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Callaway Golf (ELY)

Anika Advani
Jonathan Bach
Ryan Yaraghi
September 26, 2014

Table of Contents
Section
I.

Thesis

II.

The Business: Turnaround

II

III.

The Industry: Excessive Pessimism

III

IV.

Hidden Value: Optionality

IV

V.

Valuation

Thesis

What is not priced in?


Business:
Turnaround
New Management Team
Product Refocus
Cost Cutting

Industry:
Excessive Pessimism
U.S. Market
International Market

Hidden Value:
Optionality
Top Golf
NOLs
Sale Leasebacks

I.

Business

Business Overview
2013 Product and Geographic Revenue Breakdowns
Designs, manufactures, markets, and sells golf
products and accessories

Drivers, fairway woods, hybrids, irons, wedges


and putters

Golf balls

Golf apparel, footwear, bags, gloves, headwear,


towels, umbrellas, eyewear and travel gear

2013 Geographic Sales Breakdown

2013 Product Sales Breakdown

Other Foreign
Countries, 9%

Golf Balls,
16%

Rest of Asia,
10%

Europe, 14%
Accessories,
21%

Golf Clubs,
63%
Japan, 19%

Sources: Investor Presentation


4

America,
48%

History
CALLAWAY
INC.
FOUNDED BY
ELY
CALLAWAY

COMPANY
BECOMES
PUBLICLY
TRADED

ACQUIRED
ODYSSEY
SPORTS

ELY
CALLAWAY
RETIRES &
DIES

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

BIG BERTHA
BECOMES #1
DRIVER

BUYS TOP FLITE,


BEN HOGAN

Company proceeds to diversify business and enters poor product lines


Loses focus on core products
TaylorMade takes market share from Callaway
2007 2012: U.S. $ market share falls from 19.6% to 13.9%

Turnaround: Chip Brewer hired as CEO


5

NEW CEO
HIRED, CHIP
BREWER

Management History

Ely Callaway
Founds Callaway Golf in 1982 and grows company to $840mm revenue by 2001
Dies in 2001 of Pancreatic Cancer

Ron Drapeau
Takes over following Elys death in 2001
Resigns in August 2004 due to slumping sales and bad acquisitions

Patrice Hutin
Succeeds Drapeau in August 2004
Resigns position in November 2004, lasting only 4 months

William Baker
Takes over from November 2004 until August 2005

George Fellow
Takes over as CEO in August 2005, fails to maintain company through recession
Resigns in June 2011

Anthony S. Thornley
Becomes CEO in June 2011
Only to resign in March 2012

Current Management
Chip Brewer: Case Study

Adams Golf Case Study


Chip began working at Adams in 1998 as VP of Sales & Marketing
Helped establish the company as a player in the wood market
President & CEO, 2012
Age: 50
Job Experience: President &
CEO of Adams Golf since 2002
Reason for Hire: Chip has
extensive knowledge of all facets
of the golf business, particularly
in the sales and marketing area,
and has a real passion for the
game of golf. Chip also has great
relationships with customers and
others in the golf industry and he
has done a great job turning
around and leading Adams Golf.

Adams golf was considered a One-hit Wonder with its Tight Lies
fairway wood but sales slumped, bottoming in 2000
Chip takes over roll as CEO in 2002
Helps turn the business around, profitable by 2003
Transforms from a one-club shop to being a major player in
woods, hybrids and iron markets
Eventually succeeded in selling Adams Golf to TaylorMade in 2012

Chairman, Ronald S. Beard.

