Well, that felt good. After naming Peloton (PTON) as one of my two stocks to avoid, along with Tesla (TSLA) , owing to product liability issues in my April 23 Real Money column, Peloton management finally did the inevitable Wednesday and recalled all units of its Tread+ treadmill. Tread+ has been blamed for 72 customer injuries in addition to that horrifying video that is populating the internet of the child being sucked under and, sadly, killed by a Tread+ machine.
As I noted in my prior RM column, Peloton only noted $13.7 million in warranty reserves in its last 10-Q, and I believe that will be insufficient to cover the costs of a full Tread+ recall, the details of which are contained in this CPSC release. We will find out more Thursday night on Peloton's first quarter earnings call. Unlike its sister agency in automotive, NHTSA, the CPSC has very little authority to force a product recall, and obviously Peloton management wanted to get the announcement "out of the way" before earnings.
Peloton's CEO John Foley's initial statement was so wildly misleading (to use his own word) that I can't believe he is still running a public company. This being 2021, PTON shares are actually trading up a bit this morning, although at $84 still reflect a huge drop form their level of two weeks ago. That plunge makes me feel pretty damn good about that particular RM column and my weekly options plays in PTON last week.
But weekly options plays are just that. They only live for five days, at most. As always in investing, the most important play is the next play. My guess is that Peloton does not survive this. The company does not break out sales by product, but Bloomberg Intelligence estimated that treadmill sales represented 10% of Peloton's $1.825 billion in revenues for the fiscal year ended June 30, 2020, and that the ultimate financial cost to the company of the Tread+ recall could be in the range of $500 million-$600 million. A full recall - including all the customer service that is involved, especially the shipping of very heavy treadmills - is going to be covered by $13.7 million in reserves? Uh-uh.
So, PTON is now a balance sheet play, and I am eagerly awaiting Thursday night's release of their balance sheet for its quarter ended March 31st. Any reserving for a Tread+ recall would have taken place after that date, anyway, and my guess is that they haven't done much. This company is horribly run, as evidenced by the lack of issuance of a press release on the Tread+ recall. Fortunately the media covered it well. The misplaced bravado of Foley and Co. was not matched by fiscal conservatism, and now you and I can make money from it.
First question: bikes are a much bigger part of Peloton's business than treadmills, will sales of Peloton's exercise bikes be impacted by the treadmill recall? Do you live under a rock? This is a BRANDING issue. Even though, to my knowledge, there have been no safety incidents related to Peloton's bikes, this unprecedented recall will likely hurt Peloton's image in the eyes of consumers. I believe that management, especially this group, will be unable to defray that perception, especially as COVID lockdowns are being lifted/loosened all over America and Peloton's ultimate competition, gyms, come back to the fore for workout-hungry customers.
Then the next move for profit seeking investors is what I call the "death short." This is the opposite of the "buy the dip," "nothing to see here" Kevin Bacon-ing that has been reported from some of PTON's sell-side analysts this week. Peloton built some sort of weird-cult-like following with its interactive classes, but cults can easily be swayed, especially when the gym just opened up.
As I always write, trade accordingly. How?
- Sell any bounce in PTON shares. This might occur as PTON reports earnings after the close today. If that happens, I will be shorting the stock like a maniac.
- Stay short the shares or go very long and very out-of-the-money with your options plays. The easy money in short-term options plays has been made, make sure your "death short" play is more long-term focused here. Also, the Nasdaq, of which Peloton is a constituent, is wildly overvalued at current levels, so that should help your case.
- The absolute worst pieces of paper in the blizzard of stuff that is the securities market in 2021 are Peloton's 0% Convertible notes due 2026. The company finished an initial offer of $1 billion worth of these notes in February. Yes, that's right, Peloton has zero-coupon bonds outstanding. My head just exploded a bit after writing that, but if you can find a way to get short these notes, please contact me via RM.
Remember, product liability issues often linger for years. We are only the first inning of Peloton's issues with Tread+.