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Peloton Interactive: Race To The Bottom

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About: Peloton Interactive, Inc. (PTON)
by: Richard Windsor CFA
Summary

Peloton launches a dubious lawsuit against rival Echelon.

I see this as an admission that it has no IP.

Peloton must cut its hardware prices to succeed.

Peloton (NASDAQ:PTON) effectively admits it has no IP.

If Peloton has to resort to a dubious lawsuit to keep competition at bay, I think it is a tacit admission that it has no barriers to entry, increasing my fears that the $6.5bn valuation is still much too high. This is especially the case as Echelon has just raised money at a much more reasonable $100m.

Peloton is suing its rival Echelon, accusing it of flooding the market with "cheap, copycat products" and a false advertising campaign designed to undercut Peloton's business.

I have had a close look at Echelon's product range, and while it is very similar to Peloton's, it differs in that there is a much wider range of bikes available. Some of these are at much lower prices, and instead of having an integrated screen, there is a screen holder for the user to bring his own device and use the app.

By contrast, Peloton has one bike that starts at $2,245, which is roughly comparable to Echelon's premium bike, but Echelon's is some 27% cheaper at $1,638. Other than the idea of remote spinning classes via the internet (which one can't patent), I can't see what intellectual property or trademark of Peloton's that Echelon has infringed.

Spin bikes have been available for years, and sticking a screen with an internet connection on the front of the bike is hardly a patentable idea that is going to hold up to examination. Nor is attaching sensors to the bike to monitor its progress, which is something professionals and enthusiasts have also been doing for years.

Hence, when one asks the question with regard to what barriers to entry has Peloton constructed to keep competition at bay, there are no answers that I can think of. A further clue to the lack of IP is the fact that Peloton spends just 6% of its turnover on research and development, which is a paltry sum compared to a real technology company.

I think what is really going on here is that Peloton is trying to be the Apple (NASDAQ:AAPL) of spin bikes and make a healthy return through the sale of hardware. In order to do so, it must lock its users in, and it is not even close to being able to achieve this. Because it has no lock-in, it is having to resort to stopping its competitors from operating or face a big erosion of its hardware gross margin.

From the S-1, one can see that its gross margins on hardware are almost the same (42-44%) as they are for services. These are very healthy gross margins for a bicycle, and so, I think that users are being asked to pay a lot for the brand.

Echelon has seen this, and because there are no barriers to entry, it is able to sell a competing product at a much lower price and still have a positive gross margin in order to gain share.

Peloton's one hope for a sustainable barrier to entry is its community where it already has 511,00 active subscriptions and an 89% attach rate. It needs to focus on this community and keep it active and engaged, thereby ensuring that Peloton becomes the go-to place for remote exercise. In order to do this, it needs to cut the price of its hardware to a lower level and push the size and vibrancy of its community over Echelon's much smaller 100,000 community.

This is a huge advantage and, I think, is the only hope for Peloton to begin making money. This is how Peloton can put Echelon out of business as I think its legal action is going to fail badly. Hence, I think that things are going to get a lot worse for Peloton before they get better, and if it waits for the outcome of this lawsuit (which I think it will lose) before cutting its prices, then it will be giving Echelon more time to catch up.

The only race Peloton is going to be running is a race to the bottom in terms of hardware pricing and further bad performance of its stock price. I was negative when it listed. I am more negative now.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.