David Einhorn sees value in Peloton, yet his optimistic outlook hinges on a significant condition.
Peloton Interactive's (PTON -8.57%) shares are considered undervalued by hedge fund manager David Einhorn, according to his remarks at an investor conference. Einhorn, the founder and chief of Greenlight Capital, believes the fitness equipment maker's stock could be worth up to $31.50 per share, representing a 330% increase from its current trading price.
However, there's a catch. To achieve this, Peloton needs to make significant adjustments to its financials.
While Einhorn's reasoning is sound, there's a big problem – it's highly unlikely Peloton will be able to implement the required changes. The company's business has been on a downward trend, and its future isn't looking any better than its past.
Cost savings are crucial, but a tall order
Remember how Peloton's exercise bikes and treadmills were all the rage during the early days of the COVID-19 pandemic? People were stuck at home with the time and the income to purchase these items, thanks in part to stimulus checks. Indeed, the concept of online workouts led by live trainers wasn't exactly new, but lockdowns sparked unprecedented demand for connected fitness equipment.
In 2021, Peloton's equipment saw peak interest.
Responding to the situation, Peloton made cuts where it could. For instance, in an attempt to save costs, the company shifted production of its equipment to lower-cost third-party manufacturers in 2022.
But Peloton's struggles have persisted. It's grappling with decreased appeal in the market, stagnant membership growth, and persistent losses, leading to the departure of CEO Barry McCarthy in May 2024.
His successor was announced just last week, offering renewed optimism to shareholders. In connection with the release of Peloton's fiscal 2025 Q1 results, the company announced that Ford and former Apple executive Peter Stern would take over beginning of this year. Einhorn presumably believes Stern will continue to trim costs to boost Peloton's earnings before interest, taxes, depreciation, and amortization (EBITDA). This is how Einhorn arrives at his stock price target: If Peloton Interactive manages to produce $450 million in annual EBITDA, there's a case to be made for shares being worth more than $31 per share.
The problem? Peloton's cost-cutting initiatives only put it on pace to generate between $240 million to $290 million of adjusted EBITDA for fiscal 2025. Given the company's lack of revenue growth, making enough cuts to boost EBITDA by $160 million to $210 million is unrealistic, especially in the short term.
And that's not all.
Peloton Interactive's biggest challenge remains
Einhorn's argument highlights the inherent challenges for high-profile activist investors who acquire large stakes in companies (Greenlight owns about 7 million shares of Peloton). From an outsider's perspective, cost cutting seems like an easy way to improve profits, but reality paints a different picture. It's much easier said than done to implement drastic cuts to expenditures that could hinder growth.
Take Einhorn's criticism of Peloton's spending on research and development as an example. Peloton still spends around $300 million on R&D – a sizable sum, even for larger companies with ample resources. Peloton could theoretically function well without such heavy investment.
But the technology behind Peloton's connected fitness equipment isn't simple. Its exercise bikes and treadmills require the same level of tech as a high-end mobile phone or computer. Constant updates and improvements are necessary to keep these offerings appealing to customers and to stay ahead of the competition.
Other expenses that can't easily be reduced include sales and marketing. As you can see below, memberships took a dip during fiscal Q1, in line with a 30% reduction in operating expenses.
Connect the dots. Although Peloton is saving money by cutting back on R&D and marketing, it's not helping the company grow its subscriber base. If this downward trend continues, it will eventually lead to eroding EBITDA. It's just a matter of time before the company's revenue can't cover minimum expenditures to maintain margins.
The one expense that might be ripe for reduction? Administrative costs, which include stock-based compensation. Peloton spends over $300 million each year on these awards, equivalent to one-tenth of its revenue.
Such compensation is crucial in attracting and retaining talent. Scaling back this spending could lead to key personnel leaving the company. Peloton has already made significant strides in reducing its cost structure over the years.
Not now, and perhaps never
Peloton has limited options to achieve the EBITDA Einhorn desires. Its reliance on higher-margin subscription fees is crucial to its recovery, but the appeal of these subscriptions is waning, both among new and existing customers.
Maybe the newly appointed CEO, Peter Stern, has the right game plan, but until leadership presents a tangible scheme to revive this company, there's not much justification for thinking Peloton's shares will increase beyond their recent surge in the past few weeks.
Despite Einhorn's belief that cost savings, particularly in areas like research and development and administrative costs, could boost Peloton's earnings, implementing such drastic cuts may not be feasible without affecting the company's growth and competitiveness in the market.
Furthermore, Peloton's struggle to maintain its appeal in the market, along with stagnant membership growth and persistent losses, raises questions about the company's ability to reach Einhorn's projected EBITDA of $450 million, no matter how much costs are trimmed.
