ACUSHNET HOLDINGS CORP GOLF
January 06, 2017 - 4:42pm EST by
Azalea
2017 2018
Price: 19.03 EPS 0 0
Shares Out. (in M): 74 P/E 0 0
Market Cap (in $M): 1,410 P/FCF 0 0
Net Debt (in $M): 305 EBIT 0 0
TEV ($): 1,859 TEV/EBIT 0 0

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Description

Investment Thesis:

The recent IPO calendar does not typically represent a source of prosperous investment ideas for value investors. However, I believe the October 2016 IPO of Acushnet Holdings Corp. (“Acushnet,” “Golf,” or “the Company”) represents a rare exception. Although shares of Acushnet are up ~11% over GOLF’s formal IPO price, the IPO was priced at an ~25% discount to the mid-point of its estimated offering range (shares currently trade at an ~16% discount to the initial offering range). While some may view the tepid demand for the Company’s shares as an ominous sign, I believe the poor investor reception to the IPO is not a reflection of the Company’s fundamentals and outlook, but is primarily driven by a desire to provide liquidity to financial investors (who sold a portion of their shares in the offering) within a predetermined time span. It’s prudent to be skeptical when insiders are selling shares, but it should be noted that while GOLF’s financial Investors pared their Acushnet stakes in the IPO, the Company’s strategic owner (Fila Korea) deployed ~$265 million to significantly increase its equity stake (to 53% from 33%) in the Company at a premium, albeit a modest one, to the IPO price in a related transaction with the financial investors. Additionally, a number of Acushnet’s top insiders (management and directors) personally acquired $3.6 million of GOLF’s shares at the IPO price including $1.2 million deployed by the Company’s long time CEO Wally Uihlein. Acushnet offers a number of attractive investment attributes including:

 

  • Strong Base of Recurring Revenues – During 2015, GOLF generated 43% of its revenues from consumable products (golf balls and golf gloves) that provide the Company with a strong base of recurring revenues. Acushnet’s Titleist Golf Balls segment (36% of sales) boasts superior profitability as it posted an operating margin of 17.3% in 2015, more than 600 basis points above the Company average.

 

  • Strong Brands – GOLF boasts an extremely strong product portfolio including a dominant position in golf balls (~50% global share) and a #1 market share position in a number of key categories including golf shoes and golf gloves. Acushnet’s brands include Titleist, FootJoy, Scotty Cameron, and Vokey Design.

 

  • Attractive Target Market – Acushnet’s target market is the ~8 million global dedicated golfers that spend a considerable amount of time and money improving their games. These dedicated golfers play 25 or more rounds per year and spend an average of $1,200 per year on their game (includes balls, clubs, gear and apparel, but does not include greens fees).

 

  • Favorable Customer Mix Supported by Exclusive Relationships – The success of Titleist’s Pro V1 and Pro V1x golf ball franchise has enabled GOLF to deepen its relationships with on course golf shops (these pro shops accounts for more than 50% of GOLF’s U.S. sales) via exclusive relationships that has created a meaningful entry barrier.

 

  • Improving Industry Fundamentals – Acushnet currently operates in an out of favor industry, but there are some encouraging signs including an increase in rounds played in each of the past two years (in the U.S.) and increased participation among younger players. Demographic factors are also favorable as the retiring baby boom generation should provide a sustained tailwind with rounds played increasing significantly during retirement.

 

  • Top Notch Management – Acushnet has a deep and talented management team and is currently led by Wally Uihlein, who has been with the Company for the past 41 years and has served as its President and CEO since 1995.

 

  • Hidden Assets – The Company owns most of the real estate associated with its operations including its corporate headquarters in Massachusetts and a 30 acre testing facility near San Diego, California.

 

 

Why Does this Opportunity Exist?:

 