Sources: Investor Presentation, PGA


7

Current Management
Chip Brewer: Case Study
Pre-Chip

Post-Chip

Current Management

Mark Leposky

Dr. Alan Hocknell

Harry Arnett

SVP of Global Operations

SVP of R&D

SVP of Global Marketing

Since 2012

Since 2009

Since 2012

Age: 49

Age: 42

Age: 42

Previous Experience: President


& CEO of Gathering Storm
Holding Company (2005 2011)

Previous Experience: Senior


Manager of Advanced
Technology and Senior Director,
Product Design and Engineering
(1998 2004); Vice President,
Innovation and Advanced Design
(2004 2009)

Previous Experience: VP of
Global Marketing in TaylorMade,
Adidas, and Ashworth Golf

As a senior team, weve seen the


organizations mentality change. I
have to push a little bit as a leader,
but the team I have gets that.
We will push, but at the end of
the day, my team and I will
protect the golfers.
CEO, Chip Brewer

We benchmark our competition


quite diligently and we know we
stand on top right now with
our technology; the numbers
dont lie, our drivers produce
superior numbers.
SVP R&D, Dr. Alan Hocknell

Sources: 10-K, Reuters, WorldGolf


9

Harry has demonstrated an


impressive ability to develop and
execute compelling strategies
on a global scale that clearly
connect with golfers.
CEO, Chip Brewer

Business Turnaround
The Turnaround Strategy

I. Return Focus to Core Business

Chip Brewer looks to


bring Callaway back to
its roots with a multi-part
turnaround strategy:

II. Revamp R&D to return Product Competitiveness

III. Supply Chain Consolidation & Cost Cutting Initiatives

IV. Improve Marketing and Sales Strategy

10

Business Turnaround
I. Refocus on Core Brands
TopFlite Golf Balls

Ben Hogan Clothing

Acquired in 2002 as part of $165m


purchase following Spaldings bankruptcy

Acquired in 2002 as part of $165m


purchase following Spaldings bankruptcy

2003 Callaway enters the Golf


Technology market

Business quickly flops prices, market


share and margins all fall

Callaway largely unable to incorporate


unrelated clothing business into product
line

Pushes GPS through uPro RangeFinder

Under Chip Brewer, brand is sold to


Dicks Sporting Goods for $20m in 2012

Under Chip Brewer, brand sold to


Perry Ellis in favor of licensing deal

Technology Initiatives

Becomes major cost center never


master technology, distraction from core
product R&D

Under Chip Brewer, spins technology


business to Third-Party Model

By exiting periphery businesses, Callaway is allowed to refocus on core products Callaway brand clubs & balls

11

Business Turnaround
II. Revamp Product Lines Wood Clubs and Irons
Woods

Irons

New woods released


under X Hot Brand

Release three new


product lines X Hot
Irons, Mack Daddy
Wedges and Apex Irons

2 Woods rated Gold


by Golf Digest
New clubs priced at a
premium to previous
offerings
Dollar Share increases
from 11% in 2012 to
26% in Q1 2014

Putters

2 Irons rated Gold by


Golf Digest

Announced 2 new
putters for 2014
Versa and Tank lines

After selling TopFlite,


company promoted
Callaway Brand Balls

3 Putters rated Gold


by Golf Digest

Redefines ball
aerodynamics

Increase despite rule


change eliminating
anchor based putters

New irons priced lower


than previous offerings
to appeal to broader
segment

Dollar Share increases


from 27% in 2012 to
32% in Q1 2014

Dollar Share increases


from 16% in 2012 to
20% in Q1 2014

Sources: Investor Presentation, Boyar Report, SEC Filings


122

Golf Balls

Increase despite rounds


played in United States
decreasing

Dollar Share increases


from 7% in 2012 to
11% in Q1 2014

Business Turnaround
II. Revamp Product Lines Sales Impact

2013 % of Total Sales

% Sales Accretion as of H1 2014 compared to H1


2013

Other
21%

13.9%

15.0%
12.0%
9.0%

Wood Clubs
30%

8.9%

8.4%

7.4%

6.0%

Golf
16%

3.0%
0.0%
Wood Clubs

Irons

Putters

Golf Balls

Putters
11%

Sources: Investor Presentation


132

Irons
22%

Business Turnaround
II. Revamp Product Lines Big Bertha Driver
In 2013, Callaway revamps entire product line of clubs and balls
Callaway re-engineers their Big Bertha line of driver, to widespread
approval
Both drivers are making their ancestors proud and living up to the
Big Bertha name by delivering higher ball speeds and distance
while advancing driver technology Golf Digest
3 Drivers rated Gold by Golf Digest
Can adjust for four variables: loft, lie, shot bias, center of gravity
height

