Value Investors Club / DRIVE SHACK INC (DS)

Description

Drive Shack, Inc.

Some VIC readers are already somewhat familiar with Drive Shack (DS) because it up into

recently was known as Newcastle Investment Corp. Newcastle started out as a mortgage REIT

managed by Fortress Investment Group. Newcastle cratered during the financial crisis and

slowly worked its way back. Starting in 2013, Newcastle begun to spin assets off into more

focused companies. They include New Residential (NRZ), New Media (NEWM) and New

Senior (SNR). Assets now left at Newcastle include real estate debt and American Golf, a golf

course owner and operator. In December of 2016 Newcastle converted to a C. Corp., in order to

more efficiently invest in growth, and changed its name to Drive Shack. It has been selling its

real estate debt assets and will be largely out of that business this year. The company will then

be solely focused on golf.

I think the company is fairly valued today based on private market values for golf course assets

and net cash on the balance sheet (assuming liquidation of debt assets and liabilities) While

there is likely some opportunity to continue to create shareholder value in the traditional golf

course business through management and opportunistic purchases, I don’t think that in itself is a

compelling enough investment opportunity at this price. The larger value creation opportunity

likely lies with a new golf related concept that is part of DS’s growth plan.

Drive Shack Concept

Some may be familiar with Top Golf. DS plans to roll out a similar concept. Top Golf, a

concept born in England in 2000, is a modified driving range with a restaurant and bar. The

driving range extends roughly 200 yards and has various targets. People are able to play games

against each other, similar to say bowling. The balls have chips that allow shots to be scored

automatically. Top Golf has 33 locations with another 10 plus under development. Some of the

more interesting statistics are that 45% of guests play traditional golf once a year or less and 68%

of guests are 34 years of age or younger. This concept has proven to appeal to a younger

demographic at a much higher rate than traditional golf and to golfers and non golfers alike.

The economics of the facilities are very compelling. The cost to develop ranges from $15 to $25

million and they generate in the range of $3 million to $6 million in EBITDA. Not many retail

concepts today have economics this good. We can get an idea of the value creation at Top Golf

through looking at Callaway (ELY) a public golf equipment manufacturer. Starting in 2006

ELY invested $55 million in Top Golf for approximately a 20% stake. In 2015 Providence

Equity Partners acquired a minority stake in Top Golf that valued the company at $1.4 billion,

which marked ELY’s stake at approximately $280 million or 5X its original investment.

You can become more familiar with the concept here: https://topgolf.com

Drive Shack has a current pipeline of 25 sites and its first location is under construction in

Orlando, FL. The 66,000 square foot dining and entertainment complex is located in the 300

acre Sports and Performance district. It will have 90 outdoor driving bays, a restaurant, bar,

shops, lounge and a rentable event space. The facility is scheduled to open in late this year.

American Golf

Newcastle Investments made a $110 million debt investment into American Golf in 2006. In

December 2013 it restructured the company's debt and as a part of that acquired the equity in the

company. Since its acquisition in late 2013, EBITDA is up 50%. American Golf operates 78

golf courses across thirteen states with the majority of the courses (52) being in California. It

owns 27, leases 41 and manages 10 courses. Current EBITDA is approximately $28 million

with management projecting a 9% increase for 2017.

American Golf’s owned/leased properties include 19 private courses and 48 public courses. The

private courses are operating at about 82% capacity (membership), which has increased each

year since the purchase. American Golf created a “Players Club” for the public courses and

membership has doubled over the last year to 38,000 members. Each member pays $35 per

month to have access to the courses. This program has helped drive the improvement in the

bottom line over the past couple years and should continue to into the near future.

Golf went through a period of overbuilding in the 2000’s that resulted in overcapacity. Over the

last several years the number of courses has declined from a peak of 16,200 in 2006 to 15,300

today. Meanwhile, rounds played peaked in 2000 at 518 million but has stabilized in the range

of 460 million over the last several years. Certainly the trend toward fewer courses and stable

play is a decent backdrop for continued moderate improvement in this side of the business.

