Topgolf Callaway Brands is profiting from the increasing number of people who are starting to play golf. Both on-course and off-course golf participation in the United States has recently surpassed 45 million, marking a significant milestone. The reason is that off-course golf attracts a different demographic than traditional golfers, and off-course golf is now larger than on-course golf. Topgolf Callaway Brands is the dominant player in the off-course golf industry, which positions it to benefit from this growing trend. But does it mean that it will be a good investment? In this analysis, we will explore the various aspects of Topgolf Callaway Brands to determine its potential as an investment.
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Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
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The Business
Topgolf Callaway Brands was founded as Callaway Golf Company in 1982 in California, United States. With the acquisition of Topgolf in 2021, the company changed its name to Topgolf Callaway Brands in 2022. Topgolf Callaway Brands is a contemporary golf and active lifestyle company that offers golf entertainment experiences, designs and produces high-quality golf equipment, and sells golf and active lifestyle accessories through various brands such as Topgolf, Callaway, Odyssey, TravisMathew, Jack Wolfskin, and OGIO. Topgolf Callaway Brands has three business segments: Topgolf, Golf Equipment, and Active Lifestyle. Topgolf offers off-course golfing venues (think of it as the golfing equivalent of a bowling alley), where they generate revenue from gameplay, the sale of food and beverages, and events. By the end of 2023, Topgolf had 89 company-operated venues in the United States, 4 company-operated venues in the United Kingdom, and 5 franchised venues in Australia, Mexico, the United Arab Emirates, Thailand, and Germany. Topgolf also licenses Toptracer, a ball-tracking technology. In addition, their digital media platform includes a mobile golf game and other digital content creation. Topgolf contributes 41% of the revenue. Golf Equipment designs, manufactures, and sells high-quality golf equipment, including golf clubs and golf balls, under the brands Callaway and Odyssey. Topgolf Callaway Brands has the number one U.S. golf equipment market share for golf clubs and number two in golf balls. Golf Equipment contributes 32% of the revenue. Active Lifestyle designs, develops, and sells high-quality soft goods products under the Callaway, TravisMathew, OGIO, and Jack Wolfskin brands. These products include golf apparel, footwear, golf accessories, hats, luggage, backpacks, jackets, trousers, dresses, skirts, tents, and sleeping bags. Active Lifestyle contributes 27% of the revenue. As Topgolf Callaway Brands is the dominant brand for off-course golfing and holds a significant market share in golf equipment, I believe that Topgolf Callaway Brands has a brand moat.
Management
Their CEO is Oliver "Chip" Brewer. He joined Topgolf Callaway Brands (formerly known as Callaway Golf Company) in 2012 as CEO. Prior to joining Topgolf Callaway Brands, he served as the CEO of Adams Golf. He earned an MBA from Harvard University in 1991. Oliver "Chip" Brewer is a golf enthusiast and has previously served on the board of the National Golf Foundation. In an interview, he stated that one does not need to be an avid golfer to run a golf equipment company. However, he also acknowledged that the golf industry can be deceptively tricky to comprehend. We don't have much information on Oliver "Chip" Brewer, but since he became CEO, he hasn't been afraid to sell off underperforming brands such as Top-Flite and Ben Hogan, or make acquisitions such as TravisMathew and Jack Wolfskin. He also dared to acquire Topgolf Entertainment Group, which forever altered Callaway Golf Company. According to Comparably, Oliver "Chip" Brewer has an employee rating of 93/100, which puts him in the top 5% of similarly sized companies. Personally, I believe that Oliver "Chip" Brewer's extensive industry experience and his boldness in selling and acquiring brands/businesses make me very confident in his ability to lead Topgolf Callaway Brands in the future.
The Numbers
The first number we will investigate is the return on invested capital, also known as ROIC. I would like a 10-year history with all figures exceeding 10% for each year. The ROIC of Topgolf Callaway Brands has been inconsistent, with some years showing negative ROIC, some years with underwhelming ROIC, and some years exceeding the required 10%. In 2020, when Topgolf Callaway Brands reported its latest negative ROIC, it was during the pandemic. At that time, Topgolf Callaway Brands was a different company. Topgolf Callaway Brands hasn't been able to deliver a high return on invested capital (ROIC) since the acquisition of Topgolf, which is slightly concerning despite the acquisition being relatively new. It is also concerning that ROIC decreased from 2022 to 2023, which isn't a trend that you would like to see. I would like to see an improvement in ROIC in 2024.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Topgolf Callaway Brands has consistently increased its equity every year since 2014, with the exception of 2020, when it was negatively impacted by the pandemic. Their equity received a boost in 2021 with the acquisition of Topgolf, and it is encouraging to note that Topgolf Callaway Brands was able to further increase its equity from 2021 to 2022 and again in 2023.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. opgolf Callaway Brands had consistently achieved positive free cash flow in most years prior to their acquisition of Topgolf. Since the acquisition, Topgolf Callaway Brands has experienced negative free cash flow, which is concerning. Management has mentioned that, given the variable timing of REIT reimbursements, they believe the most appropriate cash flow metric is embedded cash flow, which is free cash flow excluding new venue and store growth CapEx. And if we use embedded cash flow, Topgolf Callaway Brands was free cash flow positive in 2023. However, I personally prefer not to use embedded cash flow. Management has also mentioned that they anticipate free cash flow will ramp significantly in 2025 through 2028, which will hopefully result in positive free cash flow. As free cash flow is negative, so is the levered free cash flow margin, and we cannot define whether the shares are cheap or expensive based on the free cash flow yield.