Golfers can adjust spin independently of launch angle


Never been done before in any driver

Sources: Investor Presentation, PGA


14

Business Turnaround
III. Implement Cost Cutting Initiatives

Gross Margin Expansion

Mark Leposky, Senior Vice President of Global


Operations, brought in 2012 by Brewer, reduced
global operations spending by 32% over past 2 years

43.9%

41.7%

43-44%

29.8%

Reconfigured companys transportation


network

2007

2012

2013

2014
Guidance

Future
Goal

Global Operations Spending

Eliminated underperforming suppliers


Developed alliances with key suppliers

37.3%

100%

Streamlined global supply chain

100%

89%
68%

50%

Led to cut costs

0%

Allowed the company to manufacture


technologically advanced products and
handle micro launches

2011

Improved customer service levels


Streamlined logistics network 95% of
customer repair orders are returned within
24 hours, compared with just 10% of
orders previously
Company had previously removed innovations
if too costly to manufacture
Sources: Investor Presentation, Boyar Report
15

2012

2013

Business Turnaround
4. Implement new marketing and sales strategy with Harry Arnetts (SVP Marketing & Sales) vision
New focus to find long-hitting, young dynamic professionals
Gary Player

Phil Mickelson

Johnny Miller

Lydia Ko

Henrik Stenson

Patrick Reed

Harris English

2014 Last Week - #3

2014 Last Week - #4

2014 Last Week - #27

2014 Last Week - #57

2014

Past

Arnold Palmer

Sources: Investor Presentation, Boyar Report, PGA


16

Business Turnaround
4. Implement new marketing, sales, & retail strategy
Utilizing new methods such as social
media and video to capture attention
Derives approx. 70% of its sales from
retail distributors such as golf
specialty stores and sporting goods
retailers.
30% Remainder from green-grass
channel or on site pro shops
Previous sales force was compensated
focusing on where 30% comes from,
not 70%
Now, sell based on respective
territories now and compensation
given to sales force
Allow product testing for retail
associates

Sources: Investor Presentation, Boyar Report


17

Business Turnaround

Result: business turnaround is proving to be a success

Golf Club Brand Rating


Overall Quality, Value, Product Innovation & Brand Reputation
9.5

TaylorMade
Callaway
Titleist
Ping
Cleveland
Odyssey
Mizuno
Cobra
Nike
Adams

9.0
8.5
8.0
7.5
7.0
6.5
6.0

99

00

01

02

03

04

05

06

07

Sources: Investor Presentation (Golf Datatech)


18

08

09

10

11

12

13

14

Business Turnaround

Result: business turnaround is proving to be a success


Historical Sales Continuing Business
2nd year of turnaround shows continuing sales growth

$890
$834
$769
2012

2013

2014

U.S. $ Market Share


Longer term market share growth potential as Callaway gains momentum

19.6%

2007

17.5%
2008

17.6%

17.3%

15.1%

2009

2010

2011

Sources: Investor Presentation


19

13.9%
2012

15.1%

14.2%

2013

March YTD
2013

19.3%
March YTD
2014

Business Turnaround

Market Misconception
$11.00

7/24/14 ELY
announces earnings,
beating margin
estimates

$10.00

$9.00

$8.00

4/2/14 ELY
announces earnings,
beating revenue and
earnings estimates

$7.00

$6.00
Sep-13

Oct-13

Nov-13

Dec-13

Jan-14

Feb-14

Mar-14

20

Apr-14

May-14

Jun-14

Jul-14

Aug-14

II. Industry

Industry: Extreme Pessimism


The golf industry isnt doing as poorly as people think
Market Conditions
Net closures are largely market correction from
inflated wealth due to housing bubble
Net closures will continue, but is slowing

