🚴‍♂️The Rise of Home Fitness: Peloton Files its S-1 (Long Twitter Fodder)🚴‍♂️

In case you haven’t heard, Peloton Inc. filed its S-1 earlier this week. An S-1 is like a bankruptcy First Day Declaration. It’s an opportunity to sell and control a narrative. In the case of the S-1, the filer wants to appeal to the markets, drum up FOMO, and maximize pricing for a public capital raise (here, $500mm). So, yeah, want to call yourself a technology / media / software / product / experience / fitness / design / retail / apparel / logistics company? Sure, go for it. In an age of WeWork, a la-dee-da-kibbutz-inspired-community-company-that-may-or-may-not-be-valued-like-a-tech-company-despite-being-a-real-estate-company, hell, anything is possible.

Frankly, we’re surprised Peloton didn’t throw in that it’s a “CBD-infused-augmented-reality-company-that-transacts-in-Pelotoncoin-on-the-blockchain company” for good measure. Go big or go home, dudes! PETITION Note: the bankruptcy/First-Day-Declaration equivalent of this absurdity must be every sh*tty retailer on earth claiming to be an “iconic” brand with loyal shoppers who, despite that loyalty, never spend a dollar at said retailers, all while some liquidators are preparing to sell them for parts:

Value = $0.00.

(JK. Some schmuck will pay for this.) https://t.co/7fCFrmzs5I

— 💥PETITION💥 (@petition) August 27, 2019

But we digress.

For those who don’t live in Los Angeles or New York and are therefore less likely to know what the hell Peloton is (despite its 74 retail showrooms in the US, Canada and UK and pervasive ad-spend), it is a home fitness company that sells super-expensive hardware ($2,245 for the flagship cycle and $4,295 for the treadmill)* and subscription-based fitness apps ($39/month). It’s helped create the celebrity cycling trainer and aims to capture the aspirational fitness enthusiast. And, by the way, it’s a real company. Here are some numbers:

• $196mm net loss (boom!) on $915mm of revenue in the fiscal year ended June 30, 2019 ((both figures up from 2018, which were $47.8mm and $435mmmm, respectively, meaning that the loss is over 4x greater (boom!!) while revenue grew by over 2x));

• Hardware revenues increased over 100%, subscription grew over 100% and “other” revenue, i.e., apparel, grew over 100%;

• 511,202 subscribers in 2019, up from 245,667 in 2018;

• 577k products sold, with all but 13k in the US;

• a TAM that, while not a ludicrous as WeWork’s the-entire-planet-is-an-opportunity-pitch, is nonetheless…uh…aggressive with total capture at approximately 50% of ALL US HOUSEHOLDS

and;

• $994mm VC raised, $4+b valuation;

A big part of that net loss is attributable to skyrocketing marketing spend. But, Ben Thompson highlights:

Peloton spends a lot on marketing — $324 million for 265,535 incremental Connected Fitness subscribers (a subscriber that owns a Peloton bike or treadmill), for an implied customer acquisition cost (CAC) of $1,220.18 — but that marketing spend is nearly made up by the incremental profit ($1,161.40) on a bike or treadmill. That means that subscription profits are just that: profits.

The company also claims very low churn** — 0.70%, 0.64%, and 0.65% in 2017, 2018 and 2019, respectively — though this thread ⬇️ points out some obfuscation in the filing and questions the numbers (worth a click through):

1/ $PTON Peloton subscriber churn looks to me to be around 20-30% per year. But they reported churn of 0.7%!!
Math with me here.. the reported churn is a 'monthly' churn, calculated as net cancels in the period, divided by 3 months. So 0.7% = 2.1% per quarter, or around 8.4%/yr.

— Inquisitive Investor (@QuisitiveInvest) August 27, 2019

Ben Thompson hits on churn too, noting that major company promotions haven’t rolled off yet:

Only the 12 month prepaid plans have rolled off; the 24 and 39 month plans are still subscribers whether or not they are using their equipment (and given the 0% financing offer, I wouldn’t be surprised if there were a lot of them). 

