Kline. This is 7Investing Now. I am live in Las Vegas, you cannot tell. But in that direction behind me is the most amazing mountain view overlooking the Las Vegas Strip. It’s not quite as cool as some of the Australian views I’ve seen, Anirban. But it is not bad. And so it’s like 2:30PM here What time is it in Australia?

It’s about 9:30am in the morning, November 8.

We had daylight savings. I had a 6:15am flight so I got an extra hour. But basically I’ve had two hours of sleep, seven and a half hours of travel. So I am excited. We are going to talk Peloton (NASDAQ: PTON) you may not have noticed Anirban, but things are not good in Peloton land. So Peloton reported. And since they reported their shares have fallen by about 35%.

This is a company that makes exercise bikes, they’re a software subscription service is actually how they make most of their revenue. The bike is basically breakeven. So two bad things happened here. One, sales were a little lower than expected. That’s okay, we’re still close. But basically they said, Hey, sales next year are going to be bad. We have different views on this, why don’t you share your I’m gonna say you’re not a big fan of this company. I’m not a giant fan either. But I see the case maybe more than you do.

Anirban Mahanti  1:46  So my case at a very high level in tech or in consumer discretionary if you have something really novel that around which you can build a moat that is sustainable for a longer period of time because then you can add on other things. The problem I see with many things like Peloton for example, you know, the idea is cool, but ideas replicatable like this, right? So Apple (NASDAQ: AAPL) is already doing this stuff. Apple fitness plus already has, you know, they don’t have group classes yet, but they are going to be rolling out group classes. They already have recorded lessons with their instructors that you can follow on by which you don’t have to buy you can buy the cheapest bike possible. And you can work with it right?

So then I was logging into Zoom and I see Zoom is offering similar classes so it’s very difficult I think in this particular niche to establish yourself as a player if you have nothing else, to I guess bankroll the cracks. Apple has its entire business to bankroll fitness plus, Zoom has an entire business to bankroll whatever it wants to call it. Zoom fitness, and whatnot. Peloton has only this. So that’s one thing.

When a company’s products and services are like a feature of other companies, products and services, I think that’s a problem. That often means margin pressure. And then this company doesn’t even have high margins, right? I mean, the margin should be low, think lower than 30%.

Dan Kline  3:25 The margins on selling a bike are basically like 5% but that’s not their business, their business is the subscription. And let me let me push back a tiny bit. I can do this with another business I don’t want to own by the way. So it’s not like I’m arguing –

Anirban Mahanti  3:42  So you’re not bullish?

Dan Kline  3:43  No, but I view this a lot like Lululemon (NASDAQ: LULU). You can buy yoga pants at target that are like 95% as good as Lululemon yoga pants, and lots of people do do that, but a certain percentage of women at the yoga studio, I used to regularly go to yoga studio, wouldn’t be caught dead in anything but Lululemon yoga pants, and I actually think that’s what the Peloton business model is.

But I will say my faith in that has been shaken a little bit. So I’m here in Vegas with our former colleague more my former colleague of yours, Matt Frankel, who has a Peloton. And I said to Matt, like, is it still awesome? Like he used to rave about it all the time? And he said actually, like it becomes kind of repetitive and at some point, like you just want to go to the gym. And that was the first time I was like, Wait, maybe this isn’t like the enduring cult I kind of expected it to be the way sort of Lululemon is.

Anirban Mahanti  4:36  Yeah. So to do to add to your question to your point, right, so yes, you can build a cult around it. Lululemon has a cult and I mean, if you think about Lululemon, Lululemon has competition there are some other competition in that area you could sell Nike can compete in that you know the price points that they’ve got. It is hard to make a brand once you’ve made a brand, you can sustain with that brand for a while.

Now, how much does it take Apple to actually take one of its stores and put a fitness studio into it? It Doesn’t actually take much for them to do that and say, okay, we can also now not only teach you how to use your Mac, but also teach you how to do exercise. It is a possibility. And I just think that is a tough area.

And the other thing to remember is Lululemon is competing with Target and Nike, these guys are going to compete with Apple and Zoom. And so that’s a different type of competition I think about. The last thing I think is, what we’re gonna stop pushing back is, a lot of people are going to go back to the gym, especially the gym fanatics are going to go back to gym because they want the social life of the gym. And you know, you meet people and you feel a different vibe, you hear the loud music. So there’s that. The other thing is that you if you had hit a critical mass, they’ve got what 1 million plus about subscribers, that’s nothing in the subscription land.

Dan Kline  5:58  It’s like 2.4 million own the bike and have a subscription. It’s like closer to 6 million when you look at just the subscription. But from a price point from a margin revenue point, the person who owns a bike and has a subscription is a much better customer, than the person that gets the service.