Although the timing of Acushnet’s recent IPO was inopportune, I believe it has likely created an opportunity for investors to own a high quality business at a favorable valuation. As the ink was drying on the Company’s initial S-1 filing in June 2016, Golfsmith, the largest specialty golf retailer in the U.S./North America, filed for bankruptcy in August 2016. In addition to the Golfsmith news, there have been a number of other developments recently that have cast a pall over the industry including Nike’s exit from the golf equipment business (clubs and balls), the bankruptcy of a number of other golf/sporting goods retailers (Sports Authority, Sports Chalet, Lumpy’s, etc.) and Adidas’ decision to pursue a sale of most of its golf business (TaylorMade, Adams, Ashworth) owing to poor recent results. The continued drumbeat of golf course closures has also likely weighed on investor sentiment towards the golf industry. Additional factors that likely contributed to weak demand for GOLF’s shares include the limited float (just 22.2 million shares out of ~74 million were sold in the IPO with the market cap based on the float effectively placing Acushnet into micro cap territory) and uninspiring recent results from Acushnet’s high margin golf ball business. While Acushnet could have decided to not proceed with the offering given the weak demand, there was likely a strong desire for liquidity from Acushnet’s financial investors. During an October 2016 interview with Golfweek, Acushnet COO David Maher commented on pursuing an IPO amidst tough industry conditions and stated, “First and foremost, Acushnet was acquired in 2011 by Fila and some private equity partners who were investing money on behalf of the Korean Pension Fund. We knew when that deal happened that it had a five-year redemption time stamp. So, we knew we would be at this point, and this has been planned for a long while.” Acushnet CEO Uihlein also commented on the topic in early 2015 when the Company first began publicly exploring an IPO stating, "A large amount of our current private equity originated with the Korean Pension Fund. Those monies are solicited with promises of a return, a return which is tied to an exit.” In my view, the desire for liquidity coupled with an opening, albeit a small one, in the challenging IPO market, likely compelled Acushnet to proceed with the offering.

 

While the negative industry developments are worth monitoring, I believe that they should be beneficial for Acushnet’s business longer-term. The rationalization of both manufacturers and retailers bodes well for Acushnet as it will likely lead to a less promotional environment going forward. Although the closure of golf courses makes for interesting headlines, it is important to keep this supply reduction in perspective. Since 2006, which represented the peak level of golf courses in the U.S., the supply has contracted by just 5% (through the end of 2015), which is a far cry from the 40% growth during the preceding two decades. It also warrants mentioning that during the boom years, there were a number of golf courses built to help sell houses (many developers often built golf courses to satisfy open space requirements) rather than based on any rational expectation of future demand/profit.

 

The results of Acushnet’s crown jewel golf ball business have been uninspiring in recent years including a 3.1% constant currency revenue decline during the first nine months of 2016. However, it should be noted that Acushnet introduces new versions of its Pro V1/Pro V1x line of golf balls in odd-numbered years so the 2016 performance is a bit misleading. The 2017 introduction of the latest version should provide a boost to the Company’s golf ball business. In addition, the recent decision by Rory McIlroy, who is currently the world’s # 2 ranked golfer, to start using Titleist balls (and wedges) following Nike’s exit, could also provide a catalyst for Acushnet’s golf ball business. Notably, Mr. McIlroy is not (currently) being paid to play with the Company’s products, which is a strong testament to the product’s quality/performance. It also warrants mention that there has been a great deal of consumer interest in a private label golf ball recently introduced by Costco that has created some uncertainty about the continued dominance of Titleist golf balls. However, I believe that the enthusiasm for this Costco offering will likely prove short-lived (more on this development later).

 

Finally, while the Titleist and FootJoy brand names are well known among golfers and non-golfers alike, the Acushnet name is fairly obscure even among the sport’s biggest enthusiasts. In fact, I wouldn’t be surprised if there were multiple professional golfers that couldn’t associate Acushnet with its marquee brands even though they are paid to endorse the Company’s products.

 

 

History:

 

Acushnet was founded in 1910 by Phillip W. “Skipper” Young and two of his MIT college colleagues. The business was initially known as Peabody, Young & Weeks, but later became the Acushnet Processing Company, named after the town the business was established in. By 1918, the Company was the largest supplier of uncured rubber, but the Company shifted its focus in the early 1920s following a collapse in rubber prices and began producing a number of molded rubber products including bathing shoes and caps, toy boats, and hot water bottles. The Company’s golf origins date to 1932 when Skipper Young was playing golf at the New Bedford Country Club and missed a crucial putt and suspected that something was wrong with his golf ball as he believed the putt was well struck. Young had the ball x-rayed at a local hospital, which revealed that the ball’s core was, in fact, off center. Following his discovery, Young set out to develop the highest quality and best performing golf ball in the world. It took Young three years to perfect the golf ball and in 1935 the first Titleist golf ball was introduced to club professionals and professional golfers as the best ball ever made. Interestingly, even today, every Titleist golf ball is x-rayed as part of a process check that was initially implemented by Young.

