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Lululemon Just Threw Peloton a lifeline

Aside from Oculus, Peloton Interactive Inc (NASDAQ:PTON) is the biggest success story from the Kickstarter crowdfunding platform. Its original stationary bike had a price of $1,500 and its 2013 Kickstarter campaign raised $307,332. Fast forward to 2019 and Peloton Interactive Inc (NASDAQ:PTON) was greeted by the market with raving fanfare at its Initial Public Offering. However, after surging in price from the mid-20's to over $150 a share during the Covid-19 pandemic, the value has come crashing down. Today, the share price is hovering around $5.00.

That puts the company's market capitalization just shy of $1.7 billion and even though it has $813 million in cash, it also carries over $1.6 billion in long-term debt. Given that Peloton Interactive Inc (NASDAQ:PTON) has only been in existence since 2012, it seems to have grown a little too fast and almost right out of business. Every shareholder should be ecstatic that Lululemon Athletica Inc (NASDAQ:LULU) has decided to partner with the brand.

Peloton and Lululemon: A Powerful Partnership

Peloton Interactive Inc (NASDAQ:PTON) is a well-known name in the home fitness industry, thanks to its high-quality exercise bike and immersive fitness classes. With a dedicated community of 3.03 million subscribers, Peloton has revolutionized the way people exercise at home. They're also good at listening to feedback and adding new features to its platform.

The Peloton bike is still the top seller. It has a price tag of $1,445. The Peloton Tread has sold around 200,000 to 250,000 units and projected selling around 100,000 Row units in 2023. All of its products "Connected Fitness" come with a $40 monthly fee for streaming classes, some that cannot be viewed by non-product owners. Peloton also has a digital-only subscription which costs $13 a month and has over 1 million users.

On the other side, Lululemon Athletica Inc (NASDAQ:LULU) is what some would argue the leader in the athletic apparel sector, providing premium quality apparel for a wide range of sports and fitness activities. Their reputation for quality and functionality has made them a favorite among fitness enthusiasts. This partnership is set to last 5 years and has to be seen as a good deal for Lululemon as well. In fact, it's key to know that Lululemon plans to discontinue selling its Studio Mirror by the end of the year but will continue to provide service and support for the Mirror devices. They will also discontinue their digital app-only membership tier on November 1, 2023. To me, this means that the partnership is more than just for branding purposes.

Details of the Partnership

Under the terms of the strategic partnership, each company will be the others' exclusive apparel and content provider. Both plan to market to their collective global communities in an attempt to expand brand reach and awareness. Will all the Peloton instructors start to wear Lululemon branded merchandise? Probably. Is Lululemon Athletica Inc (NASDAQ:LULU) evaluating Peloton Interactive Inc (NASDAQ:PTON) for a possible future acquisition? Only time will tell.

Currently, Peloton Interactive Inc (NASDAQ:PTON) has a little more than 3 million users and could get a nice boost from the co-marketing deal. To be fair, it looks like this deal could help Peloton more, but only if a sizable portion of Lululemon's customer base sign up for Peloton. Analysts are skeptical as to what the deal will actually bring.

Benefits and Potential of the Partnership

Bernstein analyst Aneesha Sherman discussed the benefits from this deal, pointing out that Lululemon Athletica Inc (NASDAQ:LULU) will earn some revenue share from its co-branded apparel that gets sold by Peloton. On its end, Peloton will earn some revenue share from Lululemon studio members who use Peloton's digital workout platform, although neither revenue stream is expected to be financially material in the short-term.

Sherman noted the bigger potential benefits for the two brands are around long-term brand awareness and new customer acquisition. Peloton expects to see increased website and showroom traffic as Lululemon's membership base gets exposed to Peloton's workouts. Exclusive Peloton content will be available to those who sign up for Lululemons free Essential membership program, which has over 13 million accounts.

Path to Sustainable Profits

Peloton Interactive Inc (NASDAQ:PTON) has yet to turn a profit and gross margins on Connected Fitness products is generally around 30%, while subscription gross margin is around 70% it's easy to see where the company hopes to grow. Based on their current economics, reaching somewhere in the range of 4 to 5 million total subscribers could potentially get Peloton to sustained profitability. However, this would still depend on managing costs and translating subscribers into consistent engagement and retention. It's easy to see why the Lululemon Athletica Inc (NASDAQ:LULU) partnership looks enticing.

Revenues are expected to rise in the mid-single digits to $2.95 billion this year. Peloton is continuing to expand overseas and has been adding to its digital content library with new pilates and yoga classes.

Peloton Interactive Inc (NASDAQ:PTON) has been exploring various strategies to reduce costs, such as optimizing its supply chain, improving logistics efficiency, and leveraging economies of scale. Additionally, Peloton has to stabilize its budget. Currently it is spending $1.3 billion a year on Selling General and Administrative costs and over $318 million on Research & Development. With gross margins of 33%, its apparent that Peloton is not able to command premium pricing and operating expenses have to be a priority.

Looking Ahead

The company will be announcing quarterly numbers during the first week of November and should help to answer some questions on its relationship with Lululemon Athletica Inc (NASDAQ:LULU). Competition in the fitness space is crowded, but there are very few companies like Peloton Interactive Inc (NASDAQ:PTON), especially when judged based on the quality of its goods and services.

More importantly, the company is already generating more revenue than higher valued publicly traded firms in the industry like Planet Fitness and Life Time Group. That lead on the top line will continue to grow and it's likely only a matter of time before the market value readjusts upwards. This deal could be the initial catalyst for that.

This article first appeared on GuruFocus.