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No matter how bad things get for Peloton Interactive ( PTON -0.61% ) bulls, they always have a metric they can trot out to boost their case.

Peloton's churn rate, or the number of connected fitness subscribers who quit each month, has always been low. Even as Peloton shares have collapsed over the last year, churn has remained remarkably strong. Less than 1% of Peloton's connected fitness subscribers leave the service each month, which seems to both vouch for the product itself and show how loyal the customer base is. If the company is able to retain over 90% of its subscribers each year, it must be doing something right, bulls argue.

A spotlight on a Peloton instructor surrounded by cyclists.

Image source: Peloton.

By comparison, even before the pandemic, gyms like Planet Fitness  ( PLNT -0.73% ) were estimated to lose 25% of new members within their first five months. Planet Fitness says that even after the first year, members have a monthly churn rate of 1.5% to 2.5% -- more than double that of Peloton. In other words, a sub-1% monthly churn rate is outstanding for any fitness business.

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But Peloton's churn rate isn't as rosy as it appears. And the way it presents that statistic helps explain why the stock price has plunged more than 80% since its peak last January and the reason the business is suddenly in disarray after being a market darling for much of the pandemic.

How Peloton defines churn

Before we discuss what Peloton's churn reveals about the stock, let's make sure we're clear on how it measures monthly retention.

Peloton has two types of members. Its biggest subscriber base is made up of connected fitness subscribers: users who own a Peloton device like a bike or a treadmill and take Peloton classes. There were 2.49 million of these subscribers as of Sept. 30, 2021, and they pay $39/month for their subscription.

Peloton also has digital subscribers, which are users who don't own Peloton equipment but pay for the app to take the classes. As of Sept 30, 2021, there were 887,000 of these subscribers, and they pay $12.99/month -- considerably less than connected fitness subscribers, though they get access to the same content.

Peloton's churn doesn't include digital subscribers. It only measures churn for connected fitness subscribers. That's important because Peloton's equipment is expensive, and connected fitness subscribers have already made a substantial commitment by purchasing a bike or treadmill. Bikes start at $1,495 -- though many current subscribers paid $2,200 -- and treadmills will cost you at least $2,495, down from an earlier price of $4,000.

Most customers don't pay for their Peloton upfront. They use financing, paying at least $39/month over a period of up to 43 months. That means many of Peloton's supposedly loyal connected fitness subscribers are financially handcuffed to their exercise bikes. If you're still paying off your bike for $39/month or more, you'll almost certainly stick with the Peloton subscription even if you hardly use it.

In this scenario, the bike becomes something of a white elephant. If you quit your subscription, you're stuck with a $2,000 clothes hanger in your living room. Your only other option is to sell the bike, but you'd almost certainly be selling it at a discount and giving up on the admirable ambitions you had in mind when you purchased the high-end exercise equipment.

Peloton's connected fitness churn rate, then, is artificially low because most of its subscribers are essentially locked in since they're still paying off the equipment. Peloton never tells us the churn rate for its digital subscribers, and it's likely much higher since those users don't have the financial burden that their connected fitness peers do and can easily switch to free workouts on YouTube and other apps.

What it says about Peloton's business

For all the hype around Peloton as a subscription juggernaut, it's fundamentally a hardware business. That explains why management doesn't even bother accounting for digital subscribers (who don't buy hardware) in the churn rate and why so much of their attention has been focused on the hardware side of the business, including acquiring Precor and building the Peloton Output Park in Ohio, its first dedicated factory.

For the company to grow its connected fitness business, it must sell more equipment, but sales of its bikes and treadmills fell 17% in the fiscal first quarter and were likely down again in Q2. Meanwhile, management is learning the hard way that the hardware business isn't easy. It budgeted for much higher equipment sales this year and is now being forced to scale back on production and lay off employees because it's on track to lose $500 million in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the first half of the fiscal year, which ends June 30.

In spite of those problems, churn remains low. But investors should remember that it's less a factor of its workout classes' stickiness than it is of the metric's exclusivity, which ignores digital subscribers, and the impact of its connected fitness subscribers' financing multi-thousand-dollar exercise equipment, locking themselves in.

If you're looking for a metric that indicates customer loyalty and interest in the classes, average monthly workouts per connected fitness subscription -- which fell to its lowest mark in seven quarters at 16.6 in Q1 -- is a better representation than churn. Notably, management declined to report that metric in its preliminary Q2 earnings report.

As for the stock's unraveling over the last year, that seems to reflect the market's realization that Peloton isn't a fast-growing subscription business but rather a luxury hardware manufacturer struggling with the challenge of forecasting demand in a highly uncertain environment.

There's no easy fix for that.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool owns and recommends Peloton Interactive and Planet Fitness. The Motley Fool has a disclosure policy.