Peloton balances connected fitness business on a shrinking cash pile

Turnrounds are full of surprises, Barry McCarthy remarked on Tuesday, as the veteran finance executive credited with pulling Netflix and Spotify through their tough early years held his first call with analysts since becoming Peloton’s chief executive.

Three months after the connected fitness company hired him, the biggest surprise had been its cash flow, he said. For some on Wall Street, that was an understatement.

In the quarter to March 31, almost $ 750mn of cash flowed out of the company, up from about $ 200mn a year earlier. The company that had raised more than $ 1.1bn at its initial public offering in September 2019 ended the period with less than $ 880mn in unrestricted cash and cash equivalents.

That, McCarthy admitted, left it “thinly capitalized” for its size. Peloton had arranged to borrow another $ 750mn, he said, but the company declined to disclose what interest rate the banks were charging.

The unwelcome cash flow surprise sent Peloton’s shares to new lows, cutting its valuation to roughly half what it had been at the IPO and under one-tenth of where it had peaked in 2020, when investors bet that a pandemic-era shift from gyms to home fitness would outlast Covid-19.

The unravelling of those hopes in the face of pressure from an activist investor, Blackwells Capital, has already led Peloton to move co-founder John Foley out of the chief executive’s chair.

It has also abandoned a planned $ 400mn factory in Ohio and cut its workforce by 2,800 people as part of an effort to reduce costs by $ 800mn. And it has faced speculation that it could be sold to a larger group – despite McCarthy’s insistence that he did not join the company to sell it.

But Tuesday’s results left analysts repeating questions they had been asking before Foley stepped back: is Peloton’s long-term vision of the size of its potential market realistic, and is it even wise to be pursuing a mass-market strategy when it built its brand on the fanatical loyalty of a wealthy but far smaller group of customers?

Chief financial officer Jill Woodworth reiterated the belief that Foley had articulated at the height of Wall Street’s optimism about the company: that half of the world’s current gym members – or 100mn people – could one day be Peloton customers.

“It sounds like new management, same story,” said BMO Capital Markets analyst Simeon Siegel, a long-term sceptic: “The company acknowledges they need to turn themselves around and restructure while maintaining that their long-term opportunity has not changed.”

With just 7mn members at the end of the last quarter, Woodworth conceded, “we’ve got to evolve the strategy fairly significantly to get to that 100mn”.

Column chart of Quarterly net income / net loss ($ mn) showing Peloton's pandemic profits did not last

There are four “drivers” of that evolution, she said: international growth, retail partnerships, expanding the reach of an app that requires no bike or treadmill, and rolling out a “fitness-as-a-service” program that lets users rent Peloton’s hardware and access its classes for a monthly fee.

The call McCarthy and Woodworth held with analysts on Tuesday made clear, however, that there is still significant uncertainty about each of those strategies.

McCarthy said he was “not sure yet” about the international rollout, noting Peloton’s “finite” resources and the fact that geographic expansion would cost money in the short term. “International has the potential to drive significant growth but the more growth it drives early in the process the more money we lose,” he observed.

It was too early to talk about potential partnerships with retailers, he added. Similarly, when asked what value digital app subscriptions would add, he replied that he did not know.

The app “could be some premium kind of model. It could be a straight subscription model. Not yet sure, ”he said.

And while he hailed the early growth in its fitness-as-a-service offering as encouraging Peloton’s belief that such subscriptions could bring in a “mass market” audience of lower income customers, he noted that it had so far involved just 1,000 units.

He was “just in love with the whole thing”, he said of the fitness-as-a service concept, but he acknowledged that he was not sure whether it would deliver the returns that Peloton hoped for.

McCarthy was more definitive about what was still stopping the company from realizing some of its ambitions, however. The business had “exploded” from about 700,000 subscribers to millions since the start of the pandemic, he remarked, but its systems still relied on “the original code that was hacked when the business was first organized”.

That was slowing down the speed at which it could do things like test alternative versions of its fitness-as-a-service offering, he said. “I mean, really? We have to wait until the end of June to be able to A / B test on the website? That’s something that would take one and a half days at Netflix, even early on, ”he recalled.

Some analysts, such as Baird, are also looking to Netflix and Spotify analogies, valuing Peloton in reference to McCarthy’s former companies, but it has yet to convince others that it can find a similar mass market of subscribers.

“The problem is the company built the business on the belief that demand would never stop,” Siegel said.

McCarthy maintains that he remains optimistic about the path ahead, “notwithstanding the stock price”. However, he has still to convince holders of that stock such as Blackwells, which declined to comment on Tuesday.

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