 

From its humble beginnings, Titleist has become the dominant player in the golf ball business as Titleist golf balls have been the #1 ball in professional golf for the past 68 years. The Company’s current flagship golf ball (Pro V1) was introduced in 2000 (Pro V1x introduced in 2003) and is used by two out of every three golfers across the major worldwide professional tours (PGA, LPGA, European Tour, etc.), more than five times the nearest competitor.

 

 

While these statistics are impressive, what’s even more noteworthy is that usage of Titleist golf balls among top amateur golfers (those that are not able to receive compensation for playing the Company’s products and typically pay for the product), is even higher.

 

 

Other key milestones in the Company’s history include:

  • American brands (predecessor to Fortune Brands) acquired Acushnet in 1976
  • In 1985 the Company acquired FootJoy
  • In 1996 Acushnet acquired Cobra Golf, which was sold to Puma in 2010

 

Business Overview:

 

Acushnet is the global leader in the design, development, manufacture and distribution of performance-driven golf products, which are widely recognized for their excellent quality. Acushnet boasts a strong portfolio of globally recognized golf brands including the Titleist (#1 ball in golf) and FootJoy, which is the #1 shoe and #1 glove in golf and is also a leading global golf wear brand. Acushnet has maintained its market leading position for a very long period of time with Titleist claiming the distinction as the #1 ball on the PGA Tour for the past 68 years and FootJoy holding the top spot for shoes (past 6 decades) and gloves (past 3 decades). In addition to its flagship brands, the Company also commands the #1 wedge on the PGA Tour via its Vokey Design Wedges and its Scotty Cameron putters are a leading putter on the PGA Tour.

 

The following provides a breakdown of the Company’s sales by product group, operating segment and geography:

 

 

 

 

Recent Background and Ownership Structure:

 

During 2010, Acushnet’s former parent Fortune Brands became the target of activist investor Pershing Square/Bill Ackman. At that time, Fortune Brands was a conglomerate consisting of a spirits business (Jim Beam), a home and hardware business (Moen, MasterLock, etc.) and a golf business (Acushnet). Ostensibly under pressure from Ackman, Fortune brands announced a plan in late 2010 to separate into three businesses. As part of the decision to streamline its operations, in 2011 the hardware business (Fortune Brands Home and Security) was spun off and Acushnet was sold to a consortium led by Fila Korea and Mirae Asset Private Equity, the largest private equity firm in South Korea. The consortium acquired Acushnet for approximately $1.2 billion valuing the business at approximately 10.4x EBITDA. Acushnet’s management team, led by its long-time CEO Wally Uihlein, remained with the Company following the transaction.

 

On November 2, 2016, Acushnet completed its IPO at $17.00 per share selling a total of 22.2 million shares to the public including 2.9 million of shares sold pursuant to the full exercise of the underwriters’ option to purchase additional shares. In conjunction with the IPO, in a separate transaction, Fila Korea (via wholly-owned subsidiary Magnus Holding Co.) agreed to purchase 14.8 million shares (~20% of Acushnet’s outstanding shares) for ~$265 million from a group of financial investors at 1.05x the IPO price. As a result of the transaction, Fila Korea's stake in Acushnet increased to 53% from 33%. The following provides an overview of the Company’s ownership structure following the IPO, the aforementioned Fila Korea Transaction, and a series of other transactions including the conversion (to equity) of the Company’s Convertible Securities (Notes and Preferred Stock):

 

Acushnet Ownership Structure Post IPO and Related Transactions

 

 

 

It is also worth highlighting that several members of Acushnet’s top management and board also acquired shares during the IPO, purchasing $3.6 million of shares including $1.2 million deployed by CEO Uihlein.

 

 

Attractive Target Market:

 

Although the global commercial opportunity for golf encompasses more than $85 billion annually, Acushnet’s addressable market, comprised of golf equipment, golf wear and golf gear, represents a $12 billion market (at retail) or approximately $8 billion of wholesale sales. The U.S. represents more than 40% of GOLF’s addressable market with Japan and Korea collectively accounting for about 30%. While there are approximately 50 million golfers worldwide that play over 800 million rounds annually on more than 32,000 golf courses, Acushnet’s target market is the approximately 8 million dedicated golfers globally (~4 million in the U.S.) who devote considerable resources (time and money) towards improving their game. These dedicated golfers play 25 rounds or more a year and spend an average of $1,200 a year on their game.  Outside of the U.S. the dedicated golfer in markets such as Japan and South Korea typically spend double that amount. Although dedicated golfers in the U.S. represented just 15% of U.S. golfers, Acushnet believes they accounted for more than 40% of rounds played and approximately 70% of all golf equipment and gear spending in the U.S. during 2014. While the number of rounds in the U.S. played declined between 2006 and 2014, Acushnet believes that the number of rounds played by its target market of dedicated golfers was relatively stable during the overall industry decline.

