Description

We believe Topgolf Callaway Brands (ticker: MODG, formerly Callaway Golf) is a timely long opportunity given the selloff in shares following the 1Q23 earnings release. For an extensive background on the company, see previous ELY write up on VIC from April 2022. Despite the company actually beating 1Q expectations and increasing its full year 2023 guidance, the stock sold off 13%. Based on our math, MODG is now trading at ~9x management’s 2023 EBITDA guidance and ~7.5x management’s 2025 EBITDA guidance. We believe this valuation is too cheap given the long runway MODG has to deploy capital in new Topgolf venue openings, which is a monopoly-like brand with outstanding unit economics earning 50%+ cash on cash returns. Furthermore, the stock looks cheap relative to its nearest peer, Acushnet (ticker: GOLF), which trades at 11.5x earnings (and doesn’t have a crown jewel asset like Topgolf).

Key Thesis Points

• Topgolf is a fantastic business with a long runway for attractive capital deployment that is extremely underappreciated by the market
  • Topgolf is a unique concept with very strong unit economics and a wide moat that is unlikely to be replicated (see Drive Shack, ticker: DSHK, which tried and spectacularly failed)
    • At the time of Callaway’s acquisition, management claimed Topgolf venues produce $17mm of revenue and $5mm of EBITDA each
    • Since the acquisition, management has increased their expectations for Topgolf unit economics twice
    • As recently as the 1Q23 earnings call (May 9, 2023) management updated the cash on cash returns for new units from 40-50% to 50-60% cash on cash
  • Management believes the TAM in the US is 250 venues, which based on the current footprint of 78 venues in the US and adding 11 venues per year, Topgolf has more than a decade of strong new unit growth for more than a decade
    • Assuming MODG is only able to open 100 more units (which would result in the company falling 30% short of its goal), the company would add an incremental ~$500mm of EBITDA (vs 2023e total MODG EBITDA of ~$630 million)
  • In addition to the domestic unit growth, the company has identified the opportunity for 250 franchised international locations
    • Given the unit economics (nearly $20mm of revenue per location), a mid to high single digit royalty could create a significant amount of high-margin franchise revenue
    • Assuming only 200 international locations at $17mm AUV, a 7% royalty rate and 80% EBITDA margin, this would generate an incremental ~$200 million of franchise EBITDA
  • In addition to the Topgolf venue opportunity, MODG has another highly attractive growth lever: Toptracer
    • Toptracer is technology installed in more than 15,000 third party driving range bays that brings unique insights and data to golfers while providing attractive ROI for the driving range
    • The company believes it can install 8,000 Toptracer units per year as they convert a TAM of more than 600,000 driving range bays
    • The Toptracer unit economics are highly attractive for MODG: subscription based revenue with 75% EBITDA margins, generating $1,500 of incremental EBITDA per bay for MODG
• Callaway’s other business segments, golf equipment and active lifestyle segment, continue to perform well and generate meaningful cash flow Callaway is a dominant brand in a consolidated and healthy industry
  • Callaway is a dominant brand in a consolidated and healthy market
    • Callaway is the market share leader in clubs with nearly 25% share, while the top four golf club manufacturers have nearly 80% market share
    • Rounds played, a measure of golf participation, is flat year over year and remains significantly above 2019 rounds played, demonstrating the resilience of the covid-induced increased in participation
  • Within active lifestyle, Travis Mathew and Jack Wolfskin brands continue to perform well
    • The management team has done an exceptional job growing Travis Mathew, which at the time of acquisition in 2017, generated $60mm of revenue and ended 2022 with more than $300mm of revenue
      • The company sees a path to more than $500mm of revenue for the brand
    • Jack Wolfskin, despite initial operational challenges, generated more than €330mm in sales in 2022 and management believes it has the opportunity to achieve €475mm in sales by 2025 (and more than 3x EBITDA from 2022 levels to €70mm)
    • The segment continues to perform exceptionally well despite a choppy retail environment, with revenue and operating income up 28% and 40%, respectively, in 1Q23
  • The golf equipment and active lifestyle segments have generated meaningful free cash flow which has been used to fund the capex required to grow new Topgolf units
    • Management has committed to Topgolf becoming free cash flow positive in 2023 and to be self-funding going forward
• The stock is cheap based on near-term earnings with line of sight to sustained double digit EBITDA growth over the coming years
  • MODG currently trades at ~8.5x 2024e consensus EBITDA vs GOLF at ~11.5x 2024e consensus EBITDA, despite consensus expectations for MODG to grow EBITDA double digits in 2024 (and beyond) while GOLF will grow EBITDA 3% in 2024
    • MODG is trading at 7.5x its 2025 EBITDA target of more than $800mm  presented at last year’s investor day, which the CEO commented on during the 1Q23 earnings call: “not only comfortable [with the target] as I mentioned, we have increased confidence in it”
  • Based on the unit economics provided, new domestic Topgolf venues alone will add an incremental $50+ million of EBITDA each year for the next decade (this is before additional EBITDA contribution from existing unit comp growth, international franchise locations and Toptracer expansion)
  • We believe there is minimal downside from current prices in a bear case, even if the golf equipment business sees a mean reversion back to pre-covid levels
    • Assuming a downside scenario with the equipment segment back to 2018 levels (down ~40%), we see an EBITDA floor of ~$600 million (at today’s prices, the stock is trading at roughly 10x “floor” EBITDA – still a discount to GOLF)
• The company is led by a strong management team with a history of smart capital allocation decisions and shareholder value creation
  • Since taking over in 2012, CEO Chip Brewer has overseen a double digit total shareholder return over more than a decade
  • Both the CEO and CFO have been buyers of MODG stock (on multiple occasions) in the open market in 2022 and we wouldn’t be surprised to see additional insider buying at current prices given their own view of the valuation
  • We believe the management team is thoughtful allocators of shareholder capital
    • MODG’s acquisition of Topgolf during covid (October 2020) was an excellent capital allocation decision given the price paid ($2.5 billion EV) and the growth opportunity ahead (Topgolf did $235 million of EBITDA in 2022, its first full year of ownership, and will do ~$320 million of EBITDA in 2023)
    • The company has grown Travis Mathew from $7mm of EBITDA in 2017, at time of acquisition, to more than $50mm of EBITDA in 2022
    • As Topgolf becomes self-funding in 2023 and the company de-levers, we would expect to see the company begin to aggressively buyback stock

Conclusion

While there is no perfect comp for Topgolf, making valuation more of an art than a science, we believe the current implied valuation for Topgolf is far too cheap. Assuming the non-Topgolf businesses trade at 10x EBITDA (a discount to GOLF), the current valuation implies Topgolf is trading at 9x EBITDA. We believe a monopoly-like business with multiple levers for growth and a decade plus runway to deploy capital at 50%+ cash on cash returns deserves a substantially higher multiple (in our view 15x+) Assuming just 12x EBITDA for Topgolf and 8x EBITDA for the rest of MODG, we believe the stock can double by 2025. If the market isn’t willing to reward MODG the multiple it deserves, we think it is likely that the board will pursue strategic initiatives to unlock value for shareholders. When asked on a podcast recently about potentially spinning Topgolf, CEO Brewer responded “we would consider all things, shareholder value is the first on a list of important metrics.”

podcast link: https://rb.gy/zfxsi

Catalyst

-Free cash flow inflection at TopGolf

-Hitting mgt 2025 EBITDA targets

-Potential future spin of TopGolf