Description

Callaway Golf [ELY - $4.3bn market cap, $5.4bn EV] is perceived as an over-earning manufacturer of golf clubs, balls, and apparel facing a secularly challenged end-market.  However, since 2016, they have diversified the business from 84% golf equipment to today just ~38% golf equipment.  While many investors are likely well aware that ELY has a stake in TopGolf, they acquired the entirety of it for ~$2.5bn during the pandemic.  We suspect investors have yet to fully appreciate the growth runway, unit economics, and defensible competitive position of TopGolf and especially the TopTracer segment hidden within it.  CEO Chip Brewer has a very strong track record both at ELY and Adams Golf previously and has recently been buying shares in the open market recently.  

Trading at ~11x 2022 EBITDA and ~9x 2023 EBITDA, Callaway can likely deliver mid-teens annual EBITDA growth for many years going forward.  By 2025, we believe ELY can be generating >$2 per share of FCF (excl growth capex), at which point it will still likely be growing profits double-digits.  We see upside to $40+ within 2-3 years (and a $60+ bull case) with minimal downside from current levels even if the legacy golf business reverts to 2019 profit-levels and TG growth slows significantly.  We do acknowledge the consumer cyclicality and would note there are golf equipment peers (GOLF) and leisure peers to hedge with if one’s mandate/macro view dictates it.  

Key Points

• TopGolf is a long-runway (~75 units today vs potential for 450+), high-ROIC (50% cash on cash…40% including maintenance capex) growth concept with a passionate and highly loyal customer base. 

• ELY originally invested in TopGolf all the way back in 2006, but acquired the entire company for ~$2.5bn from private equity owners

• Value is likely obscured by trading at the multiple of the lower-growth legacy business. 

• TopTracer is an even better business (capital light and recurring) with an incredibly strong buyer proposition (20-60%+ revenue uplift for driving ranges which have historically been loss leaders for clubs, turning them into profit centers) relative to cost that is even earlier in its life cycle (less than 2% penetrated). 

• Golf has been rejuvenated both with new players (and old players returning) during COVID and thanks to TopGolf expanding the market.  This should have a long-tailed benefit for the legacy gear and equipment businesses as well. 

• The strategic logic of using TopGolf to on-ramp new golfers (over 50% of TG customers are “non-golfers”) towards ELY’s golf and apparel brands makes sense 

• Callaway's access to golf facilities also can accelerate TopTracer's growth.    

• I’d note there could also be a nice kicker from suburbanization (harder to golf in NYC than FL), sustained hybrid work (more time saved from commuting to golf), and a broader enthusiasm for the sport (similar to the F1 effect with a new NFLX show coming out, golf viewership rising with new male and female stars)

• CEO Chip Brewer is quite strong – turned around Adams Golf (stock went from $2 to $10) before selling it to TaylorMade/Adidas in 2012.  Has now turned around many of ELY’s businesses and made what seems to be a very savvy deal for TopGolf in the midst of the pandemic.  He and CFO Brian Lynch bought ~15k shares each in March at ~$21.50 as well as ~20k (combined) shares in Dec 2021 at ~$25. 

• History of under-promising and over-delivering – originally targeted $360mm of 2022 EBITDA when deal announced, now guiding to $500mm+ with FCF-breakeven and cash burn from building new facilities reduced by $200mm (from $325mm with only $70mm remaining need)

• When the TG deal was originally announced, they said they’re targeting LT double-digit top-line growth, mid- to high-teens EBITDA growth and a path to 1bn of EBITDA by the end of the decade.  

• Now guiding to $800mm+ of EBITDA by 2025 

CEO Chip Brewer / Callaway History

Callaway was facing market share declines due to prior mismanagement when Brewer joined in 2012 after turning around (stock from $2 to $10) and selling Adams Golf.  He quickly shifted Callaway from losing to gaining share in their core clubs/balls and doubled EBITDA margins.  From there, he began expanding beyond core equipment into sports-related apparel to utilize ELY’s channel relationships, logistics scale, and to diversify the business away from secularly low-growth golf towards outdoor apparel/athleisure.  

Callaway acquired Ogio (golf bags and backpacks) for $75mm in 2017, TravisMatthew (golf equipment and apparel) for ~$125mm in 2017 (paying ~11.8x of ~$10mm of EBITDA on 55-60mm of revs).  They then acquired German-based Jack Wolfskin (outdoor apparel) for ~$475mm in 2019.  Callaway’s revenue mix has shifted from 84% golf equipment in 2016 to 38% golf equipment/24% apparel/38% Topgolf in 2021 and by 2025 will be majority TopGolf.  