Surely roadshow attendees will have questions on this point and then, market froth being market froth, totally disregard whatever the answers are. 😜

The company also highlights some tailwinds: (a) an increasing focus on health and fitness, especially at the employer level given rising healthcare costs and a general desire to offset them;** (b) the rise of all-things-streaming; (c) the desire for community; and (d) significantly, the demand for convenience. We all work more, weather sucks, the kids wake up early, etc., etc.: it’s a lot easier to work out at home. This thread ⬇️ sure captured it (click through, it’s hilarious):

Love putting my Peloton bike in the most striking area of my ultra-modern $3 million house

— Clue Heywood (@ClueHeywood) January 28, 2019

Which is not to say that the company doesn’t have its issues.*** It appears that like most other fitness products, there’s seasonality. People buy Pelotons around the holidays, after making New Year’s resolutions they undoubtedly won’t keep. There are also some lawsuits around music use. As we noted above, the marketing spend is through the roof ($324mm, more than double last year) and SG&A is also rising at a healthy clip. Many also question whether Peloton’s cult-like status will fizzle like many of its fitness predecessors. And, of course, there’s that cost. Lots or people — ourselves included — have questioned whether this business can survive a downturn.

Once again, for people in the back:
"Late-cycle IPOs are a way for the smart private money to cash out bad companies at the top and dump their risk on dumb retail investors right before a drop"
Thanks for coming to my TED talk. https://t.co/ONjf82Rfay

— Danny Seymour (@DannySeymour18) August 28, 2019

Indeed, among a TON of risk factors, the company notes:

An economic downturn or economic uncertainty may adversely affect consumer discretionary spending and demand for our products and services.

Our products and services may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, and other factors, such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates.

And:

To date, our business has operated almost exclusively in a relatively strong economic environment and, therefore, we cannot be sure the extent to which we may be affected by recessionary conditions. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products and services and consumer demand for our products and services may not grow as we expect. Our sensitivity to economic cycles and any related fluctuation in consumer demand for our products and services could have an adverse effect on our business, financial condition, and operating results. (emphasis added)

Now ain’t that the truth. This will be an interesting one to watch play out.

*****

Questions about the company’s stickiness in a downturn notwithstanding, we ought to take a second and admire what they’ve done here. Take a look ⬇️

Congratulations, Peloton fans. You are now a non-GAAP financial metric.

Please make an acronym from "Average Monthly Workouts Per Connected Fitness Subscriber." pic.twitter.com/GEti13nC7K

— Shira Ovide (@ShiraOvide) August 27, 2019

Sure, sure, it’s a ridiculous metric in an SEC filing but…but…look at the total number of workouts. Look at the average monthly. Unless Peloton is truly expanding the category, those workouts are coming out of someone else’s revenue stream. Remember: SoulCycle did pull its own IPO some time ago.

In a recent piece about the rise of home fitness and the threat it poses to conventional gyms and studios, the Wall Street Journal noted:

U.S. gym membership hit an all-time high in 2018, but the rate of growth cooled to 2% after a 6% rise the year before, according to the International Health, Racquet & Sportsclub Association. Much of the decade’s growth has been fueled by boutique studios like CrossFit, Orangetheory and SoulCycle, whose ability to turn fitness into a communal experience has sparked fierce loyalty to their brands. IHRSA says it’s too early to tell whether streaming classes will reduce club visits. CrossFit, SoulCycle and Orangetheory say they don’t see at-home streaming fitness programs as a threat.

We find that incredibly hard to believe. Is there correlation between the slowdown and growth and Peloton’s 128% and 108% growth from ‘17-’18-’19? Peloton may be more disruptive than the naysayers give it credit for.

Back to Ben Thompson:

Like everyone else, Peloton claims to be a tech company; the S-1 opens like this:

We believe physical activity is fundamental to a healthy and happy life. Our ambition is to empower people to improve their lives through fitness. We are a technology company that meshes the physical and digital worlds to create a completely new, immersive, and connected fitness experience.

I actually think that Peloton has a strong claim, particularly in the context of disruption. Clay Christensen’s Innovator’s Dilemma states:

Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use.

It may seem strange to call a Peloton cheap, but compared to Soul Cycle, which costs $34 a class, Peloton is not only cheap but it gets cheaper the more you use it, because its costs are fixed while its availability is only limited by the hours in the day. Sure, a monitor “underperforms” the feeling of being in the same room as an instructor and fellow cyclists, but being able to exercise in your home is massively more convenient, in addition to being cheaper.

Moreover, this advantage scales perfectly: one Peloton class can be accessed by any of its members, not only live but also on-demand. That means that Peloton is not only more convenient and cheaper than a spinning class, it also has a big advantage as far as variety goes.

The key breakthrough in all of these disruptive products is the digitization of something physical.