Anirban Mahanti  6:16  So I feel like it’s like crossing the chasm, like you can build a business, you can validate an idea. And then other people can take it and run away with it. And they haven’t yet crossed that chasm and crossing the chasm, like in terms of becoming big enough, sustainable enough, building multiple products. So this reminds me a lot of like Fitbit or of GoPro where the business model or even to some extent, like companies like Sonos or Spotify, right, those are the companies that reminds me of where you’re single product.

Dan Kline  6:51  I don’t want to own any of those.

Anirban Mahanti  6:54  But that’s the point, right? This means that they can be good businesses, but they’re definitely not great businesses and their business towards greatness. There’s a lot of challenges along the way. Right. And all of these companies will complain to the other big tech is doing this whole big tech, you know, but you don’t have a great idea. That’s why big tech is able to copy it. Right? You gotta have something great.

Dan Kline  7:14  first. Well, so here’s the problem, and I so I don’t buy the gym argument. If someone is paying $120 a month to be like an equinox remember or like an expensive gym. That person can afford the Peloton. And look, I just bought a Nordic track like a fitness trainer like it’s an exercise machine, but it’s I fit connected. And it’s not nearly as good as what I’ve heard about Peloton, but I didn’t want a bike I don’t like riding a bike. I wanted something where I was lifting weights, and I pay a personal trainer to come train me three times a week.

But the days he doesn’t I wanted to have something. I think that’s probably pretty typical of the Peloton user. The problem for me is the words you use there – business. I would argue that Peloton is a good business, it is not a good investment that when you look at the valuation, I’m not precisely sure like can Peloton go from 2.4 to 10 in the next like five years, probably. But can it go to 30 ever? Like I don’t think it can. So it’s like yeah, I can add a rower, it can add a strength machine, but it can’t add like a blender. Like there’s just some point where like what it is, is just very limiting.

So again, I actually think it’s an important brand. I would love to actually see like when this is down to $10 billion in valuation, I actually would love to see Apple buy them. I think it’s an Apple like device. But am I getting that right that this is just like, it’s a really good idea. It’s really good execution in a space where everybody else executes pretty badly, but it’s not an investment.

Anirban Mahanti  8:49  Yeah, I think I agree with that. So like, you know, we have Nordic, we have a Nordic in our base given Nordic cycle or one of the spin bikes to use the correct terminology and we have a cross trainer. I absolutely detest the iFit. And I detest that the make you every time I say I want to use this thing in manual mode I have to say that you’re I want to skip signing into iPad, right? This is bad GUI design and its a way of them to try and I use this equipment with my Apple fitness plus right and to for me, that’s more than enough. For somebody else is probably not enough.

So see, here’s the thing, I am not sure whether having equipment, bankrolled into the subscription or bundled together is actually necessary. That’s the thing I’m not you know, because you like you said Nordic, I said Nordic, many people want Nordic many people may want a different bike, you know, I think you should be able to dissociate the bike from the equipment. And then you should be able to exercise in any sort of platform.

And then if they have a better experience, then you know, maybe the $5 billion valuation, they’re worthwhile for somebody to buy. Then at that point, they’re not buying just a brand, they’re buying the brand plus the users. And Apple has done that a number of times, they bought things like Beddit, which is like this bed, you know, sleep tracker system, they have users. So Apple bought, of course, Beats, but good hardware

Dan Kline  10:19  Yeah I think this is closest to Beats like in that Beats, which is not a great product, is a really great brand. Peloton, I’d argue, is a great product. And it has a very loyal user base. I also think it is an Apple like product, the biggest mistake I think they made again, push back if you want his they cut the price of their core bike, where Apple doesn’t really cut prices, it sort of releases new things. And the old thing gets cheaper.

They did release an enhanced bike, but it’s not like it’s not the way like a new iPhone is clearly a different model. It’s like, oh, this bike has like a bell in a basket. Like I’m teasing a little bit there. But it’s not that different. So I actually think they did something that Apple would never do. Apple never, ever undercuts its value on products that are working. They might do it for home pod or something that isn’t working. But they don’t

Anirban Mahanti  11:08

They just discontinued it.

Dan Kline  11:10  Did they just continue home pod?

Anirban Mahanti  11:11  Well, they discontinued the larger home pod, right? Because they figured that that price point does not work. So well as I for the larger home pod was great. Right? But you know, they’re basically pushing ahead with the mini because the price point is great. Yeah, so like, okay, maybe to your point, good valuation. One of the things I think Peloton lacks is the ability to integrate with other devices, your experience, so they’ve got a good bike and a good experience on that bike. But how about you know, interacting with other fitness tracking devices like your Apple Watch, and things like that, that might be something for Apple, where if it buys it, they can integrate all that experience together, then put it nicely seamlessly to the health app and things like that at the right valuation, right. This is what’s still a $20 billion companies.

