Hearing out three bullish arguments for Topgolf Callaway Brands

Today, let's take things a step further with Topgolf Callaway Brands (MODG)...

In yesterday's e-mail, I took a look at the golf company's financials. As I mentioned, MODG shares have lost nearly 80% of their value in the past three and a half years – and they currently sit close to a 10-year low.

For some extra context, Topgolf Callaway reported disappointing third-quarter earnings last month: Year over year, revenues were down 3% and adjusted earnings per share tumbled 88%.

After looking at the financials yesterday, I concluded:

From what I see here so far, Topgolf Callaway has a lot of "hair" on it – a large, failed acquisition that's now being unwound, with many details unresolved, and which saddled the company with stifling debt.

But the stock has fallen so much that I think it's worth a deeper dive – and worth determining if the acquisition unwind is indeed the right move.

So let's hear out some bullish arguments on Topgolf Callaway and see if there's a good bottom-fishing opportunity here...

The company consists of two segments: Callaway, which makes golf equipment and apparel... and Topgolf Entertainment, which Callaway acquired in March 2021 for $2.66 billion in stock.

The deal has gone so badly that the company announced on September 4 that it's undoing the merger and splitting back into two parts. Meanwhile, the stock has continued to fall.

That day, Topgolf Callaway also published a presentation about the separation – in which it outlined the two parts in this slide:

Most folks understand golf equipment and apparel, but may not have been to an actual Topgolf venue... so here are some pictures on its homepage:

You can see that, rather than being a golf course, it's an entertainment destination that features golf, but also food and other entertainment – like modern bowling alleys.

Topgolf operates more than 100 venues worldwide (with more than 80 located in the U.S.) and has been opening new ones at a rapid clip. In fact, one of them opened just a couple years ago not far from Stansberry Research's office in downtown Baltimore.

Topgolf is a growth business that excited investors – including Callaway, which wildly overpaid to acquire it – but after booming during COVID, its growth has slowed... which is the primary reason MODG shares have crashed.

For further insights, I want to share three bullish reports on the stock from earlier this year – from my old friend Jonathan Boyar of Boyar Research... one of my readers named Zain S... and a member of my favorite stock idea website, Value Investors Club.

I'll note that MODG shares now trade well below when two of these reports were published (and for the other one, the stock was right around where it trades now). So clearly, a couple folks were too early... but it's possible that they will ultimately be proven right on the stock.

If that's the case, it would mean Topgolf Callaway's current levels (the stock closed yesterday at $8.18 per share) are a much better price today than they were earlier this year...

First up is Jonathan's nine-page report, which he kindly gave me permission to share (I've posted it right here). He published it on August 14 when the stock was at $11.40 per share, and here's his overview:

MODG shares have once again sold off on disappointing same-venue sales (SVS) posted by its Topgolf segment. Although the results are discouraging, we note that Topgolf benefited from a postpandemic surge and is now starting to see things normalize in the face of a more challenging economic environment.

We believe that the challenges facing Topgolf are not too dissimilar from the headwinds facing other similar entertainment properties that depend on consumer discretionary spending, with Comcast's Universal Parks & Reports having just reported that sales declined by 11% due to many of the same factors as those affecting Topgolf.

And as he continued:

Over the years, Topgolf has proven to be a resilient business that has seen increases in venue revenue and profitability over time. The addressable market for Topgolf venues remains massive (over 500 venues, vs. just over 100 at present), with the business less than 20% penetrated, especially in international markets.

In our view, the market has thrown out the baby with the bathwater when valuing MODG shares. At current levels, we believe that investors are effectively acquiring the Topgolf business at a discounted valuation while receiving the Company's Golf Equipment and Active Lifestyle businesses (an additional $15 in value on top of the current share price) for free.

It should be noted that management is actively looking to unlock this value and has recently announced that it is pursuing strategic alternatives for its Topgolf segment.

In the final section of his report, Jonathan turned to valuation:

At current levels, we believe that investors are effectively acquiring Topgolf at a discounted valuation while getting the Company's Golf Equipment and Active Lifestyle businesses for free.

These two businesses together represent an additional $15 in value (on top of the current MODG share price). In 2021, MODG acquired the Topgolf business for ~$2.4 billion (excludes REIT debt, which is similar to rent but is treated like debt due to GAAP rules; notably, the obligations to Topgolf REIT financing partners are nonrecourse to MODG), including 58 venues (~$41 million per venue), just below the current $3.1 billion enterprise value for all of MODG.

However, Topgolf now has 101 venues in its portfolio (96 company-owned in the U.S., 4 Company-operated in the U.K., and 5 international venues where it receives royalties). MODG announced the acquisition of Topgolf during the middle of the pandemic, when financing conditions were difficult. Accordingly, we believe that MODG acquired the business at a fair price.

And that's not all – as Johnathan continued with his conclusion:

However, for the sake of conservatism, we apply a 20% discount on the per-venue price paid in valuing the current portfolio of venues or $33 million per venue. It should be noted that this approach does not give Topgolf any credit for future expansion: the global market for Topgolf venues is significantly underpenetrated, according to management, with a global addressable market of over 500 venues. For the Golf Equipment and Active Lifestyle business, we apply a 10x multiple to the Company's 2024 projection for those businesses.

