Topgolf Callaway: Attractive Play Considering Rising Interest In Off-Course Golfing (MODG)

Thesis

Topgolf Callaway Brands Corp. (NYSE:MODG) along with its brand portfolio, is a leading modern golf and active lifestyle company. The company has pivoted from being solely a golf equipment provider to being what I like to describe as a “golf entertainment company”. Post-merger with Topgolf, MODG’s long-term strategy is to expand its “golf entertainment” segment by opening up more venues domestically and globally. I believe in the firm’s ability to achieve its target of +11 new venues annually because the golf sentiment is changing; there are now more off-course players than on-course players (more on this later).

Although the Topgolf segment isn’t very profitable, I believe the income generated from golf equipment sales will enable them to finance their expansion plan. Not only is this segment profitable, but it is also resilient. I like to believe the reason for this is its exposure to high-income individuals. MODG does carry a significant amount of debt on its balance sheet, given the merger with Topgolf. The firm also faces heavy competition in its two other segments.

My price target is $24.12 per share, which equates to a 42% return from the current price. I will explain my investment thesis in more detail as I talk more about the company in the following sections.

Company Overview

A little background about the company MODG was formerly known as Callaway Golf Company, but on September 6, 2022, the firm changed its corporate name to Topgolf Callaway Brands Corp. The name change came after the merger with Topgolf. MDOG provides golf entertainment experiences, designs, and manufactures golf equipment through brands such as Topgolf, Callaway Golf, Odyssey, Travis Matthew, Jack Wolfskin, OGIO, and Toptrace

As I mentioned in my thesis, MODG does face heavy competition but the firm is managing this by making its brand stand out from others through sponsorships, MODG has sponsored some of the best and most well-known golfers like John Rahm and Xander Schauffele. I was going to do a comparison in terms of multiples and margins between MODG and its competitors but most of them are either private or owned by big enterprises that are not in the same field as MODG, such as DICK’S Sporting Goods (DKS).

Some major competitors in the Active Lifestyle and Golf equipment include Png, SRI Sports Limited, Mizuno, TaylorMade, Bridgestone, and more. As for Topgolf, the only direct competition I see is Drive Shack. I expect this segment to get more competitive as more companies see its potential.

70% of revenue comes from the U.S., 13% from Europe, 14% from Asia, and 3% from ROW. The company derives revenue from three segments: Top Golf, Active Lifestyle, and Golf Equipment.

Business Segments & Outlook

Top Golf (39% of Revenue)

The Topgolf segment was born post-merger. This segment is what I like to call “golf entertainment”. It is a leading golf entertainment company with an innovative platform of products and services that includes its modern open-air golf and entertainment venues. It is divided into three divisions: Venues, Toptracer, and Top Golf Media. Annually, the segment has around 25 million unique players and 7 billion golf ball hits.

Despite an increase in operating income, the segment’s margin decreased primarily due to an increase in pre-opening costs due to the opening of 11 new venues in 2022, combined with a planned increase in marketing spend.

Topgolf prices vary depending on location, time of day, and the number of people in your group. To begin, there is a $5 one-time membership charge. Hourly charges often vary from $25 to $70 per bay, including food and beverage expenditures. The company plans on expanding by opening 11 New Owned and Operated Venues Annually and 8+ New Franchised Venues annually by 2025.

As you can see from the slide above, The golf sentiment is definitely changing with more off-course players than on-course. This is understandable because what off-course offers is a more fun, entertaining, and easier way to play golf. I believe off-course golf will gain more popularity as more venues open both domestically and globally. I expect MODG to benefit from this growth given their leading brand Topgolf.

According to the National Golf Foundation. In 2022, more than 41 million Americans played golf. 15.5 million of those took part only in off-course activities such as driving facilities, indoor simulators, or golf-entertainment businesses such as Topgolf.

All in all, I believe Topgolf is still in its early stages. Considering that 14 years ago off-course golf only had 4.3 million players, as of 2022, it had 27.3 million. As of December 31st, 2022 MODG had 77 Company-operated venues in the United States, four Company-operated venues in the United Kingdom, and five franchised venues in Australia, Mexico, the United Arab Emirates, Thailand, and Germany. The company recently said that it has identified ~500 total venue opportunities globally.

