On March 8, Callaway Golf (ELY +0.97%) announced it had completed its merger with Topgolf that was proposed back in October 2020. The company, which already owns the Callaway Golf, Odyssey, OGIO, Travis Mathew, and Jack Wolfskin brands, issued 90 million shares to obtain ownership of the 86% of Topgolf it didn't already own.
Here's what Callaway shareholders are getting with the Topgolf merger, and why it might supercharge Callaway's business going forward.
Headline details
Topgolf operates huge driving ranges with technology-enabled driving bays. The majority of its locations have 100 or more bays and also sell food, drinks, apparel, and equipment. Unlike a typical driving range, Topgolf venues cater to larger groups and a wider audience than the hardcore golfer demographic. At the time of the merger call in October, it had 58 venues in the U.S. and saw 23 million visitors in 2019 (it didn't disclose 2020 visitor numbers).
With such large venues, it can cost upward of $40 million to build a Topgolf location. However, once completed, management estimates that on average a typical venue generates $17 million in annual revenue and $5 million in adjusted EBITDA. Topgolf and Callaway plan to open 10 venues a year from 2022 onward, which will require large capital investments for a business that is likely not yet cash-flow positive. However, with Callaway's profitable equipment and apparel business, plus the $366 million in cash it has on its balance sheet, the combined companies will be able to bridge the gap until Topgolf as a whole starts generating a profit.
Image source: Getty Images.
Hidden gems
Topgolf is not just an entertainment brand but a software and media business. Its Toptracer technology is used by the PGA Tour for ball tracking on TV broadcasts, and the company has started to license the technology to third-party driving ranges around the world. At the time of the merger presentation, the technology was in 7,500 bays and grew sales 233% from 2017 to 2019.
On the media side, Topgolf owns World Golf Tour, a profitable mobile game with 28 million players. This asset doesn't directly affect Topgolf's financials all that much but has the potential to be used as a free marketing tool or springboard for golf e-sport competitions.
Lastly, investors should think about what Topgolf can do for Callaway's traditional business. With these mega-locations getting tens of millions of visitors each year, there is a lot of potential to cross-sell Callaway clubs and balls, as well as its OGIO, Travis Matthew, and Jack Wolfskin brands.
Valuation
In 2020, Callaway generated around $190 million in free cash flow. However, this number got an artificial boost from a decrease in inventory and a non-cash impairment to the Jack Wolfskin brand. In 2019, a normal year without COVID-19 impacts, Callaway had $1.7 billion in sales and generated $30 million in free cash flow. Not a bad business, but not as good as its 2020 free cash flow number suggests.
Topgolf generated over $1 billion in sales in 2019 (it hasn't disclosed 2020 numbers) and was growing at a 30% rate the last few years before 2020. Combine the two companies, and it looks like a business that will do slightly less or around $3 billion in sales in 2021. There are a lot of moving parts from a profitability standpoint, but if you believe management's projections, the combined entities have a path to a few hundred million in profits sometime soon. Callaway's goal is to hit $1 billion in adjusted EBITDA at some point this decade with the combined companies.
There's a lot to like about the Callaway and Topgolf merger. Topgolf on its own has a long runway for growth. Toptracer technology is growing at a triple-digit rate, and if you believe Topgolf's locations can give Callaway an advantage in equipment and apparel sales, this business could be a lot larger five years from now.