In the case of Peloton, they digitized both space and time: you don’t need to go to a gym, and you don’t have to follow a set schedule. Sure, the company does not sell software, nor does it have software margins, but then neither does Netflix. Both are, though, fundamentally enabled by technology.

If Thompson is right about that value proposition, is it possible that, in a downturn, Peloton can win? At $40/class, it would take 57 classes to break even on the hardware and then you’re getting a monthly subscription for the cost of one class. Will people come around to the value proposition because of the downturn?****🤔

Before then, we’ll find out whether the market values this company like a tech hardware company or a SaaS product. And the company can use the IPO proceeds to market, market, market and try and lock-in new customers before any downturn happens. Then we’ll really test whether those churn numbers hold up.

*The company doesn’t break out the success of the two other than to say that the majority of hardware revenue stems from the bike. We would reckon a guess that the treadmill is losing gobs of money.

**It stands to reason that the company would have strong retention rates given the high fixed/sunk cost nature of its product.

***One risk factor is curiously missing so we took the initiative to write it for them:

We sell big bulky products that appeal more to coastal elites.

Unfortunately, given the insanity if housing prices and spatial constraints, a lot of our potential customers in Los Angeles, San Francisco and New York simply may not have room for our sh*t.

****Unrelated but WeWork’s Adam Neumann insists that WeWork presents an interesting value proposition in a downturn: viable office space without the long-term locked in capital commitment. It’s not the craziest thing we’ve heard the man say.

---

DISCOVER MORE WITH PETITION

🔥Amazon is a Beast🔥

The "Amazon Effect" Takes More Victims

Scott Galloway likes to say that mere announcements from Amazon Inc. ($AMZN) can result in billions of dollars of wiped-out market capitalization. Upon this week’s announcement that Amazon has purchased Boston-based online pharmacy startup Pillpack for $1 billion — beating out Walmart ($WMT) in the process — his statement proved correct. Check this out:

We like to make fun of the Amazon narrative because we’re of the view that it’s overplayed — particularly in restructuring circles — and reflects a failure to understand broader macro trends (like the direct-to-consumer invasion noted below). Still, the market reaction to this purchase reflects the undeniable power of the “Amazon Effect” and we’d be remiss not to acknowledge as much. This purchase will likely be a turning point for pharmacies for sure; perhaps also, farther down the line, for benefits managers and pharmaceutical manufacturers. It also may provide Amazon with meaningful cross-pollination opportunities with its payments business — a subject that nobody seems to be talking about (more on this below).

Putting aside the losers for now, there are a variety of winners. First, obviously, are Pillpack’s founders, TJ Parker and Elliot Cohen. They stand to make a ton of money. Also its investors — Accel Partners, Atlas Venture, CRV, Founder Collective, Menlo Ventures, Sherpa Ventures and Techstars — at an 8x return, at least. Oh, and Nas apparently. And then there is Amazon itself. Pillpack isn’t a massive revenue generator ($100mm in ‘17) and it isn’t a big company (1k employees) but it packs a big punch: licenses to ship drugs in 50 sates. With this purchase, Amazon just hurdled over a significant regulatory quagmire.

So what is Pillpack? Per Wired (by way of Ben Thompson):

PillPack is trying to solve the problem of drug adherence by simplifying your medicine cabinet. Medication arrives in the mail presorted into clear plastic packets, each marked in a large font with vital information: day, time, pills inside, dosages. These are ordered chronologically in a roll that slots into the dispenser. Let’s say you need to take four different pills in the morning and two others in the afternoon every day: Those pills would be sorted into two tear-off packets: one marked 8am, followed immediately by the 2pm packet.

Put another way, Pillpack specializes in the convenience of getting you your medications directly with a design and user-experience focus to boot. The latter helps ensure that you’re taking the proper levels of medication at the right time.

Still, there are some limitations. Per The Wall Street Journal:

Amazon will be limited in what it can do, especially to start. PillPack’s specialty—packaging a month’s supply of pills for chronic-disease patients—is a small part of the overall market. It has said it has tens of thousands of customers versus Amazon’s hundreds of millions.

Current limitations notwithstanding, Thompson notes how much Pillpack’s service aligns with Amazon:

Amazon, particularly for Prime customers, is seeking to be the retailer of habit. That is, just as a chronic condition patient may need to order drugs every month, Amazon wants to be the source of monthly purchases of household supplies, and anything else one might want to buy along the way.

