Peloton- Are Investors Here for the Comeback?

It is an ominous sign for a company when the first two marketing promos of the year are major TV shows using your product to knock off main characters. That is what Peloton (PTON) faced when the Sex in the City reboot And Just Like That… and Billions characters met their demise while trying to get in a sweat.

The stock performance of PTON over the past year begged the question if the company would join the hapless characters on the wrong side of the ground. 

However, a major change in the C-Suite and rumored M&A have thrown the struggling stock a lifeline. This has investors asking whether they should hop back on the bike and buy some shares?

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On February 8, Peloton shares had their best day ever when news broke that founder John Foley would step down as CEO. He will be replaced by Barry McCarthy.

Who is Barry McCarthy? Mr. McCarthy was CFO of Netflix (NFLX) from 1999-2010 and CFO of Spotify (SPOT) from 2015-2019. The stock reaction suggests the market approves the hire. McCarthy has a great track record for growing subscription base as evident by the success at both NFLX and SPOT. 

McCarthy is aware of the issues facing Peloton. In a memo to staff he stated that he is “here for the comeback story”, according to CNBC.

PTON shares gained 434% in 2020 as pandemic-related demand drove exponential growth. The stock peaked at $167 in January 2021. It would give up 80% of its value over the nest 12 months. 

Valuation concerns were certainly at play. Execution was perhaps the bigger crime for investors. The pandemic disrupted consumer spending habits, leading to the purchase of material items as services were shut down by government mandates. PTON was a big winner in this environment as gyms closed, forcing people to work out from home.

The company did not have time to develop a supply chain to support new market dynamics. This constrained the company’s ability to meet customer orders, leading to long delivery times. We are in a society that gets triggered when their Prime shipping takes three days, multi-week delivery delays is not acceptable.

PTON scrambled to improve its capacity utilization. It signed long-term partnership agreements to increase its manufacturing footprint. The problem is that the long lead times for delivery and a re-opening from the pandemic allowed demand to dry up. PTON was stuck with the cost of an aggressive expansion while demand dried up. 

This mismanagement was evident in the Q2 results. PTON missed EPS expectations by 47 cents. Revenues rose 6% year-over-year to $1.13 bln, below analyst expectations and a steep decline from the 54% growth posted in Q4.  Q2 Paid Digital Subscribers, an area the company has described as the back bone of its future growth, grew 38% year-over-year to 862K. This was well below the 906K expected by the street.

Guidance was not much better as it forecast Q3 and FY22 revenues, EBITDA and Connected Fitness Subs all below expectations. Q3 sales are expected to decline -23% y/y. The Connected Fitness Sub growth is projected to be 41% y/y, a sizeable increase but a deceleration from the 66% posted in Q2. PTON also slashed its gross margin outlook to 28% from 32% as rising costs from its restructuring impact the bottom line. 

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Earnings was accompanied by news of the CEO transition. PTON also announced plans for a cost reduction to improve profitability and free cash flow. The first step was to reduce its global workforce by 2800 employees. 

The timing of the CEO transition garnered attention. Rumors that activist investor Blackwells Capital called upon PTON to put itself up for sale made the rounds. The Wall Street Journal reported that Amazon (AMZN) and Nike (NKE) were interested in adding the PTON portfolio to assets. Apple (AAPL) has long been a rumored suitor. The chatter led to a surge in short covering. The stock rallied 25% to close at $29.60 on Monday on these rumors.

PTON move suggested it was interested in fixing its problems rather than putting itself up for sale. The initial reaction was to sell the news. It is easier to jump on an M&A train than to wait for a turnaround.

However, bulls would come back in and drive the stock into the $30s. The hire of McCarthy was well-received as he is viewed as the perfect executive to lead the turn around and drive the primary goal for the PTON business model- Connected subs. Plus, it does not completely remove M&A possibilities.

Potential buyers of the PTON stock now face a difficult decision. Do I chase the name higher? Can I wait and find a better entry? Should I avoid this name altogether?

Our initial take is that the easy money has been made. The stock has a 293 million float and a Short Interest of approximately 11%. There is room for a short squeeze but there needs to be a fundamental catalyst to shake bears out of their position. The ‘shock’ headlines are likely gone for the moment. That means we are in an area where business fundamentals need to surprise. The issues facing PTON suggest that will take a few quarters to turnaround. Shorts are not going anywhere.

We are likely in a choppy range bound trade until we get further evidence that the comeback is on. Traders will enjoy the price action but longer-term investors are probably better off sitting on the sidelines, waiting for concrete evidence that the business is improving.