Callaway (ELY 1.17%) is known as one of the premier golf brands in the world. It consistently ranks in the top five or higher in golf clubs and balls sold worldwide, with its wide range of woods, irons, and putters. However, the golf equipment market hasn't been the best industry to be in over the past decade, with worldwide equipment sales actually declining from 2007 to 2019. This has led Callaway to diversify its business, acquiring apparel brands such as TravisMatthew and Jack Wolfskin in recent years.
To further push outside of its core equipment market, Callaway recently announced a merger with entertainment company Topgolf, issuing 90 million shares (worth around $2.5 billion at the current share price) to complete the transaction. The combined company currently has a market cap of $5.25 billion and will be managed by Callaway CEO Chip Brewer.
Here's why investors should be excited about the Topgolf merger, and why it could drive growth for Callaway over the next decade and beyond.
The Topgolf concept
Founded in 2000 by two brothers in the United Kingdom, Topgolf is a golf entertainment and technology company. Its core offering is an entertainment-focused driving range that can have over 100 hitting bays. The locations offer entertainment, food and drink, and fun golfing games to go along with the standard driving range experience. At the time of the merger in late 2020, Topgolf had 63 venues opened worldwide including 58 in the U.S, with plans to open around 10 a year over the next decade.
The technology side of the business is Topgolf's Toptracer software. Every location uses Toptracer to help track the speed, distance, and accuracy of each shot and power the games Topgolf offers at its ranges. Toptracer is also licensed to third parties like the PGA Tour and other, smaller driving ranges. Driving ranges install Toptracer's technology at their driving bays and license the software, creating a recurring revenue stream for Topgolf. Lastly, Topgolf also owns the number-one mobile golf game, World Golf Tour. At the time of the merger, the game had 28 million members and was profitable.
Financials and unit economics
Investors don't yet have access to Topgolf's audited financial statements, but Callaway management gave out some insights into the business at the time of the merger. On average, a Topgolf venue does $17 million in annual sales, mixed fairly evenly between golf activities, food and beverage, and events. This leads to an average of $5 million in profits generated per location each year. While these unit economics look great, it can cost upwards of $40 million to build out a location (these are typically huge complexes in areas with expensive real estate).
With these large upfront costs and limited land availability in major American markets, Topgolf can only open around 10 locations a year. Assuming the unit economics stay the same at new locations, if Topgolf can get to around 120 locations within the next five years, that could be $600 million in annual profits generated from locations alone, before accounting for TopTracer, mobile game, equipment, and apparel profits.
With over 23 million unique visitors in 2019 -- a number that should steadily grow with new location openings -- Topgolf gives Callaway prime selling real estate for its equipment and apparel brands. These entertainment complexes are the perfect environment to sell golf die-hards that new $400 driver, or to get the casual fan at a company party to buy some TravisMatthew golf apparel for their next round. These physical locations can give Callaway a selling advantage versus its big competitors like TaylorMade or Ping.
It will take strong execution from management to make the Topgolf acquisition worthwhile. But with over $630 million in cash and available borrowings at year-end, the company is in a strong financial position to continue investing heavily into Topgolf and its legacy businesses. If Callaway executes on its strategy and can reach close to $1 billion in annual profits, the current market cap of $5.25 billion will look like a steal a few years from now.