Description

We believe an investment in DriveShack (DS) offers a great long-term opportunity to participate in a very popular, growing new entertainment concept with a 4-year fair value of about $19, offering 300% upside or a low 30s% IRR.

Over the past couple years, DS has undergone a dramatic transformation from an operator/owner of golf courses to an operator of entertainment golf venues called DriveShacks, pretty much the exact same concept as TopGolf. Through the transformation process, DS has sold or is in the process of selling all but two owned golf courses in 2018/2019 for gross proceeds of $180-200m with the additional two courses to be sold in a couple years for another $55m or so. They plan on plowing the proceeds into opening up over 20 DriveShack locations between now and 2022, with the first already open in Orlando and expected to be EBITDA positive in 2019. They also hired the former CEO of TopGolf, Ken May, in late 2018 who took TopGolf from 7 to 34 locations and 2,000 to 12,000 associates (including franchisee associates). Before TopGolf, he had been at FedEx for 25 years, starting off unloading packages and end up as CEO of FedEx Kinkos with 20,000 people working for him. Wes Edens, the founder of Fortress, serves as Chairman of DS and has been buying large amounts of stock in the market at $4-6, now owning just over 10% of the company. DS has said Fortress’s real estate group helps with analyzing demographics for sites and procuring/negotiating new locations. DS also has a significant NOL from its previous operations which means new DriveShack related profits will be shielded from taxes for a very long time.

TopGolf – TopGolf has 52 locations with 14 additional ones under construction and operates in the US, Australia and the UK. Google DriveShack or TopGolf for more information but it’s essentially a bowling alley meets a driving range where groups of friends can sit around couches, order food/beverages and compete by hitting golf balls at different obstacles. The stats on the number of millennials and non-golfers that the concept has attracted are pretty interesting to see.

From TopGolf’s most recent funding round presentation:

Topgolf averaged 45,600 visitors per day with total visitors hitting 16.6 million in 2018. Of those visitors, 68% were male and 32% were female. 16% of Topgolf visitors were under 17 years old, 54% were between 18-34, 14% were between 35-44, 14% are 45-64, and 2% were over 65.

The average group spent two hours at Topgolf and had four people at their bay. Topgolf attracts a wide range of golfers with 51% of its players being non-golfers. 27% were occasional golfers (1-7 rounds annually), 14% were moderate golfers (8-24 rounds annually), and 8% were avid golfers (25+ rounds annually).

TopGolf’s latest funding round (Series F) was at a $2.1bln valuation and included Callaway Golf (already an investor beforehand) and Fidelity.

https://www.sec.gov/Archives/edgar/data/837465/000119312517378726/d474526d8k.htm

TopGolf’s current fundraising round is at a $2.7bln valuation and it’s important to note that TopGolf operates a franchise model while DriveShack will build corporate owned facilities.

The unit economics of a DriveShack/TopGolf location are also really good, assuming the business isn’t a fad, which I don’t think it is having been a golfer since childhood and firsthand, experiencing TopGolf.

DriveShack estimates about $30m to build a new location with an 18-month period to hit steady state revenues of about $20-25m and a 30% EBITDA margin. We estimate maintenance capex in the several hundred $k level, thereafter, thus a very good ROIC, again, assuming the concept isn’t a fad.

In their Q4 earnings call, DS also discussed a smaller, 72-Bay venue (as did TopGolf, recently) that DS thinks will double their addressable market to smaller cities, too at unit economics of $15-20m in revenue and 25% EBITDA margins.

As previously discussed, DS has one location open in Orlando and has plans to open locations in Raleigh, West Palm and Richmond in 2019. They also won the contract to manage a driving range on Randall’s Island with a DriveShack to be built alongside the range in 2020. They will also construct locations in Chicago (downtown), Portland Oregon, Newport Beach and Houston. The company estimates that they should have over 20 locations open by 2022 (we assume these are all 92-100 bay locations and any 72 bay will be in addition to the first 20+).

American Golf – in the transition of their business model to operating DriveShacks, as previously discussed, the company is selling all of their owned golf courses and transitioning to management agreements to operate courses. This significantly improves the economics as they are no longer subject to the high fixed cost earnings volatility of running a poor business like a golf course. DS has guided to this business generating about $10m in EBITDA with limited capex on their current load of courses managed and low single digit revenue growth based on the addition of new managed contracts.

The rub here really lies in two issues, (1) maintaining high customer traffic and utilization, ie that this business is not a fad so the ROICs stay intact and (2) the ability to adequately finance the high construction cost of a large number of locations as a $300m market cap/$500m EV company in order to grow earnings power and ‘land grab’ the right locations quickly enough to mitigate additional competition outside of TopGolf.

While we believe this is a great concept and the risk of (1) is low, (2) is a bigger risk but we believe there are few better owner/managers to navigate this risk than Wes Edens and Fortress. While the company hasn’t disclosed how they will fund the growth, they did say in the most recent earnings call that they will do so creatively, though we estimate a 6.5% interest rate on plain vanilla corporate debt (probably backed by individual locations) to fund growth without any covenants on overall EBITDA given how poor blended EBITDA looks as they build new locations that burn cash for the first year or so.

Valuation/Modelling:

In our model, we assume the midpoint of company guided revenue and 30% EBITDA margins, along with a 18-month timeline to reach mature EBITDA. We also assume locations are built along the company’s expected timeframe of about 4 in 2019, 5 in 2020, 10 in 2021 and 4 in 2022 to get us to 23 locations operating by the end of 2022. However, given the 18-months to steady-state EBITDA, we must look at 2024 EBITDA and FCF to assess true earnings power, which we discount back to today. We also assume cash from the proceeds of the golf course sales are used to pay for new DriveShack locations. Finally, we assume about $12m in annual corporate overhead and no cash taxes.

While we do believe they will continue to build locations past 2022, we stop construction in 2022 in the model below in order to assess the steady-state FCF yield at maturity with 23 locations.

The assumptions above yield about $1.60 in FCF/share in 2024, offering upside to $19 at 12x FCF from $4.75 today or 300% upside (not discounted).

Catalyst

The company continues to build new locations, economics are in-line with their targets and earnings power grows.