Dan Kline  11:58  I think it’s still like a $30 billion company. It’s that that’s the problem. And look, I want to the one thing I want to push back on, is we’ve seen this with Netflix (NASDAQ: NFLX), I actually don’t think the slowdown in bike purchases actually shows that long term demand, like rich jerks who buy a Peloton and I’m teasing a little bit because a lot of those people are my friends. That market isn’t going to get smaller. It’s a status symbol.

But it’s like Netflix subscriptions. If you add 10 million in q1 of the pandemic, you might only add another million or two. And maybe you’ll get to a higher number at the end of the year. I actually think that’s where Peloton is. And they’re basically saying like, yeah, like we sold a lot of our 2022 bikes already. So like yes, yeah, like, I think the markets not fair about that. And we’ve seen this in retail too, where you know, you jump in.

Anirban Mahanti  12:51  So it’s a market cap of $17 billion right now. So I guess the

Dan Kline  12:56  Down from about $30B

Anirban Mahanti  12:58  Down from 30, yeah, with the cut. The big question in my mind is how big is the TAM? And do they have the machinery to actually expand the TAM? That’s what I think an acquisition comes in handy is somebody who has this subscription based but can create more attachment with the product you know, it becomes a useful thing whereas if you don’t have a subscription with you.

I think we said Netflix and to some extent Spotify Spotify’s business model is different Netflix was so ahead in the game I guess in terms of streaming right that it really had a long run with it no competition I think that makes a difference and you know and then when Disney+ came in and you know to competition add them we saw how quickly Disney+ could also ramp up right so people just didn’t you know I guess realize the power of the platform

Dan Kline  13:49  But Disney+ is unique we’re seeing even HBO Max and Peacock and all these other high you know, Paramount plus whatever you want to call it. Those are all like at best not that successful. Disney was a very unique player here and look, you’re right, if Peloton had two years where none of these other – but I also think Peloton from a sales and marketing point of view. They’re kind of doing a bad job.

So they bought Precor. Precor has an enormous gym presence. Why are there not at every West Palm Beach, Florida in general, which has a lot of high end homeowners associations. Why does the gym in my building not have two Pelotons? Like it makes no sense. Like we have exercise bikes. Were leasing those exercise bikes we could easily be leasing a Peloton. They clearly just don’t have the sales apparatus for that when they bought Precor that gave them a lower bike point that they could have put Peloton screens on they should have been at every hotel, at every high end community and it feels like that that opportunity is kind of been squandered.

And now like you might see the either newly public or about to be public IFit which I agree is a terrible product as someone who owns a NordicTrack device. The fact that But the manual tracking doesn’t specifically track what exercise I’m doing. Even though I’m doing exercises on their poster that seems to be that you can take their classes but their classes are all centered around everything has to use the machine and like some of the it’s like wait I don’t need to do a push up using the weight machine like, like, Peloton does that nicely like if they ask you to do like weightlifting, you don’t have to like do it while riding a bike. So I think a better company owning Peloton, a better sales operation, could actually do better with the product.

Anirban Mahanti  15:31  Okay, I think I agree with that. Yeah, somebody who has a Sales Machine is somebody who can basically do an adjacent sale. Somebody basically someone like Apple at the right valuation can can make this a very nice tuck in acquisition that works really comfortably for Apple. Yeah. And, and it would make in short, I mean, here’s my problem with Peloton right now, it might appear attractive, but I am not sure 100%.

Again, I don’t follow this business that closely. I’m not sure whether that’s a value trap, or great value. I don’t know. You know, and I’m kind of ambivalent and I have negative opinions about it. But that doesn’t really mean that I am — I don’t have well formed views on it. I just have views, but I’m not necessarily well formed.

Dan Kline  16:19  I think the bull case will take five years. If everything goes well just sort of build to that where they could say, hey, look, we’re actually a subscription company. Because you know, so you see you own a Nordic track bike. Those are like I don’t know what 1300 1400 American dollars like they’re expensive. I bought a $2,000 Nordic track exercise thing. There is zero chance I’m not going to pay for that subscription because my thing not so much the bike because you can use the bike with other things. My thing is pretty tied to I fit. So yeah, that is the advantage Peloton has.

