five months ago we said that Peloton was a highly investable idea but
our views have evolved in the last few months as new information has come to
light so what information changed our minds and more importantly
how can investors know if their thesis is busted or has just taken a temporary stand back we'll
walk through all those details and more my name is Brian Feroldi and my name is Brian Stoffel
we've both owned stocks that have gone through long periods of bad news and when that happens the
stocks typically tank what should an investor do when it happens to them well it's really important
that investor comes up with the system that works for them because sometimes the stock is tanking
for reasons have nothing to do with long-term potential other times it's a sign that things are
broken and we've said these four steps are crucial to figuring out the difference between these two
scenarios the first thing you must do is you need to revisit your thesis for buying the company
in the first place second you need to seek out information that is available to you at the time
third you need to make sure you give yourself time before doing anything about a stock falling
because we don't want to have any knee-jerk reactions finally you need to make a decision
about what you're going to do with that company next well brian in june of this year you and i
ran peloton through your anti-fragile framework and the company scored pretty well getting an
overall score of 11. that's well into your robust category even bordering on anti-fragility that's
right and unsurprisingly i followed that up by actually buying shares of the company so this is a
stock that i own and if anybody has owned it along with i know the pain of the last couple of months
now luckily when we need to go back and reevaluate our thesis there are some parts of this framework
that are very easy to check that's because they are objective you can compare the facts to where
things are now versus where they were before and these are the areas that we can look at so back in
june of this year peloton was in pretty good shape financially it almost had three billion dollars
cash just under a billion dollars in debt and it was producing positive free cash flow of 400
million dollars per year but if we look at where they are now their cash balance has plummeted
to the point where they have just about the same amount of cash and debt and just as important free
cash flow has gone from a positive 400 million to negative 1.4 billion dollars unsurprisingly
as we're filming this the company announced that they were going to have to raise more funds
with the secondary offering to help shore up this balance sheet financially this company's picture
really changed a lot but some things have stayed the same then there was no concentration risk
just like now there's no concentration risk in the same light when we looked at glassdoor back
in june the company got great ratings as well as our ceo and founder john foley if we look today we
see much the same things while the ratings aren't quite as high as they were before they are still
excellent before there were three founders in the executive suite today there's still three founders
in the executive suite back then insiders owned about 15.8 percent of shares outstanding or about
46 million shares if we look today that number has gone down it's down to about 12 and 36 million
respectively at the same time that is still a very high level of insider ownership so let's
go back and change what we can from my previous evaluation we know that the company's financials
have taken a big hit before i thought they were anti-fragile lots of cash lots of free cash flow
little debt the story is not the same anymore there's about even amounts of cash and debt and
they're losing a ton of money so i'm gonna switch that from a plus one to a negative one carry that
all the way down because everything else remains the same and the score goes from an 11 to a nine
so looking at the objective parts of your score card the difference was about two points but
now it's time to look at the subjective parts of your scorecard specifically we're going to
look at the barbell method so the barbell method rests on two extremes so with the barbell method
the company has the vast majority of its resources and gets the most of its revenue from a wide moat
low risk business on the other side of the extreme the company has several experiments
ongoing that generate a little bit of revenue but could generate high risk high return potential for
investors now we love investing in companies with lots of optionality because if those experiments
fail it doesn't really hurt the company but if they succeed it could drive stupendous
returns over long periods of time so here's how i thought about peloton's barbell method back then
part of this has changed because the numbers have changed part of it has changed because i didn't do
enough homework so back then the big side of the barbell was the company's bikes and treadmills
and the connected fitness subscriptions that came with that this is where the users have to pay 40 a
month to be able to take the classes on the other end of the barbell we had digital subscriptions
and that's where you can pay 13 a month to have an app on your phone and participate in workouts
without needing to own the bike or the treadmill the company also had other initiatives like a
clothing line with the hopes that peloton branded clothes could rival the likes of under armour
lululemon and if we look at what is the wide moat protecting the bikes the treadmills the connected
fitness subscriptions well i thought there was a bunch the first was the network effect how is
there a network effect i've read tons of articles about how communities form around different themes
and they gather on a regular basis and i think i gave them a little bit of credit for that because
i think that that can get people to stick with it i also said that there were switching costs
specifically i was thinking about what i call sneaky switching costs where you've already put
over two thousand dollars on a bike or a treadmill so paying that forty dollars a month especially if
it's connected to your credit card isn't that big of a deal you don't even think about it
and it's no problem to keep paying that even if you haven't done a workout in two or three weeks
we also gave them points for brand value because everything that we've read and seen suggested that
