Peloton Interactive: Death Spiral In Action

seekingalpha05-03

Peloton's fiscal Q3 earnings release has resulted in a very positive market reaction, with the stock spiking by more than 10% in pre-market trading on May 2.However, PTON stock eventually closed in ...

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The stock has spiked by more than 10% just after its fiscal Q3 earnings release and news regarding the CEO stepping down. I want to share my opinion about this and explain why I am still pessimistic about PTON's prospects. The company's revenue continues stagnating, and user metrics are deteriorating across the board. The valuation also does not look attractive, which makes me downgrade PTON to \"Strong Sell\". Peleton Interactive Q3 earnings & recent developments Peloton Interactive released its fiscal Q3 results just recently and the market reacted with big optimism to the release, with the stock spiking by more than 10% pre-market on May 2. However, I do not share the market's initial optimism when I look at the below table. Peloton's 8-K report Total revenue declined by 4% on a YoY basis, and sequential dynamic was also negative. Fitness Products revenue dropped by 14% YoY, and the modest growth in Subscription was not even close to offset. The top-line weakness does not surprise me, given deteriorating user metrics across the board. Acceleration in \"Average Monthly Paid App Subscription Churn\" indicates that users likely do not see value in the Subscription offering. The optimism might be caused by the significant improvement in the bottom line as the net loss narrowed by more than $100 million YoY, which helped the free cash flow to move above zero. While I generally consider bottom-line improvements to be positive for investors, I think that the potential to further expand profitability might be limited in Peloton's case. Of course, Peloton will likely save $200 million more in costs as a result of a fresh layoff round announcement. However, sustainable shareholder value is built when the company focuses on the quality of its top line. There is a great quote from the great Steve Jobs which I always think about when I analyze companies: If you do the right things on the top line, the bottom line will follow. However, it appears that Peloton tries to affect the bottom line only by cutting costs, but not by focusing on the top line. I think so because its revenue is stagnating and dynamics in user metrics look like a big red flag. That said, the effect on EPS of Peloton's cost-cutting measures will ultimately be offset over just a few years by the decreasing revenue and inflationary pressure on costs. I would also recommend to rush into optimism due to the announced new CEO search initiative. First, there is no guarantee that PTON will be able to find a strong candidate for this position who will agree to take charge of this stagnating business. Second, even if the new CEO has a solid background and a clear turnaround roadmap, we have to understand that he will not start from scratch. Instead, he will start with almost a $1.7 billion total debt position, which is substantially higher than the company's current $1.15 billion market cap. To avoid misreading, I want to emphasize readers' attention that for the total debt, I add up the convertible senior notes and the term loan. I ignore the long-term operating lease liability because it is almost fully offset by a long-term operating lease asset. I also ignore current liabilities because they are covered by current assets by almost two times [and are almost equal if cash is excluded]. PTON's latest 10-Q report Overall, I think that the company's weak balance sheet coupled with deteriorating key revenue drivers is quite a bearish combination for investors. Therefore, I cannot say that my opinion about PTON's perspectives became more positive as a result of the latest earnings release. PTON stock valuation update PTON has plunged by 63% over the last 12 months and had a tough start to 2024 with a -49% YTD share price change. The stock looks cheap from the valuation ratios perspective, but I prefer to better look at the discounted cash flow [DCF] model. Author's calculations I use a 15% WACC, in line with the recommended range by Finbox. I use long-term revenue consensus estimates, which project a 5.6% CAGR for the next decade. I expect zero FCF margin in the base year, but project a 50 basis points yearly expansion, which correlates with the projected revenue growth. The company is in a notable net debt position, which should also be taken into account when simulating DCF. As shown in the above DCF, the fair value of the business is $0.75 billion, which is around 37% lower than the current market cap. That said, PTON is still overvalued even after a massive share price drop. Risks to my bearish thesis When a company like PTON has apparent fundamental weakness, there are still some possibilities that the share price might spike in case of some one-off events. One such potential catalyst is a short squeeze, a scenario which is feasible due to a substantial 15.6% short interest. Should a short squeeze happen, short sellers will be forced to buy back shares to cover their positions, which will lead to increased demand for PTON stocks, driving the price upward. Another possible upside scenario for PTON is in case the company becomes an acquisition target from a corporate heavyweight. Peloton gained a widespread brand recognition during the pandemic, experiencing a surge in demand for its bikes amid lockdowns. The increased brand visibility could be the reason why a giant like, for example, Amazon (AMZN) might decide to diversify into the home workout space and leverage Peloton's established market presence . Bottom line  To conclude, the recent earnings release does not add optimism to me. I would have considered the new layoffs round to be a positive development if the company demonstrated positive trends in revenue and key user metrics. However, the revenue continues stagnating and user metrics deteriorate. This makes the new layoff round to look like a desperate measure from the management and its positive effect on costs will, sooner or later, be diminished by the revenue weakness and inflation. The stock is still overvalued, and I downgrade PTON to \"Strong Sell\".","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2432974374"}