 

 

Consumable Products Drive Recurring Revenues:

 

Golf equipment manufacturers are not necessarily associated with delivering strong levels of recurring revenues. However, Acushnet is an outlier since it derives a large percentage of its revenues from consumable products including golf balls and golf gloves. During 2015, these products accounted for 43% of Acushnet’s overall sales. Golf balls are truly a consumable product as it is estimated that American golfers lose ~300 million golf balls each year. Even if golf balls are not lost during a golfer’s round, they are subject to quick obsolescence during the normal course of plays since they are typically struck by golfers at swing speeds upwards of 115 miles per hour. Acushnet commands an approximate 50% share of the top grade wholesale golf ball (~$1 billion) market and a near dominant position (~66%) of the premium performance segment, which represents roughly half of the top grade market. It is very rare to find the premium priced product (Titleist golf balls retail for ~$48 per dozen representing an over 20% premium to many of its competitors’ premium offerings) in a particular industry is also the volume leader. During 2016, Titleist launched the MyProV1.com online shop to enable consumers to create and purchase their own personalized Pro V1 golf balls. Acushnet believes the website will further drive repeat purchases of the Company’s product.

 

An attractive aspect of Acushnet’s golf ball business is the diversification of its customer base with over 25% of its golf ball revenues derived from corporations that purchase logoed golf balls. The Titleist brand boasts a strong global reputation associated with being a premium brand so it is no surprise that corporate customers account for a large percentage of Acushnet’s golf ball sales. There’s probably no easier way to lose a current or prospective client than by sending them a dozen Condor golf balls. While the amount of golf ball revenues that Acushnet derives from corporations has declined from pre financial crisis highs (management indicated that current corporate golf ball sales are about 80% of their peak levels), the business continues to provide a nice repeatable revenue stream for the Company and management is working on a number of initiatives to drive further growth in this segment of the market.

 

Golf Balls are Acushnet’s largest and most profitable segment accounting for 36% of revenues during 2015, but ~55% of overall profitability reflecting segment margins that are ~600bps greater than company averages. The following provides a summary of Acushnet’s revenue and profitability by segment during 2015:

 

  • Titleist Golf Balls (36% of revenues; 17.3% Operating Margin)
  • Titleist Golf Clubs (26%; 8.7%)
  • Titleist Golf Gear (9%; 9.4%)
  • FootJoy Golf Wear (28%; 6.2%)
  • Other (2.1%; 13.1%)

Acushnet Generates Strong Financial Results – Free Cash Flow Underappreciated

 

Acushnet’s attractive consumables business that commands outsized profitability helps to generate strong financial results. Over the past five years Acushnet’s revenues have increased at a 3% CAGR (6% constant currency) while EBITDA has increased at a 12% CAGR with EBITDA margins increasing by 400 basis points (14.3% vs. 10.3%). During GOLF’s 2016 IPO roadshow, management cited its new golf ball manufacturing plant in Thailand (opened 2013) as the largest source of the improved profitability.

 

 

 

 

Although the Company’s reported (as detailed in its S-1 filing) free cash flow appears uninspiring, a closer look at the numbers reveals a business with strong free cash generating abilities. During Acushnet’s private equity stay, interest payments associated with the Company’s convertible notes and 7.5% bonds (redeemed in July 2016) consumed a large amount of the Company’s cash flow. With conversion (to equity) of the convertibles and the redemption of the 7.5%, the Company’s free cash flow generation profile has improved markedly. The following table illustrates Acushnet’s free cash flow as reported and with an adjustment for the interest payments on the aforementioned securities.

 

 

 

As a testament to the Company’s strong and consistent free cash flow generation, I would point to the Company’s intention (not formally announced yet, but detailed in its S-1 filing) to pay a quarterly dividend expected to aggregate to $35 million annually (~2.5% dividend yield). It is worth noting that the dividend level also reflects Magnus’ desire for cash flow in order to pay off a loan that is backed by a portion of its Acushnet shares (the loan was utilized to increase Magnus’/Fila’s stake in Acushnet). In my opinion, Acushnet’s strong free cash flow generation coupled with its underlevered balance sheet (net debt/EBITDA of just 1.5x) could enable the Company to return a significant amount of additional value to shareholders. During its private equity stay, Acushnet operated with a significantly higher debt load so the Company is no stranger to successfully managing through outsized debt levels. Accordingly, I would not be surprised to see the Company add a moderate amount of additional leverage to fund a special dividend or outsized share buyback. Perhaps Acushnet will look to retire a large block of shares held by the Company’s financial investors when the lock-up period expires.

