Description

Situation Overview:  Drive Shack (DS) has been written up twice by greenshoes93 in 2019 and in 2020 pitching DS’s preferred. Today, the company has shifted capital allocation priorities to building its Puttery venues – a lower capital and higher return concept that can potentially offer multiple years of investment opportunity. Please refer to greenshoes93’s writeup for the history and evolution of DS from controlling the traditional golf business to its current state.

What does Drive Shack Do?

DS is an owner/operator of golf-related leisure and social entertainment venues and courses with food and beverage offerings. Their three main operations are:

• American Golf Co. (AGC): AGC is one of the largest operators of traditional golf courses in the US. Under AGC, DS operates 60 golf courses.  The majority of their courses (44) are located in California. AGC serves ~3 million visitors per year and generates steady cash flows. Over the past years, management has sold practically all of their owned locations and the cash was used to fund the development of their Drive Shack venues. I expect traditional golf to generate revenue of ~$250-$260M (~$210M Golf + ~$50M in F&G) and EBITDA of ~$20.

• Drive Shack Venues: Drive Shack venues are very similar to TopGolf.  The company has 4 venues today. These are decent venues that are expected to deliver 10-20% returns. Over the past few quarters, management has shifted its capital allocation from these Drive Shack venues to prioritizing its new Puttery venues concept, which offers a higher return investment (+20%) with a lower capital requirement (~$10M) and shorter build time (2-3Qs).

• Puttery Venues: This is the exciting part of the DS evolution. Puttery offers Urban Mini Golf venues with food and beverages to Millennials and Urban Professionals. These venues are smaller (15k-20k sq. ft.) and can be located in more urban areas.  Puttery is an already proven concept that DS is bringing from the UK. 

Why Do I Like Drive Shack?

1. Attractive Unit Economics: The exciting part of the Drive Shack business is the Puttery Venues.  A typical Puttery venue (15K - 20K sq. ft.) that cost between $7M - $11M is expected to deliver an attractive EBITDA between $2M - $3M (over +20% development yields).  

This is still a concept but modest assumptions of average check per player (~$20 - $25) and reasonable volume assumptions support management’s expectation. The return of corporate events, in addition to private events, birthday parties, etc. can get performance in the upper range of expectation. DS’ Puttery venues target the more affluent customer base and should expect average check and F&B revenue mix slightly higher than similar operations.  See Appendix 1 and 2 for revenue mix and profitability of similar assets.

DS is planning to begin operation of two of its Puttery venues by this summer - the Charlotte and Dallas venues are complete and currently recruiting employees. The Washington DC and Miami locations should also be opening in 2H2021.  Another 3 Puttery venues should be nearly complete in 2021 and management is targeting an additional 10 venues to be opened in 2022. 

If successful, these 17 Puttery locations should be contributing ~$50M of EBITDA run-rate (vs market cap of ~$260M) by the end of 2022.  DS can then continue to recycle the cash flows from its operations and open as many Puttery Venues as possible over the next few years.  

2. Long Runway with Reinvestment Opportunities: While opening 17 venues is more than sufficient to test/prove the concept and keep management busy over the next few quarters – DS has a robust and growing pipeline of future venues in prioritized markets. If successful, they should have plenty of room to allocate capital at attractive returns.  Accommodating landlords and the trend towards leisure and experience entertainment should also help as a tailwind to expanding these venues in many markets over the next several years. Unlike the Drive Shack concept where DS is following TopGolf, the company has an opportunity to be the leading brand in Puttery within the US. This should also help in finding attractive locations to develop.

Why do I think it will be successful?  The concept is already fairly successful in the UK. Junkyard Golf, Swingers, and Puttshack are already seeing success in the concept and planning to expand in the UK.  Junkyard Golf sees potential to open ~40 venues across the UK; Puttshack plans to open 25 venues over the next 5-years; Swingers is backed by Cain International (private equity) to expand in the UK and North America.

As a potential right tail surprise - Bowlero, the operator of bowling centers, has 321 locations in North America and serves ~25 million guests per year – nearly 75% of which are in the Top 25 MSAs. These venues have been growing at an average 4-year SSS of ~5%.  There are ~4,000 bowling centers in North America.  DS is going after a more specific and smaller market today and is different from bowling, but it helps demonstrate the size of the US market for leisure and experience entertainment venues.

3. Strong Management Team:  DS is led by CEO Hana Khouri.  Prior to joining DS, Hana was the National and International Director of Operations at Top Golf. She also spent a year as Wes Edens’ Chief of Staff at Frotress. She has solid experience in opening and running entertainment venues – she has opened over 20 venues while at TopGolf.  In addition, her capital allocation shift to prioritizing investments in the Puttery Venues has been a very promising start. 

She clearly has impressed and earned the trust of Wes over the time she recruited, and her time as his Chief of Staff.  Wes Edens, the founder of Fortress, is the largest shareholder of DS (~8%) and serves as the Chairman of DS.  Hana, at ~38 years old, is young, already very well accomplished, and can grow DS into an impressive franchise. 

4. Balance Sheet and Ability to Finance Growth:  DS currently has ~$80M in cash and a modestly levered balance sheet.  There should be enough cash on hand to complete the 2021 venue development but will likely need to raise capital at some point in 2022.  By then, we should get a good look at how the 4 open Puttery venues are performing. If successful, my expectation is that DS will likely have decent access to the debt capital markets. After that, cash flow from the traditional golf and as they mature, cash flow from the Drive Shake and Puttery venues should also start contributing to cash to fund future venue developments. With ~$10M development cost per venue, it will take a couple of years before the operation becomes self-financing. Consolidated P&L will also probably not print large EBITDA performance over the next few years as they will likely continue to have pre-opening expenses for their new venues.

Risk to Consider: The outcome of DS will be very path dependant on the success of the first few Puttery venues and how they fund 2022 development costs. Dilutive equity capital raise is a probable senario if the concept remains promising but DS has difficulty accessing the debt capital markets. However, if the Puttery Venues concept fails to deliver the expected results - the modest capital requirement (~$10M) and short development time of these venues (2-3 quarters), should give the board an opportunity to delay or terminate the Puttery Venues program before raising dilutive capital and sinking too much cash into a mediocre business. 

5. Valuation:  DS is currently trading around a $290M EV.  Management is driving towards operating 17 Puttery venues and 5 Drive Shack venues by the end of 2022; these venues are expected to contribute EBITDA of ~$65-$70M plus an additional ~$20M from the traditional golf. Depending on how management funds the 2022 venue development (debt or equity), I estimate the DS stock should be worth around ~1.5x total revenue - or between $4.50 to $4.00 by next year (+40% upside).

Size appropriately. This is a proven concept in the UK but is still an early stage concept in the US and for DS. The outcome will be highly path dependant. I expect a limited downside risk if the concept or the balance sheet fails to support the expected outcome. However, if successful, which I expect them to be, DS should enjoy a long runway to deploy capital and create value over the next years.

Appendix 1:  Revenue Mix of comparable operation. TopGolf in the US; Puttshack and Junkyard in the UK

Appendix 2:  Profitability and cash flow conversion of comparable assets

Source: Bowlero/ISOS Investor Presentation July 2021

Catalyst

1. Strong opening and execution on the two Puttery venues (Dallas and Charlotte) this summer
2. Opening the DC and Miami locations by the end of 2021
3. Clarity on how management can fund 2022 development spending.  Points #1 & #2 above would impact the options and path the company takes on the source of capital.