peloton had a rabid user base that was basically cult like affinity for the products finally we
gave this company points for counter positioning because we thought it had counter positioning in
its biggest competitors which was gyms so now what we need to do is go back and evaluate well where
is the company getting its money from and what i did was i broke down where the company's gross
profit came from and it comes in two buckets that blue area is the gross profit it gets from selling
bikes and treadmills the red area is the gross profit it gets from subscriptions specifically the
connected fitness subscription which requires a bike or a treadmill and the digital subscriptions
would do not require a bike or treadmill and what we see is the dynamics are changing very quickly
now brian and i both hoped that subscription would eventually become the main driver of gross profit
we see that happening but the problem is is that we see a significant dip in the gross profit from
its products it's even a bigger problem because that drop in the last bar comes over just three
months into this fiscal year now prior to what we've seen in the last couple of months the number
of connected fitness subscribers were absolutely going up at a rapid pace which was wonderful to
see since the bikes and treadmills were flying off the shelves conversely their focus on digital
subs which is when you become a peloton member without having to buy the bikes and services
was also growing rapidly but what we've seen is a huge slowdown in the growth of these two numbers
which suggests that the products aren't as sticky as they used to be now this becomes even
more problematic when we look at the breakdown of how much the company gets from these two products
connected revenues are almost 10 times more important to the company's top line than those
digital subscriptions that's a problem and it's a problem because you don't get a connected fitness
subscription unless you buy a bike or a treadmill the gross profits and the sales for the bike and
the treadmills are going down and the company has cut the prices for them it wouldn't do that unless
it was having trouble selling we also seen some troubling numbers when you look at the company's
churn and its growth rate this chart shows you the growth in the connected fitness platform
combined with the annualized churn rate what we've seen more recently is growth in connected fitness
subscriptions is going down rapidly while at the same time churn in that same category is going
up rapidly that is a terrible double whammy meanwhile there are also signs that the company's
brand value has taken a big hit if you look at spending on sales and marketing in just the
past three months that figure is up 150 percent over the prior year period and in the prior year
period their products were flying off the shelves that suggests that the brand name peloton isn't
as strong as we gave it credit for so what does this all mean if we take all of these factors into
consideration we're going to make some significant changes to the subjective scores we gave the
company when it comes to network effects we're going to cut it in half we can do the same thing
with the switching costs as proven by that churn i think we need to take some points off there too
when we look at the brand value when we see the sales and marketing budget going up so much while
the sales of the actual products goes down that tells us that we're giving them too much credit
for their brand finally people are returning to gyms in droves which suggests that the counter
positioning isn't as strong as we once thought so what does this mean for peloton's final score well
we'll get to that in a second but before we do we wanted to give a shout out to this video's sponsor
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right brian we've already done the work of subtracting the objective changes but let's talk
about the subject of changes we'll do optionality first because we haven't really talked about that
we see that digital subscriptions are slowing the clothing line hasn't gained a ton of traction and
maybe we're giving too much credit right now to what the company is trying to do so i'm going
to nudge that from a two and a half back down to a two and then when we consider that the
network effects are really miniscule right now the brand value has been cut in half we've eliminated
counter positioning but we're still giving them a decent amount of credit for those switching costs
that's going to change the score from a three and a half all the way down to a two so when
you add all those changes together that changes this company's score in total from an 11 to a
seven that drops it from the high end of your robust category to basically saying that this
is a fragile business given that i now consider this to be a fragile business many people are
wondering well what am i going to do about it the answer is i'm going to sell my shares now i want
to be very clear about something and that is that if i was the type of investor who spread out a lot
of bets very evenly at small levels peloton might make a lot of sense to get into the stock could do
very well moving forward if the company writes a chip however i want to own companies that i
think are anti-fragile right now and i don't think peloton fits that description peloton never found
its way into my portfolio so i don't have to make the same decision that you do however i can say
that i probably wouldn't be in a rush to sell this stock i would like to see a couple more quarters
of progress to see if this was a one-time thing or a trend but there's no doubt in my mind that the
bull case for owning peloton stock is not nearly as strong as it was just a few months ago brian
while talking about peloton is important i think that the process that we go through to arrive at
these decisions to gather the information and to try and process it is the real takeaway here and
more importantly we know that we're going to be wrong a lot peloton certainly isn't going to be
the first company that we are wrong about that doesn't mean that our systems don't work well it
just means that the business world is dynamic and things are constantly changing well let us know in
the comment section below are you going to be holding peloton do you think this is a buying
opportunity perhaps we should revisit this in another six months or so until then brian's out