Additionally, there may be opportunities to purchase, lease or manage new courses and improve

cash flows like they have done running the existing portfolio since 2013.

Capital Structure

When DS fully liquidates its remaining debt assets it will have approximately $250 million in

cash. Debt will consist of $102 million term loan at labor plus 4.70% with matures in June 2019

with two one year extension options available, a $52 million in junior subordinated note and $62

million in several preferred stock issues with a coupons averaging in the range of 8.5%. The

current market cap is $270 million. Debt plus equity minus the cash puts the current EV at $236

million. With $250 million of cash on the balance sheet, DS will have plenty of pre-funded

ability to grow the Drive Shack concept over the next several years.

Future Potential Value

Let’s look at what DS might look like in five years.

American Golf - The existing golf business generated $28 million in EBITDA in 2016 and is

projected to generate around $30 million this year. Golf course companies trade in the private

market for 8X to 9X EBITDA, putting the value around $255 million. To be a bit conservative

we will hold that value at that level for the five year analysis and only add free cash flow to the

future value, which for a five year period we put at $40 million.

Drive Shack Concept - Making the assumption that the Drive Shack economics are as forecast by

the company, in five years I’ll assume they have ten units up and running using $200 million of

the current cash (existing and soon to be converted). Using the lower range of management

estimates I’ll assume these units generate an average of $3.5 million run rate each of EBIDTA

for a total of $35 million. Given the economics and growth profile I give this business a multiple

of 12.5X, for a value of $440 million.

So in total, $255 for American Golf, $440 million for the Drive Shack business and $130 million

in cash ($50 million of original cash, $40 million in free cash from American Golf and $40

million in free cash from Drive Shack, equaling a total asset value of $825 million, less $216

million in debt and preferred stock, leaves an equity value of $609 million ($8.70 a share)

compared with a value today of $270 million ($4.00 a share) a return of 117%.

Management.

Fortress Investment Group (FIG) controls DS through at management agreement. Wes Eden’s

the founder of Fortress, has purchased 7% of DS in the open market since December 2016. This

is not a large part of his net worth by any means but does signal his interest in the DS concept. It

could be said that the management agreement is favorable to Fortress. They were paid $10

million in 2016. The management agreement however does have a cancellation provision, so

engaged shareholders could have some opportunity to negotiate better terms or a change

altogether.

From the 10K - Drive Shack Inc. is party to a Management Agreement with FIG, LLC, its

Manager and an affiliate of Fortress, which provides for automatically renewing one-year terms

subject to certain termination rights. The Manager’s performance is reviewed annually and the

Management Agreement may be terminated by Drive Shack Inc. by payment of a termination

fee, as defined in the Management Agreement, equal to the amount of management fees earned

by the Manager during the 12 consecutive calendar months immediately preceding the

termination, upon the affirmative vote of at least two-thirds of the independent directors, or by a

majority vote of the holders of common stock.

Summary

As the balance sheet get further cleaned up over the next year as the remaining debt assets are

sold the company will present a more easy to follow picture financially and a cleaner narrative.

That along with new strategy, focus and potential buzz and good results surrounding the opening

of the first Drive Shack could provide a boost to the stock. Longer term, incremental gains in the

traditional golf course business along with a high growth Drive Shack business could result in a

very good return (100% plus) over the next five years.

I hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Opening of the first Drive Shack in Orlando, FL in late 2017

Transition to a balance sheet soley related to golf.

Growth of Drive Shack concept

show sort by

			2017	2018
Price:	4.02	EPS	.49	.41
Shares Out. (in M):	69	P/E	8	10
Market Cap (in $M):	270	P/FCF	25	25
Net Debt (in $M):	-30	EBIT	20	20
TEV (in $M):	240	TEV/EBIT	12	12