Like all aggregators, Amazon wins by providing a superior user experience, particularly when it comes to delivering the efficient frontier of price and selection. To that end, moving into pharmaceuticals via a company predicated on delivering a superior user experience makes total sense.

Thompson notes further:

The benefit Amazon will provide to PillPack, on the other hand, is primarily about dramatically decreasing the customer acquisition costs for a solution that is far better for consumers; to put it another way, Amazon will make a whole lot more people aware of a much more customer-friendly solution. Frankly, I have a hard time seeing why that is problematic.

To be sure, Amazon will benefit beyond its unique ability to supercharge PillPack’s customer acquisition numbers: just as Walgreen and CVS’s pharmacies draw customers to their traditional retail stores, PillPack’s focus on regular ordering fits in well with Amazon’s desire to be at the center of its customers day-to-day lives. This works in two directions: first, that Amazon now has a direct connection to a an ongoing transaction, and second, that would-be Amazon customers are dissuaded from visiting a retail pharmacy and, inevitably, buying something else along the way. This was a point I made in Amazon’s New Customer:

This, though, is why groceries is a strategic hole: not only is it the largest retail category, it is the most persistent opportunity for other retailers to gain access to Prime members and remind them there are alternatives.

A similar argument could be made for prescription drugs: their acquisition is one of the most consistent and predictable ways by which potential customers exist outside of the Amazon ecosystem. It makes a lot of sense for Amazon to reduce the inclination to ever go elsewhere.

It seems that Amazon is doing that lately for virtually everything. Consistently, further expansion beyond just chronic-disease patients seems inevitable. Margin exists elsewhere in the medical chain too and, well, Jeff Bezos once famously said “Your margin is my opportunity.” David Frankel of Founder Collective writes:

The story of the last five years has been that of bricks and mortar retailers frantically trying to play catch-up with Amazon. By acquiring PillPack, Amazon is now firmly attacking another quarter trillion dollars of TAM. Bezos is a tenacious competitor and has just added the most compelling consumer pharmacy to enter the game since CVS was founded in 1963.

TJ Parker understands the pharma business in his bones, has impeccable product sensibilities, and now has the backing of the most successful retail entrepreneur in history.

Expect some real healthcare reform ahead.

No wonder those stocks all sh*t the bed. That all sounds downright horrifying for those on the receiving end.

*****

Recall weeks back when we noted this slide in Mary Meeker’s “Internet Trends” presentation:

Healthcare spending continues to rise which, no doubt, includes the cost of medication — a hot button issue of price that even Donald Trump and Hillary Clinton have agreed on. This purchase dovetails nicely with Amazon’s overall health ambitions. Per the New York Times:

But Mr. Buck and others said Amazon might have a new opportunity. A growing number of Americans are without health insurance or have such high deductibles that they may be better off bargain shopping on their own. He estimated that 25 million Americans fell into that category.

Until now, he said, PillPack has not aggressively competed on price. With Amazon in charge, “how about they start posting prices that are really, really aggressive?” Mr. Buck said.

As Pillpack increases its scale, Amazon will be able to exert more leverage in the space. This could have the affect of compressing (certain) pharmaceutical prices. To get there, Amazon will undoubtedly seize the opportunity to subsume Pillpack/pharma into Amazon Prime, providing Members discounts on medicine much like it provides Whole Foods shoppers discounts on bananas.

There is other opportunity to expand the user base as well. People are looking to save money on healthcare as much as possible. With cash back rewards, Amazon can offer additional discounts if consumers were to carry and use the Amazon Prime Rewards Visa Signature Card — which already offers 5% back on Amazon.com and WholeFoods purchases (plus money back elsewhere too). Pillpack too? We could envision a scenario where people scrap their current plastic to ensure that they’re getting discounts off of one of the most rapidly rising expenditures out there. Said another way, as more and more consumer staples like food and medicine are offered by Amazon, Amazon will be able to entice Pillpack customers with further card-related discounts. And grow a significant amount of revenue by way of its card offering. No doubt this is part of the plan. And don’t forget the data that they would compile to boot.