If you buy a Peloton, you’re admitting failure, you’re basically on the couch eating ice cream. If you say hey, I’m canceling my Peloton subscription. So their churn is very low, it ticked up a bit. And I’ll push back on one thing you said you equated it to Fitbit, and GoPro those products stink. GoPro is an incredibly limited, like sure, if I’m writing a waterslide and want to point it like the use cases you buy a GoPro like why did I get this? Like what is it for and look, I’m wearing a Fitbit, it’s bad. It’s not as good as the Apple Watch.

Here is why I wear it. The Apple Watch doesn’t give you the option of not seeing your heart rate at all times. And I was finding that sort of paralyzing, I’d look at like my heart beats per minute. Like, why am I at 92 And it’s like, it was just too much information for me. So I’m intentionally wearing a crummier watch. But Peloton is actually the best product in its class. So I think it does have that going for it.

Anirban Mahanti  17:54  Yeah, I mean, again, I don’t have the experience of using it. So and I’m probably not the right demographic for it. In the first instance.

Dan Kline  18:01  I think you are. You’re you’re pretty well off. Like you know you have the ability.

Anirban Mahanti  18:06  I would not buy it just because I have a very limited threshold for buying subscription products that’s not from Apple. Basically, it has to be an Apple product and if Apple has a competing product, there’s no chance I’m buying so because Apple has fitness plus there’s just basically no chance I’m going to go and get Peloton because yeah, I’ve got I’ve got the Apple one premier package basically has everything. So the only things I paid for extra is really Netflix and Amazon Prime and I pay for prime because I get a lot of stuff from Amazon. And it’s just convenient. I like one bill. I don’t want to pay 100 bills.

Dan Kline  18:47  So I pay for Netflix because I don’t want to get divorced. I almost never watch it. My wife, my wife and son like true crime. So they watch it a lot. I pay for discovery plus, because all of those like cooking shows are good like background when you’re working you just throw on like diners, drive ins and dives or whatever and it’s cheap. It’s like there’s a lot of value there.

But I have the Apple subscription we did a show and I’ll pivot here because I think we’d beaten Peloton to the ground. We did a show about app and I was very negative on Apple TV. Well guess what? I watched my whole flight here I watched three episodes Foundation. So I don’t know if you’ve seen this Have you seen this one yet?

Anirban Mahanti  19:26  I have seen the first two.

Dan Kline  19:27  So I reread the books in the beginning of the pandemic cuz I was looking for stuff to read that like wouldn’t stress me out. And I went there is no possibility they could make this a good show. Oh my god, is this a good show? It made me rethink, wait, maybe Apple has actually figured out how to make TV? So I am way more interested in checking out some of the Apple TV program.

I know that has nothing to do with Peloton but but like I was a little wrong on Amazon because some of the Amazon Prime shows the boys is really good Good, but the success to failure ratio is Netflix-ian, like where it’s like one thing is a hit? Maybe Apple has kind of figured out how everything can be a niche because I’m not a morning show person. But for like my mom that’s like the target audience.

Anirban Mahanti  20:17  Actually what I think right now, my strategy ever since Apple TV plus has come is to first see if there’s a program on Apple TV plus, because it’s quite likely that all three of us can actually watch it together. So I actually thought, I’ve always thought Apple has a great strategy in terms of contents. I love little America, I loved Home Alone, there’s the show about Jacob and you know, him being a quarter and then Tehran, and then Foundation, right? These are the ones and called I quite like CODA, actually.

So I found more things to watch on Apple TV plus, then I think many others. Sometimes I struggled because there’s just there’s just too much input and too many choices. That said, I will not cancel Netflix, or Amazon or Amazon Prime, I can’t cancel because I have other reasons to have Amazon. And Netflix, I wouldn’t cancel because, you know, I watch Bollywood movies and the big Bollywood movies either come on Amazon Prime, or they’re gonna come on Netflix, and they will never come on Apple TV plus, because Apple TV is not going to pay ridiculous amounts of money to acquire this.

So back to Peloton, I think it’s cool, I guess let me put it this way. Can they survive long enough without continuing to bleed money? That’s number one. Number two is can be validation from here go up, right? What other tricks do they have in their pocket right? So I mean, the gym trick that you put out is a great one, right? If they can execute on that, that is, you know, great branding, great visibility. That’s a possibility.

Dan Kline  22:10  So here’s the thing, they need a rower. They need a strength trainer, I would argue that they should buy or merge with Tonal, which is like sort of the default amazing strength trainer. That’s what I would have bought, except you need a wall to mount it on and I live in a rental property and I didn’t have an easy wall to do that I wasn’t going to construct something. So here here’s the argument I’ll make for Peloton, I think the valuation is probably going to keep coming down. That being said, the loss is a little deceptive.

