Stock Deconstruction

Can Peloton pedal its share price higher after IPO flop?

Peloton Interactive [PTON], the streaming fitness provider that also sells exercise bikes and treadmills, has been unable to sustain the positive sentiment the company saw before its initial public offering on 26 September. 

On the stock’s first day of trading on the Nasdaq, the share price closed down by more than 11% from its IPO price of $29, making it the third-worst market debut since the financial crisis. By the end of trading on 4 October, the stock was down by more than 15% from its launch. 

Despite Peloton having doubled its revenue in the past year, worries about consistent operating losses and the lack of a clear plan on how the company can stem these, have had a negative impact on the stock.

Adding to Peloton’s troubles is the increasing scepticism among many investors about start-up unicorns and their respective IPOs, after several have failed to live up to the hype after going public. More than 50 of the 114 companies that have gone public on US exchanges so far this year are currently trading below their IPO prices, according to The Motley Fool writer Rick Munarriz.

 

Why did Peloton go public?

Peloton managed to grow its subscription revenue by over 120% in the space of just 12 months, based on its results for the fiscal year that ended 30 June. With such impressive growth and lofty ambitions, many might’ve expected a stock offering as the next logical step.

In a letter to prospective investors in late August, CEO John Foley stated that “Peloton sells happiness”, which was the kind of pre-IPO hyperbole that could go down well with its subscription numbers. 

With 511,000 subscribers paying $39 a month and 102,000 who pay $19.49, the company looked like the picture of health. It posted revenue of $915m as of 30 June, up from $435m a year earlier. So, what went wrong?

 

Steep losses don’t augur well for a recovery

Peloton has incurred operating losses every year since it was founded in 2012. It has lost more than $300m in the past three years alone, and in 2019 losses widened to a worrying $195.6m from $47m in 2018.

What’s more, Peloton is not expecting to become profitable until 2023. Its current plans focus more on investment and growth, rather than balancing the books. 

Real estate costs have been a sore spot for the company; so far, it has disclosed a total of $784.9m in operating lease obligations – costing almost as much as the total revenue it generated in 2019. 

In an interview with Axios, Foley said: “We're investing $100m in two new studios and $100m into a new headquarters in New York City. But we don't move into any of those for another six to twelve months, so we're double-burdened by real estate right now.”

“We're investing $100m in two new studios and $100m into a new headquarters in New York City. But we don't move into any of those for another six to twelve months, so we're double-burdened by real estate right now.” - CEO John Foley

Peloton may also incur losses through a range of lawsuits filed against it over music licensing. In March, the company was sued for $150m by the National Music Publishers’ Association and in September the company faced an additional $300m bill from the same organisation.

 

Overpriced?

At the end of trading on 26 September, Peloton’s market valuation was $7.2bn, almost eight times the $915m it had in sales for fiscal 2019, according to Fortune’s Shawn Tully. To even gain an annual return of 10% of that for its investors, “Peloton’s market cap has to swell 160% by October 1 of 2029, to $18bn”.

To get there, Tully says, Peloton’s revenues need to far outpace its costs for a significant period of time. Yet at the moment, the firm’s booking of large losses looks set to continue. 

“Judging from its growing multitude of loyal cyclists and runners, Peloton holds plenty of promise as a business. The problem is that the market's great expectations may be setting a pace that's tough to match,” Tully says.

 

Market cap $6.67bn
Forward P/E -34.25
EPS (TTM) -10.72
Return on Equity (TTM) -79.32%

Peloton share price vitals, Yahoo finance, 7 October 2019

 

WeWork paradigm

As several high-profile companies fail to impress post-IPO, investors have grown sceptical.

The negative media coverage surrounding WeWork’s failed IPO is a recent example, as investors look for signs of stronger fundamentals after recent losses. As a result of recent scrutiny, WeWork said it’s postponing its IPO indefinitely as it focuses on its core business. 

Meanwhile, entertainment group Endeavour cancelled its IPO at the last minute on 26 September, saying it would evaluate market conditions to better time the offering in the future. 

This general mood suggests that even if Peloton’s fundamentals were stronger than they are today, it would still likely face an uphill battle to win over investors.

 

A ‘long journey’ or a stock best avoided?

Speaking to Axios after the IPO, Peloton’s CEO said he was not too concerned about the share price falling in its first day of trading.

While acknowledging that the company was priced into an IPO market hardened by WeWork’s troubles, Foley said: “Obviously, we'd rather have it going the other way. But I don't think it's a reflection on our fundamentals or the excitement of investors who came in. This is a long journey.”

“I don't think it's a reflection on our fundamentals or the excitement of investors who came in. This is a long journey.” - John Foley on the company's IPO flop

But those outside the company see things differently.

“For now, it would be wise for investors to hold off buying into Peloton,” says Timothy Ronaldson, writing for The Motley Fool. “Initial market impressions have been far from encouraging, and management still needs to prove that it can deliver a healthy, profitable business over the long term.”

That sentiment was echoed in Forbes by Peter Cohan, who states it is best to avoid Peloton stock entirely. This is because of the company’s cash burn, rocky path to profitability and lack of competitive pricing, he says.

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