My 'first look' analysis of Topgolf Callaway Brands
One of my readers sent me a pitch for golf company Topgolf Callaway Brands (MODG), which caught my attention for three reasons...
First, I love golf... though it doesn't love me back as much, as I hack my way around the course. I only break 100 on a good day!
While I don't play as often as I wish – only a handful of times a year – I have countless fond memories dating back to my childhood of having fun outdoors with my closest family and friends.
Below is a picture of me with my dad and two of my cousins on a gorgeous nine-hole course in New Hampshire overlooking Lake Sunapee. It's only five minutes from the home my extended family has had on the lake for 102 years. (And, best of all for a value guy like me, we can play for free because my cousin owns a condo on the course – and it's always empty!)
The second reason Topgolf Callaway caught my eye is that from 2005 until we sold the company in 2007, I was on the board of a golf-apparel company based in Seattle called Cutter & Buck... so I know something about the sector – and Callaway Golf (as it was known at the time) was a competitor.
Lastly, Topgolf Callaway's stock chart got my value-investor/bottom-fishing heart racing...
As you can see in the chart below, 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:
So is the sell-off overdone and might the stock be a buy around current levels?
Let's take a look at Topgolf Callaway – starting, as always, by looking at the historical financials...
This chart shows the company's revenue and net income over the past 20 years (note that the big spike in 2021 reflects Callaway Golf acquiring Topgolf Entertainment in March of that year for $2.66 billion in stock):
We can see that profits (and the stock) tanked in 2020 when the pandemic hit, but then both soared as the market rallied and because golf was a great COVID-19-safe sport (played outdoors and easy to keep your distance from people).
Then the stock market took off... and then investors got excited about the big acquisition, which took MODG shares to an all-time high a few months after the acquisition closed.
Since then, the wheels have come off the bus: Revenues have stalled and profits have plunged – even as the economy has been doing well.
It looks like yet another big corporate acquisition that has gone awry... It's so bad 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.
For the next piece of the puzzle, let's turn to the cash-flow statement. The below chart shows Topgolf Callaway's operating cash flow, capital expenditures ("capex"), and free cash flow ("FCF"):
We can see that the company had negative FCF from 2008 to 2013, followed by steady improvement. But then, FCF cratered when Callaway acquired a far more capital-intensive business, which required large amounts of capex to grow.
However, there's a very important silver lining here...
Operating cash flow has hit new all-time highs the past two years and capex has declined – resulting in a rapid recovery in FCF.
This is interesting enough that I wanted to look at these numbers by quarter going back to the beginning of 2020:
Remember that the Topgolf acquisition closed in March 2021, and that's of course where you see capex spike and FCF plunge. You can also see how seasonable this business is – FCF is always negative in the winter months of the first quarter.
But, as with the annual cash-flow chart earlier, I like what I see in the past two years – especially when it has been accompanied by a collapse in the stock price.
Next is the company's balance sheet with net debt – always critical to look at in a turnaround situation:
This is a big concern – net debt (debt minus cash) has skyrocketed and now sits at about $4 billion – a very high level for a company that only generated about $155 million in FCF in the past 12 months.
A widely used financial metric to measure a company's debt level is to compare total debt to trailing-12-month earnings before interest, taxes, depreciation, and amortization ("EBITDA").
Factoring in a lease adjustment for EBIDTA, Topgolf Callaway's ratio of total debt to EBITDA comes in at 6.9. That's a high number.
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 stay tuned!
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.