Debt
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After performing the calculation on Topgolf Callaway Brands, I found that the company has 26,3 years of earnings in debt. The reason for the high debt is the acquisition of Topgolf, and it has increased due to the opening of new venues, which could prove to be a wise decision in the long run. Nonetheless, the debt is way too high for my liking, especially because the company is delivering negative free cash flow.
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Risks
Based on my findings thus far, I believe that Topgolf Callaway Brands is an intriguing company. However, no investment is without risk, and Topgolf Callaway Brands also has its fair share of risks. One risk is competition. Topgolf Callaway Brands faces competition in all of its business segments. The Topgolf business operates primarily in the consumer entertainment industry, which remains highly competitive. Consumers today have a wide variety of options when deciding how to spend their leisure time and discretionary entertainment dollars. Topgolf’s venues compete for consumers’ time and discretionary entertainment dollars against a broad range of other out-of-home entertainment options, as well as increasingly sophisticated forms of home-based entertainment. Other out-of-home entertainment options against which Topgolf Callaway Brands competes include other dining and entertainment venues, sports activity centers, traditional driving ranges, other establishments offering simulated golf or multi-sport experiences, arcades and entertainment centers, movie theaters, sporting events, bowling alleys, nightclubs, casinos, bars, and restaurants. The golf equipment business, which is comprised of golf club and golf ball products, is highly competitive and is served by a number of well-established and well-financed companies with recognized brand names. The active lifestyle segment operates in a competitive sector. In most cases, Topgolf Callaway Brands is not the market leader and many of its competitors have significant competitive advantages, including longer operating histories, larger customer bases, greater brand recognition, and greater financial resources.
Macroeconomics. Topgolf Callaway Brands' golf-related products and entertainment offerings are recreational in nature and are therefore discretionary purchases for consumers. Hence, its Topgolf venues business is dependent upon consumer and corporate discretionary spending on leisure and entertainment-based offerings. Consumers are generally more willing to make discretionary purchases of golf products and to spend on leisure and out-of-home entertainment during favorable economic conditions and when consumers are feeling confident and prosperous. Thus, the demand for these entertainment and recreational activities is highly sensitive to downturns in the economy and the corresponding impact on discretionary consumer spending. This means that purchases of its products and entertainment offerings could decline during periods when disposable income is lower or during periods of actual or perceived unfavorable economic conditions. Topgolf Callaway Brands' apparel products are similarly dependent on consumer discretionary spending and retail traffic patterns.
Debt. In his book "Rule #1 Investing," Phil Town mentions the following about debt: "A business that carries a significant amount of debt compared to its income faces an uncertain financial future." "If there are any problems with the economy, a business with a significant amount of loans might be in big trouble." As an investor, I dislike unpredictability. Although I don't believe that Topgolf Callaway Brands will go bankrupt, I am concerned about companies with substantial debt, and Topgolf Callaway Brands has continued to increase debt to open new venues. I believe that debt levels have reached a point where Topgolf Callaway Brands should focus on paying off some of their debt, especially now that interest rates are high.
Reasons to invest
There are also numerous reasons to invest in Topgolf Callaway Brands. One reason is the Topgolf segment. Management has mentioned that they have divided their Topgolf business into phases. In Phase 1, Topgolf Callaway Brands funded Topgolf's operations and venue development. According to management, this phase was very successful as they increased the pace of new venue development and at the same time improved venue profitability, resulting in significant revenue and adjusted EBITDA growth. As expected, however, this accelerated development had a negative impact on earnings per share due to the increased interest expense and D&A associated with that development. Management believes that they are now in Phase 2. In Phase 2, which management believes they will be in through 2024, they expect to scale the business further, grow embedded cash flows, and stabilize EPS. In 2025 through 2028, management expects to be in Phase 3 of their Topgolf journey where they will have further growth and cash flows begin to meaningfully exceed capital requirements. As a result of the increased scale leveling of corporate investments and the impacts of the cash flow generation on interest expense, management would expect EPS to begin to grow in 2025 and ramp from there. The reason that management is so positive is that Topgolf venues open with strong economics that improve over time and the venues are appreciating assets over the long term. At present, approximately half of Topgolf Callaway Brands' venues opened in the last five years. Accordingly, management expects the profit contribution from its venues to expand over time.