TopGolf 

TopGolf was founded in 2000 in the UK and entered the US in 2005, reimagining the classic driving range as a modern social, gamified experience with upscale food and beverage.  Proprietary RF-micro-chipped balls paired with dartboard-like targets in an ~300-yard outfield form the basis of social games with live scoring.  The average group of 4 spends ~$15-20 each to play (80%+ GM’s) and ~20-30 on food and beverages over the course of ~2 hours. 50% of TopGolfers are Female, 50% identify as non-golfers, and 60% are ages 18-34.  

“I still think they have one of the most valuable brands. People love this brand. They love the experience. Any time I talk to people about it, I used to wear the swag all the time. And I used to just carry these coupons around because people are like, "Oh my God, I love Topgolf."

Here's a little coupon code for your next visit. Like there's just this passion for the experience, and it's not like you tell people about and they go, "Yes, I guess, some people find that interesting, but not me." But you never get that reaction from people. You always get a like, "It's just awesome. It's awesome to go to Topgolf.” – Former CMO, TopGolf

Callaway first invested ~$10mm in TopGolf in 2006, followed by a few more interim rounds along with Chip Brewer joining the board in 2012, resulting in a cumulative investment of ~$70mm for 14% of the company.  In October 2020, Callaway issued 90mm shares (vs ~90mm outstanding at the time) to TopGolf’s PE investors to merge the companies, resulting in Callaway owning 51% and TopGolf holders (Providence Equity, WestRiver Group, Dundon Capital Partners).  Just prior to COVID, TopGolf had been rumored in the press to be pursuing a potentially $3-4bn IPO or SPAC deal.  With the shares at ~$20 pre-deal, the implied ~$2.5bn EV (including debt) seemed like an insane price at the time for a business that did $59mm of EBITDA on 2019 (so 40x+), was still somewhat closed for COVID, and not expecting to flip FCF positive (due to growth capex) until 2024! 

Fast forward to 2021, and TopGolf did $190mm of EBITDA and is guiding to $210-220mm for 2022, implying a much more reasonable (to a downright steal) mid-teens multiple and now expect the business to flip to self-funding later this year.  I’d note that the new venues opening in 2022 are 4Q-loaded, so the run-rate exiting 2022 is materially higher than current guidance.  

TopGolf potentially has a decade-long runway of 15%+ annual growth (from ~70 locations today to 400+, adding ~10-11 per year) at ~40% cash on cash returns.  This value is obscured as the company was acquired by Callaway during COVID and has never really traded publicly without the confusion of the traditional golf business (potentially over-earning from COVID) and limited investor understanding of the TopGolf concept. 

Venues range from 20k-100k square feet on 9-15 acres.  Construction generally takes 9-12 months (less for smaller venues) with costs ranging from $10-40mm.  Importantly, landlords typically finance ~75% of the costs.  On avg, a unit costs ~$30mm with ~$7.5mm cash contribution from TopGolf, primarily for technology, furniture, fixtures, and equipment.  The venues generate ~$17mm of revenue on average, ~$5-6mm of EBITDAR less ~$1.9mm of rent, for ~$3.7mm of cash EBITDA for an ~45-50% cash on cash return for TopGolf.  We assume ~600-700k of annual maintenance capex to get down to ~40% cash on cash returns.  If you’re curious about how sustainable it is for landlords to fund 75% of the costs, check out some of EPR’s comments – they seem to love funding these things and point to 3.5x+ rent coverage, consistent with our understanding of the unit economics. 

 Venues come in 3 formats:

• Large venues for populations >1mm population within 25 min catchment with 100+ bays across 3 floors.  Examples incl Edion NJ, Colony TX, Ontario CA, El Segundo CA.  These venues cost $35-60mm to develop.  

• Medium venues for populations 500k-1mm with 70-100 bays across 2-3 floors.  Examples incl Baton Rouge, Greenville SC, or Ft Myers FL.  These venues cost $20-35mm to develop.  

• Small venues for populations of 200-500k with 30-60 bays on 1 floor.  Examples incl Augusta GA and Chattanooga TN. These venues cost $15-20mm to develop.  

Internationally, TopGolf is pursuing a franchise model.  Outside of 3 owned UK locations (TopGolf actually originated in the UK), has local franchise partners in Australia, Mexico, and Dubai.  They see an opportunity for ~250 units internationally at ~$1.1mm of annual high-margin (~80-90%) royalty revenue each.  Scotland and Germany facilities are currently under development and there are 150+ development agreements China, SE Asia, and Central Europe as well. 