 

 

Favorable Customer Mix Supported by Exclusive Relationships:

 

With over 50% of Acushnet’s U.S. sales coming from on course golf shops, there are no major customer concentration issues (no individual customer accounts for over 10% of Company sales). For example, Troon Golf is believed to be the largest manager of golf courses globally, though the ~270 courses it manages represents less than 1% of the world’s golf courses. The success of the Pro v1 franchise has enabled Acushnet to expand and deepen its relationship with on course golf shops (over half of GOLF’s U.S. sales) via exclusive relationships (for golf balls) that have helped the Company maintain its commanding golf ball market share. As a testament to the meaningful entry barriers of these exclusive relationships, I have provided below an excerpt of the testimony given by Callaway Vice President of Product Management of Golf Balls at Callaway Golf in 2008 as part of Callaway’s then patent suit against Acushnet (bold my emphasis):

 

“When these on-course golf shops enter into exclusive arrangements with Acushnet, it makes it  more difficult, and sometimes virtually impossible, for Callaway Golf to sell its golf ball products in these outlets without those shops risking the loss of the benefits  associated with the Acushnet program. Callaway Golf continues to experience this problem today when trying to sell its golf ball products to certain on-course golf shops.”

 

Although Callaway has experienced market share gains in the golf ball category in recent years, the share gains (premium category and above as discussed below) do not appear to have come at the expense of Titleist, but rather from other industry competitors.   

 

 

Improving Industry Fundamentals and Favorable Demographics Bode Well for Acushnet:

 

The news surrounding the golf industry has generally been awful over the past 10 years or so with golf course closures, retailer bankruptcies and declining participation dominating the headlines. While course closures and retailer bankruptcies experienced in recent years reflect some challenges the industry has experienced post the financial crisis and Tiger Woods scandal, a portion of the industry rationalization reflects a healthy correction of the supply excesses that built up during the industry’s boom times.

 

While golf participation in the U.S. has yet to finally stabilize (currently at ~24 million golfers down from ~30 million in 2005), there are signs that the industry may be in the early stages of a recovery. Although the number of annual rounds played in the U.S. declined for much of the 2006-2014 time frame, rounds played were up 0.4% through the first 9 months of 2016 following a nearly 2% increase in 2015. Meanwhile, there are a number of encouraging stats that bode well for the long term health of the game. There are still a significant number of baby boomers that have yet to retire and rounds played increase significantly in retirement. On average, golfers in the 18-34 age range play 15 rounds per year, while those aged 50 to 64 and 65 and above play 29 and 51 rounds per year, respectively. While headlines suggest that the sport may be in a long term secular decline in the U.S., recent data provide reason to be optimistic. The number of beginning golfers in 2015 (2.2 million) was up 47% from 2011 levels with millennials (age 18 to 29) composing largest single age group of beginners. In addition, the number of junior golfers (age 6 to 17) in the U.S. has grown from approximately 2.5 million golfers in 2010 to approximately 3.0 million golfers in 2015. The recent appointment of a new commissioner of the PGA Tour could help sustain this momentum since one of his main initiatives is to broaden golf’s reach.

 

While developed markets will likely represent the majority of Acushnet’s growth for the foreseeable future, emerging economies, such as those in Southeast Asia, present a great deal of longer term potential. Management believes there are a number of emerging market countries that have the necessary attributes to embrace the game including:  a sizeable middle-class population; educational infrastructure; places to play and practice; professional success that inspires the local golfers; and corporate support.

 

 

Deep and Talented Management Team:

 

Acushnet boasts a talented management team that has significant industry and company experience with members of its senior management team averaging 19 years experience with the Company. The Company is led by 41 year Acushnet veteran Wally Uihlein, who has served as the Company’s President and CEO since 1995. In 2005, Mr. Uihlein received the PGA of America’s Distinguished Service Award, the organization’s highest honor. As a further testament to the Company’s depth, approximately 50% of Acushnet’s ~2,500 U.S. associates have over ten years of employment with the Company.