Many courses that were opened were tied to


RE development
Harsh weather conditions reduced sales
Golf to be an Olympic Sport in 2016

Callaway 2014 Perspective


We really like the position were in, particularly
in the U.S. and Europe, coming out of Q2
because of our field inventory levels are aligned
with where we want them to be, which gives us
continued upside and potential for the second
half of the year.
-CEO, Chip Brewer
Sources: Investor Presentation, Boyar Report
22

Global Trends
U.S. Rounds Volume% Change Year-over-Year
6.7%
5.7%

2.2%

2.1%

2.6%

0.9%
0.0%

0.3%

(0.1%)

(0.6%)
(1.5%)

(0.6%)
(1.8%)

(2.3%)

(3.0%)

(2.5%)

(4.9%)
1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

YTD 2014 July


Rounds/Day Open Adj.

14 new courses (in 18-hole equivalents) were built in 2014 in the United States and another 157.5
closed their doors, for a net loss of 143.5 courses
U.S. Golf sales increased 4.4% from a low in 2011
Rounds per day open were higher in 2013 than in 2012
Sources: Coalition National Rounds Played Report, PGA Performance Trek, NGF
23

2013

Global Trends
U.S.: Dicks Sporting Goods Case Study

Reduced guidance due to


golf and hunting sales

Q1 sales declined nearly 38%

Q1 sales increased 22%

Poor weather highly impacted first quarter earnings

Dicks CEO not optimistic about golf industry


Dicks accounts for less than 7% of Callaway sales
Taylor Made sales decreased, but Callaway sales improved drastically in the same quarter (22%)
Dicks sales also an issue of execution:

36 stores in PA, worse weather conditions


26 stores in CA, better weather conditions
More dedicated space to TaylorMade, so product flop greatly influenced Dicks sales
Sources: Investor Presentation, Boyar Report
24

Global Trends

Market Trends
International markets appeals to a younger, more female
audience
Between 100 150 courses open globally annually, a 1%
increase in supply abroad each year
Younger average age of viewers of golf are in line with
Callaways new strategic vision to attract younger
audience
The industry has been relatively stable with regards
to number of golfers after the economic crisis.
It is dangerous to read too much into weather and
cyclicality, which are factors in our industry but short
term factors. As recently as 2012, the industry was up
7% to 8%.
Im also very pleased that the team at Callaway has
shown the ability to compete effectively in these types
of environments which bodes well for us.
CEO, Chip Brewer

25

Global Trends
Europe Market Opportunities
UK

Callaway Advantage

Market Trends

Europe

Hard good share through May 2014


was 18.6%, up 555 bps Y-o-Y
Largest demand and supply in UK
Most absolute number of junior
golfers compared to Europe
2nd most absolute female golfers

Highest overall share since 2008 and


highest driver shares since 2003
X2 Hot is #1 selling fairway wood
in the market year to date

Sources: Investor Presentation, Boyar Report


26

Hard good share through May 2014


was 18.6%, up 555 bps Y-o-Y
2011: Europe experienced first
decrease in registered golfer
2013: a slight increase was recorded
in the # of registered players
Increase in emerging countries
Highest percentage of Junior golfers

Callaway was #1 selling brand for


April and May 2014
Europe is up 7% on a constant
currency basis

Global Trends
Asia Market Opportunities
Japan

Market Trends

Callaway Advantage

Korea

Japanese market had


double digit decreases in
sales as of Q2 2014,
partially due to a
consumption tax increase

For Callaway, Japanese


growth is still up 24%
year to date, and market
share for Callaway is still
at an all time high
Callaway is currently #2
selling brand and will
overtake the #1 spot
overall

China

Similar condition as the


U.S. Too many courses
have led to fees and
prices dropping, though
will stabilize soon