TopGolf also seems to have some low-hanging fruit in terms of a better reservation system, bay utilization, digital ordering, and improved messaging around pricing (according to former CMO).  He indicated that prior CEO (now gone) combined with a dysfunctional board with 3 different PE sponsors did not fully maximize what TopGolf could be.  In many ways, TopGolf has been successful based on the strength of the concept/brand despite room for improvement on execution.  We believe the combination of Brewer’s track record and new CEO Artie Starrs (former global CEO of Pizza Hut) could lead to a real opportunity in this regard as well. 

With strong customer demand (often wait times north of 2 hours) and incredible unit economics, the key question to us is how sustainable as they – will high returns result in a slew of new competition (IE Dave & Busters -> Punch Bowl Social, etc) tapping out unit growth. 

Interestingly, the size/scale and operational complexity of the development as well as the technology needed seems to box out one-off competition.  Landlords won’t fund 75% of development costs in exchange for a 20+ year lease for a non-Topgolf concept.  Further, the only multi-unit competitor (DriveShack) has already pivoted away from large footprint TG competitors, retreating to more mini-golf-like experiences.  They even had a CEO who was formerly from TopGolf who retired and the company now has pivoted to a smaller-scale concept called The Puttery and essentially halted most of their plans to open new large-scale DriveShack’s.  

 “The other part which is interesting is, Drive Shack opened four locations. They should have, in theory, two more in the pipeline, but I don’t think they're ever going to build.

I would not be shocked if they are never going to open another one. There's nobody that can compete in the big box with Topgolf. Nobody can. Not from a technology standpoint. They own the market. They're going to own the market. And anybody that comes in, in any reasonable way, you're going to have to invest a couple of hundred million dollars, and it just doesn't make sense to do that.” – Former TopGolf CEO

 “But yes, from a Topgolf standpoint as far as what's their competitive set that's really in their space that's really trying to do what they do, there isn't anybody that can do it. We can do a couple of one-offs, but nobody can do it meaningfully.” – Former TopGolf CEO

TopTracer 

TopTracer ball tracing technology transformed televised golf and has dominant consumer mindshare vs its competitors having been featured in >150 televised golf tournaments.  Today, driving ranges can install the camera and screen system to allow golfers to trace and log the distance, speed, spin, and trajectory of every shot.  Driving ranges have reported a 25-60% revenue uplifts by installing TopTracer.  Driving ranges are historically loss leaders for golf clubs; the advent of this tech can turn them into a profit center and requires minimal upfront cash outlay. 

They've grown this business from 0 to 8k bays in just a couple years and point to an addressable market of 625k bays.  Tracer charges $2k/year which translates into $1500/yr of recurring cash EBITDA.  The goal is to add 8k new bays per year.  So today this is a modest contributor to EBITDA, but growing recurring cash flows very rapidly.  At 50k bays in a few years, a $75mm recurring EBITDA stream is can begin to really move the needle.  

Tracer also creates some interesting optionality - competing or playing against others remotely.  They hosted a "9-shot challenge" tournament with participants across 18 countries.   There is also likely the opportunity to sell (potentially highly targeted) advertising or partnerships onto the 10k+ screens (between TopGolf and Tracer) that the combined co now has. 

 "And then on top of that, just the value of the data, every shot that's hit at the Toptracer Range is captured; they have already 2 billion data points on that. And we're going to have connectivity and the ability to engage with each of those consumers. You can imagine with our AI technology and resources how valuable that would be to be able to learn that Brian Lynch is hitting it short left, and we have a product that can help him with that." - TopGolf Merger Call

"The second is Toptracer Range. I would argue that this is the hidden gem within our business. Golfers are familiar with this technology from watching televised professional golf tournaments, but it is also a technology that we are using to transform driving ranges around the world. It is a capital-light, high-margin business model, and it is growing in the triple digits." – TopGolf Acquisiton Call

“I think Toptracer I mean, from an EBITDA standpoint, is a gold mine. It's a superior technology to track man. It has licensing opportunities that are huge, particularly” – Former CMO of TopGolf

“The cost to them in doing all of the software maintenance, et cetera, is nominal. And it's kind of like the game with Topgolf. Once you're fully invested into it, it doesn't matter how many more units that you put out. You really don't have any additional costs on the maintenance side of the software.

Okay. So the more units they can get out, the higher that profitability comes, and that profitability is an annuity. So to me, one of the really interesting things that they have going on long term that I don't think people really understand yet is how value over what I'm going to call the next five to seven years, Toptracer will ultimately add to the mix.” – Former TopGolf CEO

“So as the technology rolls out beyond the U.S., so like the biggest market for Topgolf was the U.S. market for when it started, right? I think that's going to be different with Toptracer. And my view is, we're really just starting to kind of scratch the surface of it. But once you install it, at a range, you're not going to take it out. It's just incremental revenue. And it pays for itself, very quickly.” – Former TopGolf CEO

Legacy equipment/apparel business is no slouch - can likely grow through a slowing golf environment

While TopGolf and TopTracer are clearly the growth driver/crown jewel of the business and rapidly becoming the majority of profitability, the legacy equipment and apparel business do have some discrete levers to drive sustained growth.  