The Golf Equipment and Active Lifestyle segments. Management has mentioned that the Callaway brand is strong and set up for an excellent 2024 with an outstanding new product range. They have launched the Chrome Soft Golf Balls, which is Topgolf Callaway Brands' premium ball launch. Management has mentioned that it is essentially a new brand they are introducing to the market. They believe it is the best performing and most consistent ball in golf and see this launch as a big opportunity because it has a higher price point than average golf balls. Topgolf Callaway Brands also launched the Ai Smoke golf clubs in January 2024. Management mentioned that this is a very significant and comprehensive launch for the company. The Ai Smoke golf clubs are at a price point that fits a larger portion of the market, consistent with their other golf clubs that have historically established higher market share positions. In the Active Lifestyle segment, management has high hopes for TravisMathew. They plan to open eight to ten new stores, slowly expand their international footprint, and amplify the fantastic women's product with marketing and stronger in-store exposure. The women's product is resonating nicely, and although it is still small from a percentage basis, management is optimistic about its long-term potential.
Capitalizing on golf growth. According to the National Golf Foundation, there are now a total of 45 million on and off-course golfers, up 9% year-over-year and up 32% since 2019. Within this, an estimated 26,6 million Americans played golf on-course in 2023, up 1 million year-over-year, marking the largest one-year growth in participants since 2001. This increase was driven by an all-time high of first-time on-course golfers of 3,4 million. Simultaneously, 32,9 million Americans participated in off-course golf, up 18% year-over-year and up 41% since 2019. The game of golf at large is clearly benefiting from a large influx of participants, the advantages of more flexible work environments, a positive change in the perception of the game—especially among teens and young adults—and the structural growth of off-course golf. Management has mentioned that off-course golf will drive on-course participation, as around two-thirds of today's on-course beginners are coming to the course with off-course experience, compared to less than 40% five years ago. Already, 10% of today's total on-course players credit Topgolf for getting them to the golf course. Once players transition from off-course to on-course, they will need golf equipment. Topgolf Callaway Brands will be introducing specific Callaway-branded golf equipment designed for beginner golfers introduced to the sport via Topgolf.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 0,50, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 16,9% in the next five years, but 15% is the highest I use. Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on Topgolf Callaway Brands' historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $15,00. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Topgolf Callaway Brands at a price of $7,50 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 444, and capital expenditures were 427. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 299 in our calculations. The tax provision was -51. We have 183,998 outstanding shares. Hence, the calculation will be as follows: (444 – 299 - 51) / 183,998 x 10 = $5,11 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. However, Topgolf Callaway Brands had a Free Cash Flow Per Share of $-0,64. Thus, it is not possible to make the Payback Time calculation.
Conclusion
I believe that Topgolf Callaway Brands is an interesting company. And while we don't have much information about the management team, I am confident that they are well-equipped to lead Topgolf Callaway Brands moving forward. This confidence stems from their extensive experience in the industry. Topgolf Callaway Brands has delivered a low ROIC since the acquisition of Topgolf, and it has decreased year over year, which is concerning. However, management has stated it is because they have invested in new venues, which is also why the company hasn't managed to deliver a positive free cash flow in the three years since the acquisition. Topgolf Callaway Brands is facing competition in all its three segments, and will continue to do so in the future, which means that this is an ongoing risk. Topgolf Callaway Brands is also facing some macroeconomic challenges, and while these tend to be short-term, it could interfere with management's goal of reaching Phase 3 in their Topgolf Journey, where cash flows should begin to meaningfully exceed capital requirements already in 2025. Topgolf Callaway Brands has a high debt, and while I don't think the company will go bankrupt, it is a concern for me, and I prefer to invest in companies with lower debt, even though the debt of Topgolf Callaway Brand can be explained by the Topgolf acquisition and aggressively opening new venues. Management has high hopes for its Topgolf segment, and the segment should turn free cash flow positive as Topgolf venues' economics improve over time, and the venues are appreciating assets over the long term. If they are right, this could be the right time to start investing in Topgolf Callaway Brands as many of the venues are less than five years old. Topgolf Callaway Brands owns one of the largest brands in golf in Callaway, and they continue to introduce new products which should boost sales, such as the Ai Smoke golf clubs and Chrome Soft Golf Balls. The company should also capitalize on the growth in golf. Not only is off-course golfing growing at a high rate, but these off-course golfers are also taking up on-course golfing, and Topgolf Callaway Brands will capitalize on that as they are selling golf equipment and have introduced special equipment for the 10% of the on-course players that credit Topgolf for getting them to the golf course. Nonetheless, I will need to see management executing on Phase 3, a higher ROIC, and lower debt before I'm willing to invest in Topgolf Callaway Brands. Thus, I will not be investing in Topgolf Callaway Brands now.
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