Excellent sales growth in


Korea of 63% as of Q1
2014
Lydia Ko, a sponsored
golfer, was placed in
Times 100 most
Influential People

Sources: Investor Presentation, Boyar Report


27

Used to be a ban in 1984


on the sport, but has now
become an aspirational
sport
Number of courses
increases as wealthy take
up sport

39.7MM people watch


golf in China versus
24.8MM in the U.S.
Product is highly desired
as people attempt to
make counterfeits, though
fakes do not hold quality
test

III. Hidden Value

Hidden Value
TopGolf Driving Ranges
Callaway owns an unconsolidated ~17.5% stake in TopGolf, a new and fast-growing spin on the classic driving
range
Bridges the gap between the Bar and Golf experience
Currently operate 13 locations in the U.S.

1 million people have played an event at a TopGolf location since 2012


84% of players have never played golf before
40% of attendees are women
Expansion plan to 50 locations by 2017

29

Hidden Value
Other Hidden Assets
Net Operating Losses

Real-Estate Leasebacks

Long-lived unprofitability has allowed Callaway Golf


to accumulate a large amount of NOLs

Currently holds $429 million of NOLs, primarily


in the U.S.

In Q1 2014, Callaway had its NOLs valued for


~$95 million

As the company continues to succeed with its


turnaround there NOLs will allow it to greatly
offset its tax balance, unlocking shareholder
value

Callaway has recently began aggressively monetizing its


real estate portfolio
Sold building in Gloversville, NY in 2011 for
~1m
Completed lease-back transactions on:
3 buildings in Carlsbad, CA in 2011 for
~$18m
Golf ball manufacturing plant in Chicopee,
MA in 2013 for ~3.5m
Company currently owns 2 buildings in CA which it
plans on performing lease-back transactions on
Combined sq. ft. of ~269,000

30

IV. Valuation

Valuation
Callaway Assumptions
7.0%

46.0%

6.5%

6.4%

44.0%

6.0%

5.6%
42.0%

5.0%

4.0%

3.0%

4.0%
3.7%

40.0%

3.7%
38.0%

3.0%
2.7%

36.0%
2.0%

34.0%

1.0%

32.0%

0.0%

30.0%
Downside

Base
YE 2014

Upside

Long Term CAGR

Gross Margin

Sources: Investor Presentation, Boyar Report


32

Guidance
Opex Margin

Valuation
TopGolf & NOL Valuation
Top Golf Valuation

NOL Valuation

Bear

Base

Q2 2014 Locations
2017E Locations
Average Rev/Location
Revenue
Average EBIT Margin
Revenue
EBIT
TopGolf @ 1.75x Sales
TopGolf @ 8.0x EBIT
Average Enterprise Value
Discount Factor
Discounted EV

13
40
6
240
23%
240
55.2
420
442
431
0.7350
317

13
45
8
360
25%
360
90
630
720
675
0.7350
496

Callaway Stake
S/O
TopGolf Stake per Share

17.50%
77.3
$0.72

17.50%
77.3
$1.12

Upside
Bear
13 Implied NOL Valuation
47
50 S/O
77.3
9 NOL Value per Share
$0.61
450
27%
Valuation
450
121.5 Current Share Price
788 Callaway Standalone Value
972 TopGolf Stake Value
880 NOL Value
0.7350 Implied Share Price
647 % Upside / Downside
17.50%
77.3
$1.46

Weighted Average Price


Weighted Average % Return

Sources: Investor Presentation, Boyar Report


33

Base

Upside
63
95
77.3
77.3
$0.82
$1.22

$7.42
$8.34
$1.12
$0.82
$10.28
39%
$8.10
36%

Thesis

What is not priced in?


Business:
Turnaround
New Management Team
Product Refocus
Cost Cutting

Industry:
Excessive Pessimism
U.S. Market
International Market

34

Hidden Value:
Optionality
Top Golf
NOLs
Sale Leasebacks

Q&A