To summarize my last post: value investors look through Wall Street’s junk pile for down-at-the-heels companies that have lots of assets (tangible and/or intangible), viable products, but that are, for some reason, trading at substantial discounts to their intrinsic value.
One easy screen is to look for the worst-performing stocks over some recent period. Lots of tech-related and stay-at-home names jump out. One is PTON, which has gone from a high of $171 a share in mid-2021 to $22.50 as I’m writing this. What jumps out in the income statement is that the company somehow managed to go from a gross profit of $425 million and operating income of $59 million in the last quarter of 2020 to gross profit of $280 million and an operating loss of $425 million in the same period of 2021. Cash flow from operations went from about plus $500 million to negative $1 billion. This despite the company’s gross profit from its workout subscription service rising from $115 million to $225 million.
In short, a train wreck–in the middle of a period of high demand, during which PTON’s main issue seemed to be making enough bikes to satisfy demand.
rough and ready valuation
The company’s cash flow during the second half of 2020, before all the operational problems of 2021, was about $3.15/share. Let’s say that $1 of that was from subscription services and the other $2.15 from bike sales. If we say the subscription business is worth 20x cash flow and the bike business worth 10x, then the total company value per share would be $20 + $31.50 = $50 or so.
My quick reading of the financials says the 2021 loss was a combination of a huge increase in SG&A expenses and a gigantic blowout in inventories. The inventory increase was all finished goods, which is a bad sign. On the other hand, receivables remained much lower than payables, which is a good one.
Arguably, if the company could get things back to were they were in 2020, the stock should be worth more than double the current price. If management could continue to raise the percentage of revenue that comes from (higher-valued) subscriptions, even better.
Yes, there are risks. But Peloton should have considerable value as a brand name. New products under the brand umbrella are possible. The example of the auto industry suggests that a range of product models can exist under a single brand name.
The most substantial risk, as I see it, is the key assumption of value investing that if existing management is unable/unwilling to make positive changes in company strategy, then change of control will occur. The importance of this assumption can be seen in the failure of, mostly foreign, value investors to force change in extremely asset-rich, but moribund companies in Japan. By and large, these investors have been trapped for many years in companies that refuse to change and which are protected social norms that shield management for accountability, particularly from foreigners.
The functional equivalent in the US is the existence of two classes of shares, one held by founders and which give them voting control, and a lesser version held by the investing public.
The three US-style possibilities are: management improves; or the board replaces management; or third-party shareholders replaces the board. In dual-share companies, none of this is possible without the consent of the founders.
What’s unusual about PTON is that the founder has voluntarily given up his role as CEO and an experienced manage has been brought in to replace him. I think this makes what happens here bear watching.