Topgolf Acquisition Makes Sense, But Callaway Overpaid For a Company Over a Barrel

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The Wall Street Journal recently reported that Callaway Golf Co. (ELY) intends to purchase the 86% of Topgolf Entertainment Group it does not already own at a valuation north of $2 billion. Compass Point Research & Trading research analyst Casey Alexander said “obvious synergies” between the two businesses would “no doubt” result in “greater revenue on the Topgolf side of the business [it did roughly $1 billion in ’19] and greater penetration on the Callaway side.” But he doesn’t believe “the price was as good as it should have been. [Callaway] had [Topgolf] in a compromised position and yet they [still] paid what appears to be a significant premium.”

Our Take: Alexander isn’t questioning the rationale behind Callaway’s acquisition efforts. It’s the valuation he struggles to understand. “Topgolf recently required rescue financing in order to salvage their credit rating because they were in violation of the covenants on their outstanding debt. The company has experienced significant impairment [as a result to COVID-19]; look at Dave & Buster’s [the company’s best pre-COVID comp, whose market cap has fallen more than -50% from its 2020 high]. And Callaway, which was in a position to know more than most, was effectively negotiating against themselves. So, to pay 16x EBITDA two years out—with that EBITDA uncertain based on the timeline for resolution of the COVID-19 crisis and uncertain based upon the execution required to reach those [projections]– feels like a very hefty price.” The market seemingly agreed, as the ELY share price fell -20% on the news.

Callaway likely doesn’t feel as if it is overpaying (although the deal still needs to go through shareholder vote). But even if it did, that won’t lessen Topgolf’s impact on the company. “You could overpay for something and still make it work. That’s Jerry Jones’ thing: ‘I never bought anything good that I didn’t overpay for,’ said Alexander. For the record, the actual quote is, “When I look back on my life, I’ve overpaid for my big successes every time.”

Price aside, Alexander is bullish on the deal for Callaway. So when shares dropped to a more manageable $15 based on projected EBITDA, Compass Point slapped a “buy” rating on the company. Alexander reasoned, “Outside of the [$600 million] debt acquired from Topgolf, [the deal] was all stock. So, [Callaway] effectively changed the value of that deal from $2.5 billion to about $1.9 billion. Once the share price dropped to $15, the risk proposition moved in favor of being long.” Compass Point has a $23.50 price target on the combined company. “At $20/share, $24/share two years out is a 10% [return] per year. It’s not worth the risk. At $15/share, the returns would be in excess of 25% per year and [the company] is clearly worth the risk proposition,” Alexander explained.

Unlike Callaway’s Q1 2019 acquisition of the outdoor apparel brand Jack Wolfskin, there are obvious cross-sale opportunities with Topgolf. “One of the dynamics of the golf equipment business is custom fitting has become a much more prevalent method of selling clubs. Well, [with the acquisition] Callaway arguably just opened 60 custom-fitting centers, in major metropolitan areas, at a very low cost. All they would need to do is [convert] one bay and voila,” Alexander said. ELY should also be able to sell a significant amount of TravisMathew apparel in Topgolf locations. “The golf business would sell a lot more apparel if there were a lot more women at golf courses,” he added. “Well, there are a lot more women at Topgolf”— in a non-pandemic environment, at least. It does need to be noted that more than half of those who visit Topgolf locations (51%) identify as non-golfers.

ELY should be able to exploit synergies on the operational end of the Topgolf business too, with the company carrying roughly $200 million in corporate overhead to support a billion-dollar business. The Compass Point analyst said Topgolf’s bloated payroll provides “a low-hanging fruit opportunity for Callaway. They can clearly pare back on a lot of duplicate positions and knock out some of the expensive labor in the organization.” Topgolf CEO Dolf Berle has already announced his plans to leave the company.

From the Topgolf side of things, a merger with Callaway gives the company access to the public markets without having to go through the traditional IPO process at a time when companies that derive significant revenue from land-based entertainment are getting hammered. While on the surface, the $2 billion valuation appears to be a steep discount from the $4 billion IPO the company was said to be eyeing in January, that figure appears to have been nothing more than speculation. Remember, “Topgolf was a private company with highly protected financials,” Alexander said.

It’s reasonable to assume had the WSJ report come out after word of Pfizer’s imminent COVID-19 vaccine broke, the markets would have responded more kindly to the idea of a Topgolf acquisition. Alexander said, “If Topgolf was a company trading by itself on [the day of the vaccine news], the stock would have ripped. Dave & Buster’s was up $7/share that day” (granted, the share price is still down -36% since the beginning of March). The prospect of COVID-19 restrictions coming to an end and the Topgolf business returning to normal operations sooner than later would have made even those with a bearish view of the company more optimistic.

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