Will the Topgolf Merger Work for Callaway?

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Callaway Golf (NYSE:ELY) announced last week that it is merging with Topgolf, the innovative golf entertainment business, in an all-stock deal.

Callaway shareholders were not happy about the announcement, sending the stock down 19% the next trading day. Callaway is taking on a lot of debt and diluting shareholders with the acquisition, so investors shouldn’t be too shocked by the stock drop, but looking past first reactions, what they should be focused on is whether the Topgolf acquisition will be successful for Callaway over the long term.

Image source: Getty Images.

What is Topgolf?

Before deciding whether the acquisition makes sense, investors need to understand what Topgolf is. It operates super-sized, technologically enhanced driving ranges with restaurants and bars. Locations aren’t designed for individuals trying to hone their craft, but for big events and parties that will keep customers around for hours. Topgolf caters to beginners, making the atmosphere comfortable and fun even if you’ve never swung a club before.

It also should be noted what Callaway’s traditional business is. The company sells golf equipment (clubs and balls) and what it calls “soft goods” (mainly bags and apparel). Both business lines bring in similar amounts of revenue for the company. 

Why the merger could work

I think the Topgolf acquisition could work for a few reasons. For one, the business on its own looks promising, with revenue of $1.1 billion in 2019 that has grown at a 30% rate over the past three years.  

With only 63 locations worldwide, each Topgolf “super range” brings in an average of $17 million in revenue per year with a lot of room for unit growth over the next few years. Callaway has plans to add more than 20 venues from the end of 2019 through to the end of 2022 and sees the potential for hundreds more.

There are some concerns over the pandemic, but the venues are open-air and large enough to operate with social distancing, so investors shouldn’t be too concerned about it.

Topgolf CEO Dolf Berle said in a conference call last week:

While the outset of the pandemic forced the temporary closure of many Topgolf venues, we are fortunate that we have since reopened all of our locations across the network. These are outdoor venues where we have installed dividers between bays and can maintain social distancing. The result we’re seeing is a strong return to guest traffic in our venues with same-venue sales recently between 80% to 85% of 2019 levels.

And assuming we get a vaccine, these short-term headwinds should not matter over the long term.

Topgolf also owns and licenses Toptracer technology, which tracks and analyzes golf hits in real time, to professional leagues and third-party driving ranges. The software is at over 7,500 driving ranges right now and has seen 233% revenue growth over the past three years. Topgolf’s third business unit is its mobile game, World Golf Tour. It has 28 million users and is seen mainly as a marketing tool to get more people interested in the game of golf. 

Digging into the numbers

The Topgolf deal will bring $555 million in net debt to Callaway’s balance sheet and low levels of profitability (only $60 million in adjusted EBITDA in 2019). However, Callaway has $630 million in cash and available credit facilities, so it shouldn’t have any issues making payments on any of these loans. Management is estimating the combined company will have $360 million in EBITDA by 2022 as well, which, although not a guarantee, could be used to pay down some of the debt. That figure would be up from a comparable $270 million in 2019. With Topgolf’s sales at $1.1 billion and growing 30% annually, these estimates do not seem overly ambitious.

Investors shouldn’t forget Callaway’s traditional business either. The company’s products and Ogio, TravisMathew, and Jack Wolfskin brands can be promoted at Topgolf locations to the estimated 49% of customers who identify as golfers. This cross-selling could supercharge Callaway’s brands and is another reason investors may be undervaluing the combined entity going forward. 

If Topgolf continues its torrid growth and can boost Callaway’s traditional business, this may look like a bargain to investors in five years.