Active Lifestyle (26% of Revenue)

The Active Lifestyle segment creates and markets high-quality products under brands such as Callaway, Travis Matthew, OGIO, and Jack Wolfskin. In the United States and several other markets, Products of the segment include Golf bags, golf gloves, headwaters, and other items.

As you can see from the chart in times such as the COVID outbreak, although revenue dropped by only $114 million from the previous year (2019), Profitability plunged from 10% to almost negative. The drop was primarily due to an $86.9 million decrease in gross profit, and the drop in gross profit was primarily caused by the firm’s proactive inventory reduction initiatives.

Golf Equipment (35% of Revenue)

The Golf Equipment segment designs manufactures, and distributes a full variety of golf equipment, including golf clubs and golf balls. I believe this segment specifically to be resilient because of its customers being high-income individuals. So in an economic downturn, I don’t expect there to be much of a drop in sales. As for evidence, Even during the COVID shut down neither revenue nor profitability took a hit, They both experienced growth.

According to the global newswire, The golf equipment market is expected to grow at a CAGR of 3.32% by 2032. This growth includes both the active lifestyle and Golf equipment segments. I expect MODG to share in this growth given their strong market presence.

Valuation

MODG is currently trading at a FWD P/E and EV/EBITDA of 26.36x and 11.38x. I project Topgolf to grow at a CAGR of ~18% for the next five years, Active Lifestyle by 8%, and Golf Equipment by 1.80%. This results in total revenue growth of 9.85% CAGR from 2023 to 2027.

I derived my growth assumption for Topgolf based on historic figures, Sales grew by 42% in 2022 as the company opened 11 new venues. I do not expect the same growth rate going forward because, during 2022, the Company recognized a full 12-month period of Topgolf revenues, compared to only ten months during the year ended 2021.

As for Active Lifestyle, My assumption is based on continued brand momentum and market growth. The same thing goes for Golf Equipment, Maybe not the same growth because in the last five years, the Active lifestyle has grown at a much faster rate. Plus the golf equipment is experiencing a slowdown as seen in the recent quarter.

I used a terminal growth rate of 6.11%. I got that by using two industry growth rates: 3.30% (forecast) for golf equipment and 10.5% (the historic rate is 12%, but I like being conservative) for Topgolf.

Using a WACC of 8.42%, I discounted the future cash flows and terminal value. I arrived at an equity value of $4.85 billion. My fair value is $24.12, which equates to a 42% upside from the current price of $17.

I project Topgolf to experience the most growth due to new openings, customers, and continued growth in the off-course golf market. As for margins, Ever since the merger, they have compressed a little. I expect them to slowly compress as Topgolf starts to grow and constitute more of the total revenue.

Liquidity has also dropped as a result of the merger. MODG had a current ratio of 1.29x compared to 1.73x in 2018 and a quick ratio of 0.48x compared to 0.63x in 2018. Below is a sensitivity table that shows how a different growth rate and WACC can impact the share price.

Recent Performance

MODG reported Q2 earnings on August 8th, 2023. Revenue of $1,179 million vs. FactSet’s estimate of $1,190 million and EPS of $0.39 vs. FactSet’s estimate of $0.34. Topgolf revenues grew 16.6% YoY, Golf Equipment declined 0.2%, and Active Lifestyle declined 0.8%. The company opened 2 new Topgolf venues, and plans on opening 11 in total for 2023. Same-store sales at Topgolf increased by 1% YoY. Golf Equipment constituted 63% of the company’s total operating income.

Risks

1) As I mentioned at the beginning of my analysis MODG faces heavy competition. There is more to come especially in off-course golf as businesses and individuals start to realize the growth potential of golf entertainment.

2) Debt is another risk. As of Q1 23, the company had a total debt of $4.1 billion. Most of this debt was needed to fund the deal with Top Golf in 2021.

The Bottom Line

The main takeaway is that MODG is a leading golf company that is well-positioned to capitalize on the growing sentiment of off-course golf, considering they have the leading brand. The company only has nine venues outside of the U.S., which means there is a lot of room for growth abroad.

I believe the golf equipment segment will generate enough cash to support expansion plans. MODG has risks like any other business, such as debt and competition, that one needs to consider. My valuation implies a 42% upside, with the Topgolf segment experiencing more growth than its peers.