This is a stock that I think embodies a number of important issues investors have to deal with in today’s US stock market.
PTON went public at $29 a share in September 2019. It had a follow-on offering in November of last year at $46 a share. In between those two dates, it had peaked at an intraday high of $171 in early 2021, as the stay-at-home market frenzy was at its strongest.
It has been all downhill since then. PTON closed at $24.60 last Friday.
Using the principles that Benjamin Graham, the father of “value” investing, articulated during the 1930s, PTON is still substantially overvalued. How so? Its earnings and cash flow are both negative; shareholders’ equity (also called book value) is a bit under $15 a share.
Nevertheless, the stock is up by about a third in premarket trading today, on reports that both Nike and Amazon are interested in buying the company.
What’s going on?
–PTON’s value, as I see it, is mostly in an intangible asset, its brand name. The main way the brand appears in financial statements is either as R&D or marketing. Both items are expenses, that is, reductions of income. So, arguably, the stronger the brand, the lower the current income.
A half-century ago, Warren Buffett pointed out this defect in a simple-minded earnings/cash flow approach to valuation. Suppose, for example, you wanted to create a brand name equivalent to PTON’s. It could easily take years, would probably cost a ton of money, and you might not be successful. Most likely, it would be much cheaper to buy the company. But you’d never see any of this from examining the company’s annual report. (You could add up a company’s actual advertising expenditures over the past, say, decade. For most consumer firms, this is a staggeringly high sum.)
Software companies have the same kind of accounting-rule bar to putting software development costs on the balance sheet. That’s because of technology accounting scandals from the 1970s.
–PTON management doesn’t get many All-Star votes. There’s already one activist shareholder clamoring for current management to be replaced. Myself, I thought the company’s response to young children being injured by the company’s treadmills was incomprehensibly wrong-headed.
–forced change of control may be impossible. As is common in today’s world, the PTON chairman owns a special class of shares that have extra voting rights. In this case, it’s 20x the voting power of ordinary shares. So he retains voting control despite owning only about 10% of the outstanding stock. This isn’t a trivial thing. A key reason activist value-oriented investors have been so unsuccessful over the years in places like Japan or the EU is that in both areas there’s been no way to take control out of the hands of incompetent incumbents.
I think the PTON case is particularly interesting. My hunch is that if we look closely enough the real “value” stocks today include a good number of still-unprofitable newer tech companies, some of which came close to trading for the value of their net working capital at the recent market lows. PTON developments might be the catalyst needed for investors to do some shopping in this bargain basement.