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INITIATING COVERAGE

Peloton’s IPO is well-timed to exploit our obsessions with fitness and showing off

Peloton's bike
Peloton
All aboard.
By Dave Edwards, Helen Edwards
Published Last updated This article is more than 2 years old.

Rich people sweating it out in a virtual competitive bike race in the comfort of home? In what universe did Richard Simmons predict this trend in fitness?

But this is where we are. And it seems to be working.

Peloton, a seven-year old company that makes internet-linked stationary bicycles and treadmills, is riding three major trends: the influencer economy, digital addiction, and a new kind of independence trend in health & wellness.

The company’s regulatory filing last week ahead of an initial public offering showed how successful it has been in capitalizing on these trends. It has amassed 1.4 million members who use its exercise equipment and services every two or three days, and completed over 58 million workouts in the past year. Members pay more than $2,000 for either a bike or a treadmill and then pay $39 per month to access classes through their equipment and over the internet. They seem to get addicted to Peloton’s service and the instructors, with fewer than 1% of members quitting every month. Peloton is an impressive story—one that we think will continue to impress.

Influencer economy

The influencer economy is all about individuals influencing others to buy products via Instagram and Twitter. Successful influencers are worth a lot to marketers and anyone who wants to access their followers. Marketing spending in the influencer economy has grown to more than $6.5 billion in the US and Europe, Peloton’s primary markets. Much of the attention paid to influencers goes to those with millions of followers. But to many brands, microinfluencers are the true power behind the influencer economy. These microinfluencers may have fewer than 100,000 followers but these followings can be focused and dedicated.

Microinfluencers drive Peloton’s engagement—its 29 instructors have avid followings of tens or hundreds of thousands of people. For instance, @codyrigsby has 96k followers, @allymisslove has 176k followers and @robinnyc has 265k followers. That’s in comparison to 365k followers for Peloton itself.

Microinfluencers are all about engagement and Peloton’s instructors create incredible engagement. Peloton subscribers completed 11.5 workouts per month over the past year. If you ask Peloton subscribers about their experience, many will start by telling you about their instructor. Instructors have their own style and create a bond with subscribers. This isn’t unique to Peloton. For more than 25 years, we’ve been loyal spin customers of Les Mills, a New Zealand-based fitness club which offers exercise classes at 20,000 clubs around the world and through a product targeting the at-home fitness market. Given our experience, we understand the relationship one can develop with an instructor. The right instructor makes all the difference; creating a social bond, overcoming low motivation and providing just the right encouragement to get through the pain.

Peloton’s instructors are clearly an advantage for the company. They are also a major risk factor. Losing one or more instructors to a competitor could cause subscribers to think about switching since their connection with the instructor could be more important than their connection to the company.

Digital addiction

Since Peloton launched its bike, American’s per capita consumption of media and entertainment has increased by more than 10%—an increase of one hour per day. Time with smart media, which includes internet-connected devices like Peloton’s, is up more than 80% to over four hours per day. That means the average Peloton subscriber spends about 10% of his or her time with smart media like Peloton.

This time spent with—or addition to—smart devices creates an opportunity for all kinds of companies to feed us services through a screen. Peloton is capitalizing on this trend by providing indoor and outdoor visuals through the screens on its bikes and treadmills. The company also has over 100,000 subscribers who access classes without a bike or treadmill, using its digital-only service for $20 per month. There’s clearly an opportunity for Peloton to leverage its screen time with additional products and services, although it’s unclear if that’s an objective for the company.

Today, the addition to Peloton creates a highly sticky relationship with its customers. More than 90% of the bikes and treadmills sold by the company have an active subscription of $39 per month. And the average net monthly connected fitness churn—the percentage of customers who leave Peloton each month—is only 0.65%. If this churn rate continues, it implies that customers will stay with Peloton for almost 13 years on average. Since the company has only been selling bikes for five years, it’s too early to know for sure how long customers will stay, but the low churn rate is very impressive. As a point of comparison, Netflix is lauded for having the lowest churn rate for video streaming services but its still 4.5 times higher than that of Peloton.