We believe that this multiple is appropriate in light of precedent golf industry transactions, which have occurred at multiples in the low to mid-teens on an EV/EBITDA basis and peer Acushnet's current EV/EBITDA of ~12.0x. We also believe that 2024 understates the segment's true level of profitability in light of the fast-growing TravisMathew business and the potential for a turnaround at Jack Wolfskin. Taken together, we derive an intrinsic value of $27 a share, or 140% upside from current levels.

In February 2023, Jonathan also interviewed Topgolf Callaway CEO Chip Brewer on his podcast – where Brewer discussed how he turned around Callaway's traditional business and why he saw opportunity with the Topgolf business.

Up next, one of my readers named Zain S. published his eight-page report just a few weeks ago on November 20 – which he also kindly gave me permission to share (I've posted it right here). At the time, MODG shares were trading at $8.15.

In it, Zain argues that "the market has struggled with a narrative for the combined entity, so valuation has suffered," the "spin-off of Topgolf will unlock value," and the "sum of the parts should be greater than the whole here." Here's an excerpt from his report with more on the spin-off:

Transaction will return immediate value to shareholders

• At 80% ownership sold, the transaction returns $1.9bn in value to MODG shareholders
• At 198.5 fully-diluted shares outstanding, the transaction returns $9.34 per share for Topgolf, incremental to the retained value of the Callaway business
• "Callaway will be positioned to generate significant free cash flow, reinvest in growing its market-leading positions and ultimately be in a position to return capital to shareholders, while operating at an appropriate level of leverage for its operations and financial profile"

Zain also does a nice job of explaining why the net debt level isn't really $4 billion, but $1 billion. The balance is "Deemed landlord financing ("DLF") obligations, [which] are similar to rent, but treated like debt due to GAAP; there is no repayment of principal and obligations are non-recourse... Topgolf has lease agreements to finance the construction of its venues."

Overall, Zain saw 44% to 137% upside for the stock.

Lastly, Value Investors Club user Gary9 pitched Topgolf Callaway on July 26 (using the previous day's closing price of $15.61 per share for the stock), writing:

We think it's time to revisit TopGolf Callaway Brands as the stock has languished for too long and the company appears ripe for strategic change. At less than 8x 2025E EBITDA, you have several healthy, attractive, stand-alone businesses within MODG that should each command a higher multiple.

Our sum-of-the-parts valuation is $29.52 (up +89%) on 2025 estimated numbers. If there is no break-up, sale or other value-unlocking transaction, we expect MODG to put certain recent performance issues behind them and trade up to 10x 2025E EBITDA in a better tape for non-tech names. This implies a standalone MODG target of $20.70, (up +33%). In a harsh recession scenario, we have trouble seeing why MODG couldn't hold the current valuation.

Gary9 explains what has gone wrong:

From mid-2021 highs in the mid $30s to 4Q23 lows around $10, MODG has compressed greatly in valuation, losing well more than the $2.5B they paid for Top Golf in market cap. Primary reasons for this are a cooling off of the post-pandemic bump in sales and poor guidance from management around that. The promising growth engine that is TopGolf hit very tough comps since mid-year 2023 and has shown negative foot traffic and declines in same venue sales (SVS) for the past year. The (non-golf) outdoor apparel business Jack Wolfskin (acquired in 2019) has also failed to show expected sales growth since the acquisition. The market's malaise for small caps and non-tech stocks and the mis-match of disparate business profiles have all contributed to the poor stock performance.

That said, Gary9 believes the market is overreacting:

Yet, the market is clearly overlooking a lot of positives in the MODG story. Top Golf is sequentially improving from the post-pandemic lull and does not seem at all broken as a growth venue concept. More importantly, Top Golf has turned cash flow positive and thus self-funding for a continued robust venue expansion program. Jack Wolfskin management has been overhauled and its brand appears similarly untarnished with the consumer.

The rest of MODG's businesses are arguably high multiple gems.

Additionally, one of my readers named Christopher D. shared some thoughts:

I'd be curious to see whether Topgolf's "same-venue" sales growth can continue. I kinda feel like they reach a saturation point in each market very quickly because, for the customer, it's just too much to work to go there and have an experience – the classic climb isn't worth the view.

Avid golfers spent money on their country clubs. Sure, they'll go check out Topgolf, but then tire easily.

After weighing everything I've seen, my thoughts are mixed...

The original Callaway business is a decent one, and it's possible that Topgolf is just suffering a post-COVID pullback from which it can recover. Just look at what Peloton Interactive (PTON) has done since I shared my friend David Einhorn's presentation on it in my October 29 e-mail – the stock has skyrocketed 40% in only six weeks. And the separation of Topgolf Callaway's two businesses early next year could unlock value.

The key to the stock recovering is Topgolf turning around – and in my gut, I'm not convinced of it.

It smells like a bit of a fad, and it faces fierce competition from every other form of entertainment: bowling alleys, movie theaters, amusement parks, sporting events, video games, Netflix, etc. I also don't like so much debt when I'm looking at a turnaround.

In conclusion, while I think there's a decent chance that Topgolf Callaway's stock bounces, I don't make (or recommend) investments unless I'm really certain of substantial upside and minimal downside... so I would pass on MODG shares.

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.