The loss is largely a capital expenditures loss. They built a factory in the US a lot of those expenses hit this quarter. So this is a company that expects to be profitable next year, even at slowing sales. I do think that will help not necessarily raise the valuation but buttress the valuation if this, if this gets fully cut in half, and it drops to like 14 15 billion, I think that’s probably where it’s gonna end up. And it becomes a very attractive target for a company looking for subscription revenue that thinks it can grow that base.

I also think there might be consolidation in this space like look, should NordicTrack have gone public, absolutely not like like, this is an example of me being too easy. It’s not a well run company. I mean, maybe well run, but the iFit app is not well executed. So the user interface is bad. I paid for my device to be set up and set up didn’t actually include setting it up but actually just included like putting it together. Whereas like Peloton actually comes over and shows you how to use it. Like there’s just a lot of customer service.

I spent an hour trying to figure out how to set up iFit. And then I called and waited 45 minutes and I said oh no, there’s a specific app for your device. I’m like, well, Couldn’t there be like a sticker or something like a package I get? How would I possibly know that? And those are just the kind of things that we’re seeing this with SPACs a lot that companies that shouldn’t go public, content companies largely.

Anirban Mahanti  24:06  Yeah

Dan Kline  24:06  Certainly some device companies. So I do think there’s going to be some consolidation. And look, this is a good product. Like when Lululemon bought mirror, I argued that mirror was basically a big iPad, like it’s a really stupid product, in my opinion, you could just do it on your TV, there’s no reason you need that device. I actually think there’s a long history in the US of people being really into like the connected bike riding, whether that’s in a SoulCycle studio, or at home, there’s a community to it. I think they’ll do well with apparel, but I do think it’s a valuation question I think it’s a growth story question. So I will give you the last word any last thoughts on Peloton as we close?

Anirban Mahanti  24:46  Well I’m gonna agree with everything that you said towards the end because that’s exactly you know what I am happy No, it’s a good story question 100% devaluation question 100% And I don’t know the product but I agree. With iFit, I love the hardware, the software is incredibly bad. And I really have actually googled and am trying to figure out is there a way for me to permanently disable that software to just make just to just go to manual mode? Apparently there is not. And I think making good hardware  and software is really hard to crack that that is a skill. And that can work really well. It’s I actually agree with you.

Dan Kline  25:27  So what’s the lesson here seven investors, there’s an important one. Every good product is not a good investment. Every good business like you might love you’re really well run local diner. That doesn’t mean it’s franchisable because like the guy behind the counter isn’t necessarily duplicatable. So this again at a certain scale is a good business like we see this on Shark Tank a lot. The sharks will say, hey, this can make you a nice living but it’s not investable. I think in a lot of ways Peloton isn’t investable.

I’m not a fan of buying shares of a beleaguered company because you think it’s gonna get acquired because that that doesn’t always work out. I’m the guy who said Amazon is gonna buy Radio Shack, I was really really wrong about that. So you’re watching 7Investing Now if you would like to become a 7Investing member, we make this really easy to do. You’d think we’d make it hard. Our service is so valuable. You think you’d have to like wrestle Hulk Hogan and fight a bear but no, you go to 7Investing.com

Actually wrestling Hulk Hogan probably wouldn’t be that hard now he’s pretty old.

But like if you’re going to 7Investing.com/subscribe you can pay us either $49 a month that’s me you could do that. Or here’s the good one, $399 a year you get a bunch of months free. I’m not good at math. So I can’t quite figure that out. But it’s like three months, maybe four months free. That is a great deal.

If you are a student if you are actively enrolled in school, or buying a subscription for a student, you can pay $84 a year. If you’re not the student, email us at info@7Investing. We will help you through that process. It’s the holiday season. It is a great time to gift a 7Investing subscription. Same thing – email us at info@7investing.com if you would like to get in touch with us on Twitter. We of course all have individual Twitter handles. I would argue that Anirban and I are very enjoyable to follow on Twitter, but that is entirely up to you. And you can follow the company @7Investing, that is the number seven. It’s not like seven ones. It’s not Roman numerals. It is a number seven in investing. I’m a little bit goofy. I’m in Vegas. It’s been a very long day. But Anirban, thank you for doing this.

Anirban Mahanti  27:33  Thank you, Dan.

Dan Kline  27:34  Thank you, JT Street. Thank you, Sam Bailey. Thank you, all of you. I’m going to hit The Strip. We will see you on Wednesday.

7investing Operations  27:45 

Peloton (NASDAQ: PTON) Apple (NASDAQ: AAPL) Netflix (NASDAQ: NFLX) Lululemon (NASDAQ: LULU)