Health and wellness

Peloton’s current products and services target the $600 billion market for fitness, yoga, and meditation. A good portion of that is spent on services that Peloton isn’t addressing, particularly gym memberships which serve 183 million people across the globe. Within Peloton’s target geographies (US, UK, Canada, and Germany), the company estimates more than 5 million treadmills and nearly 3 million stationary cycling bikes were purchased for in-home use over the past year. This compares to Peloton’s total sales of 577,000 products to date.

In its IPO filing, the company narrows down its addressable market based on geography (US, UK, Canada and Germany), household age (18-70 years old), income ($50k+ total income), and interest in Peloton’s products in current fitness verticals and price points (based on survey results). According to this analysis, the company thinks that it has sold to 4% of its addressable market. It’s worth noting Peloton is using a very narrow description of its addressable market. It’s not uncommon for companies to simply say that anyone above a certain income threshold is a potential customer. Peloton, however, describes a potential customer as one which expresses interest in its current products at current price points. While it’s difficult to forecast how many of the remaining 13.5 million people in the company’s addressable market will purchase a product, we think it’s likely to be a higher percentage than expected when comparing against other companies that exaggerate their addressable markets.

It’s important for investors to consider the expansion opportunities for Peloton within the broader health and wellness category. People find a very real social connection with Peloton’s classes, perhaps more so than a standard gym class. On-demand and at-home fitness is only going to grow. People like not having to go to a gym at a certain time, or having to deal with the hassle of parking or childcare, and sharing equipment and space with others.

The company started with stationary bikes and has recently moved into treadmills and activities that don’t require equipment such as yoga, indoor/outdoor running and walking, bootcamp, strength training, stretching, and meditation. As the company expands, it taps into new markets for new activities. It also creates opportunities to sell new products and, importantly, high margin digital-only subscription services.

Is Peloton the next Apple?

Peloton’s fans like to compare the company to Apple. In some ways, this makes sense. Both companies sell experiences. Peloton says it sells happiness while Apple claims it sells empowerment. Both products are status symbols.

Peloton also has a similar business model to Apple—selling hardware and hardware-connected services. Peloton makes 79% of its revenue from hardware and 20% from digital services. In comparison, Apple makes 87% of its revenue from hardware and 13% from digital services.

There are two important differences between the two though. First, Apple benefits from the constant improvement in computing technology, allowing it to improve the performance of its hardware while increasing the prices it can charge. Peloton won’t enjoy the same benefits. While there is plenty of technology inside its bikes and treadmills, the performance of Peloton’s equipment won’t have the same room for improvement as does the iPhone’s chips, storage, and screens. Second, Peloton exclusively sells its products in high-income economies today, while Apple is a global company. If Peloton wants to expand into additional geographies, it is fair to assume that it may have to sell hardware at lower price points and invest in non-English services. Both of these changes could have negative impacts on the companies financial results.

Super voting shares…again

Yet again we are analyzing another IPO that gives insiders super voting shares, leaving public market investors with no voice in how the company is run. We’ve raised this criticism and caution before (here, here, here, and here) and will do so again with Peloton. Buying shares of Peloton means you are simply (ahem) along for the ride with the insiders. We think this is a bad trend for financing innovative companies because we think there is value in governance by external shareholders but it seems unavoidable.

One slightly positive note: Peloton’s insider control is shared by its entire executive team and private investors—primarily Fidelity, Technology Crossover Ventures, and True Ventures. This is better than the singular control of the founder and CEO typical in such companies. But it’s still a sub-par structure for everyone else who owns shares.

Take a ride?

Peloton is a compelling company. We like the trends powering the company, we like the products and services, and we like the overall business structure and performance. Importantly, the company is going public at the best time of its business cycle. The company usually earns two-thirds of its revenue in the period between November and February so this means the company should be able to announce good financial results following the IPO. The biggest remaining question for the IPO is valuation. Given the hype around the company, it’s possible that the valuation could be a bit high and investors would benefit to wait and hope that the stock price drops down over time, providing a better price to buy.

Overall, we think Peloton has a lot of opportunity to grow. We don’t like the company’s super-voting shares but this could be an opportunity to hold our noses.