Given these drivers, mgmt  believes that ELY can hit their growth targets even if the golf market were to suffer a 10% decline next year.  

• TravisMathew “performance and lifestyle” brand has CAGR’d revenue at 38% and EBITDA at 48% since its acquisition in 2017.  See path to $500mm+ sales in the medium-term.  Plan to open 10 new stores (on base of 31) in 2022 and 5 annually thereafter at sub-2yr paybacks.  Q1’22 SSS +~50%.  Callaway paid ~$125mm for this business and it’s now doing $50mm+ of EBITDA.  

• Channel restocking and price will continue to drive outsized revenue growth in 2022

• Product cycle - launch of new Rogue woods and irons in mid-Feb

• US golf ball market share has doubled from 11% to 21% over the last 8 years and continues to gain share.  Golf balls are margin accretive and more “consumable.”  

• Jack Wolfskin (acquired in 2019) is a very strong outdoor apparel brand in Germany and China.  Mgmt believes they can improve EBITDA from ~20mm to 70mm+ in this business with a brand reset and improved DTC execution.  

Former CEO - Now Running a Putt-Putt Concept is Quite Positive 

Right? And shockingly, I mean, I would think it's pretty straightforward, but I don't know how much the market is really absorbed, how the business over is fundamentally changing and I think in a pretty good way. And if they can parlay that in with their, what I'll say, traditional business doing pretty well from a historical basis, then I think it has the opportunity to be something that people look back five, six, seven years from now go, how did they not see that?”

“Yes, I still own Callaway shares. And I could sell them today if I wanted to, but I choose not to.”

"I personally think that Callaway got a great deal at what they did. I also think that a number of things that they have done post acquisition have been smart, long-term decisions. So once again, I'll throw a few things out there, which may or may not be on your question, but you can feel free to stop me if you want.

"My view is Chip is more focused on what is our core business, who are we and how do we keep growing that because that in and of itself is actually a phenomenal business. And again, I think that especially as part of the Callaway family, it's a smarter approach."

Risk-Reward

We view the downside as the golf/apparel business returning to 2019 levels (~$200mm of EBITDA), which at 10x implies $2bn of value.  We assume TopGolf growth levels off at ~$250mm run-rate exiting 2022, which at a 12x EBITDA multiple (which feels quite punitive), implies ~$3bn.  Together, this gets to today’s ~$5bn enterprise value for limited downside from current levels.  

The upside is that TopGolf CAGR’s EBITDA 25% annually (driven by 11 new facilities per year at 40%+ cash on cash returns, new intl franchise streams, and TopTracer’s growth) and the aforementioned discrete drivers for non-topgolf drive ~10% annual EBITDA growth.  Combined this results in >$2 of FCF per share (excluding growth capex) by 2025.  We think a 5% exit FCF yield seems fair, resulting in a target price of $40+ for a 25%+ IRR.  

We think there’s upside to each of these - the company’s own guidance (which has historically been conservative) implies $2.25 of FCF/sh.  Management has a history of exceeding their targets and believes they can hit them “even with a 10% decline in golf demand.”  Further, these targets assume cash generation pays down debt rather than accretively acquiring stock, which they have now begun to do.  Ultimately, I suspect mgmt will either sell the legacy business to PE (but retain Callaway as exclusive partner in TopGolf) or list a portion of TopGolf equity to ensure value crystallization.  In this scenario, we could see upside to >$60 (25x * $2.50+ of FCF) for a 45%+ IRR.  

Key Risks

• TopGolf turns out to be a fad or faces significant competition impairing unit economics or growth runway

• Competitors to TopTracer (IE Trackman) take share 

• Exposure to consumer health - TopGolf is a relatively discretionary experience and carries significant operating leverage.  This can of course be hedged against Acushnet or other leisure-exposed companies with weaker secular backdrops.  

• Reversal of pandemic-era strength in golf equipment demand 

• Significant manufacturing exposure to Vietnam and South China as well as supply chain challenges.  So far, mgmt has weathered these well.  

• Jack Wolfskin business has had issues in the past and is very Europe and China heavy.  

Catalyst

Estimate increases as sell-side estimates converge to company's target

Cont'd beat and raise given conservatism built into forecasts

TopGolf flips from FCF burn to positive

Cont'd share repurchases 

Continued strength in legacy golf business allaying fears around tough COVID compares 

IPO of piece of TopGolf or sale of non-topgolf biz