Per Forbes shortly after Amazon launched its Amazon Prime Rewards Visa Signature Card,

Given that Amazon credit card holders spend the highest on its platform, the company is looking at ways to expand its credit card consumer base. CIRP estimates that approximately 15% of Amazon’s U.S. customers have any one of Amazon’s credit cards, representing approximately 21 million customers. However, growth of its card base has not kept pace with its growing Prime membership. In June 2016, it was estimated that Amazon has around 63 million Prime members. Assuming that only Prime members have an Amazon credit card, it would mean that only a third of its Prime customers have one of its credit cards. According to a survey by Morgan Stanley, Amazon Prime members spend about 4.6 times more money on its platform than non-prime members. Its credit card holders spend even greater amounts than what Prime members spend. By enticing its prime customers to own its credit cards, Amazon will be encouraging them to spend more on its platform. Its latest card is aimed at attracting Prime customers by offering deals not only on Amazon.com but on other shopping destinations as well. This can lead to higher spending by existing Prime customers and help convert the fence sitters into Prime memberships.

And those numbers are dated. Amazon Prime now has 100mm members. Imagine if they could all get discounts on their meds. 💰💥💰💥

All of which begs the question: who gets hurt and who benefits (other than Visa ($V)) from this potential secondary effect? 🤔

Is Digital Media in Trouble?

Don't Sleep on Digital Media "Distress"

Last week we announced that we'll be rolling out our Founding Member subscription program in early '18. The response was overwhelmingly positive with many of you reaching out and essentially saying "what took you so long." That warmed our heart: thank you! We look forward to educating and entertaining you well into the future. The timing fortuitously dovetails into a general narrative about the state of digital media today. 

For instance, is it fair to characterize Mashable as a distressed asset sale? Well, the company - once valued at $250mm - is reportedly being sold to Ziff Davis, the digital media arm of J2 Global Inc., for just $50mm. So, what happened? New capital for media companies has dried up (unless, apparently, you're Axios) amidst weakness in the ad-based business model. With Google ($GOOGL) and Facebook ($FB) dominating ads to the point where even Twitter ($TWTR) and Snapchat ($SNAP) are having trouble competing, digital media brands are feeling the heat. Bloomberg highlights that at least a half dozen online media companies - from Defy Media (Screen Junkies, Made Man, Smosh) to Uproxx Media (BroBible) - are also considering sales to bigger platforms. Indeed, in an apparent attempt to de-risk, Univision is ALREADY reportedly trying to offload a stake in the Gawker sites it recently bought out of bankruptcy.

Which is not to say that bigger platforms are killing it too: the Wall Street Journal reported earlier this week that both Buzzfeed and Vice will miss internal revenue targets this year. Oath, which is Yahoo and AOL, binned 560 people this week. Of course, those in the distressed space know that one's pain is another's gain. To point, Bloomberg quotes Bryan Goldberg, founder of Bustle, saying "Small and more challenged digital media companies have been hit hard. This is a time for companies with cash flow and capital to start acquiring the more challenged digital assets." That sounds like the mindset of a distressed investor: the buyside and sellside TMT (telecom/media/technology) bankers must be licking their chops. Back to restructuring, these sorts of mandates may be decent consolation prizes for those professionals not lucky enough to be involved with the imminent bankruptcies of (MUCH larger and obviously different) media companies like Cumulus Media ($CMLS) and iHeartMedia Inc. ($IHRT), both of which are coming close to bankruptcy (footnote: click the iHeartMedia link and tell us that that headline isn't dangerous in the age of 280-characters!). For instance, Mode Media is an example of a digital media property that failed last year despite at one time having a "unicorn" valuation (based on $250mm in funding), a near IPO, and tens of thousands of users. It sold for "an undisclosed sum" (read: for parts) in an assignment for the benefit of creditors. Scout Media Inc. filed for bankruptcy in December of last year and sold in bankruptcy to an affiliate of CBS Corporation for approximately $9.5mm. Not big deals, obviously, but there are assets to be gained there. And fees to be made. 

In response, (some) digital media brands are looking more and more to subscribers and less and less to advertisers in an effort to survive. Longreads' "Member Drive," for example, drummed up $140,760 which, crucially, it'll use to pay writers for quality long-form content. Ben Thompson has turned Stratechery into a money-making subscription-only service; he told readers that they're funding his curiosity and their education. Indeed, his piece this past week on Stitch Fix ($SFIX) may have, in fact, impacted sentiment on the company's S-1 and, in turn, the company's IPO price. These are only two of many examples but, suffice it to say, the "Subscription Economy" is on the rise. 

Which is all to say that our path is clear. And we look forward to having you along for the ride. Please tell your friends and colleagues to subscribe TODAY: existing subscribers will get a preferential rate.