 

 

A Closer Look at the Golf Ball Business – Addressing a Key Risk:

 

There are two developments worth monitoring with regard to Titleist’s golf ball market share including Callaway’s recent market share gains and the recent introduction by Costco of a Kirkland Signature golf ball. Callaway has increased its golf ball market share by 350 basis points over the past 5 years with its share rising a further 220 bps (to 13.7%) through the first 9 months of 2016 thanks to the success of its Chrome Soft premium golf ball. However, it appears that its share gains (premium and above) have not come at the expense of Titleist, but likely from other competitors (Nike, Bridgestone, Srixon, TaylorMade).

 

Titleist and Callaway Golf Ball Market Share

 

                                                                               Source: Golf Datatech via Callaway Investor Presentation

 

In 2016, Costco introduced a Kirkland Signature line of golf balls that have garnered a great deal of consumer interest. The Signature golf balls sell for ~$15 per dozen compared to ~$48 per dozen for Titleist’s premium (Pro V1/Pro V1x) offering. Costco’s website states that "All Kirkland Signature products must be equal to or better than the national brands and must offer a savings to our members" and their golf ball offering appears to live up to its mission statement of delivering a high quality product. According to multiple tests run by golf website My Golf Spy, the Kirkland ball performed as well as (if not better) than the Pro V1 golf ball in multiple categories. While the Kirkland introduction is worth monitoring, I’m skeptical that the ball can gain meaningful traction without any tour endorsement or distribution outside of Costco’s existing stores. In addition, Costco’s potential golf ball traction could prove to be short lived as a result of Titleist’s commitment to new product development. Acushnet spends a significant amount of resources on R&D each year (an average of $44 million during the past three years) and its Titleist golf ball division currently has a team of 80 scientists, chemists, engineers and technicians in support of new technologies to bolster its competitive advantage. As a testament to the Company’s R&D prowess, Acushnet currently has nearly 1,200 active U.S. utility patents in golf balls including 918 golf pall patents issued between 2011 and 2015 representing 44% share of all golf ball patents issued during that time. The next closest competitor (in terms of patents issued over the past five years) is Bridgestone with a 17% share.

 

Utility Patents: 2011-2015

 

 

Given the significant amount of R&D investment that Titleist makes in its golf ball business, I would not rule out the possibility that the Kirkland ball is in violation of existing patents though I’d only be speculating at this point. According to the Titleist website, there are currently 67 patents associated with the 2015 version of the Pro V1x golf ball and 54 patents associated with the Pro V1 ball suggesting that the proprietary nature of the ball is likely very well protected. In addition to its R&D spending, the ~$202 million that GOLF spends each year to market its products (tour endorsement, advertising, etc.) could be tough for a new brand to overcome.

 

Another factor that may make it difficult for the Costco offering to make serious inroads is the industry’s so-called “pyramid of influence.” According to this axiom, the game of golf is learned by observation and imitation, and golfers improve their own performance by attempting to ape top golfers. Accordingly, golfers are not only influenced by how top golfers swing, but what clubs they swing with and balls they swing at. Despite the potential to deploy significant resources at a golf ball offering, I believe that it is highly unlikely that Costco would invest in the resources (sales force, R&D, tour endorsements, etc.) to become a formidable industry participant.

 

 

Hidden Assets:

 

Acushnet currently owns most of the real estate associated with its operations. In total, The Company owns over 2.5 million square feet of buildings including its 223k square foot corporate headquarters located in Fairhaven, Massachusetts. It is also worth noting that the Company owns 30 acres of land that is utilized for its testing facility located near San Diego, California. While not necessarily a significant source of value, the real estate assets are likely understated on the Company’s balance sheet since most of the real estate has been owned for many years. In addition, the Company’s owned real estate could provide some additional financial flexibility.

 

 

Valuation:

 

At current levels, GOLF trades at less than 9x trailing EBITDA. It should be noted that I have adjusted the Company’s enterprise value to reflect ~$145 million in payments associated with Acushnet’s equity appreciation rights (EARs) that are expected to be settled in cash during the first quarter of 2017. Additionally, I have modified the Company’s reported adjusted EBITDA amount by ~$10 million to account for incremental public company costs. In my view, Acushnet’s valuation does not reflect the Company’s strong portfolio of brands and cash generating abilities with shares trading at a discount to recent precedent transactions including Fila’s acquisition of the Company in 2011 at ~10.4x EBITDA (~1x on EV/Sales basis) and TaylorMade’s acquisition of Adam’s golf for ~11.1x EBITDA (~0.8x EV/Sales) in 2012. In my view, GOLF should command a premium valuation to the aforementioned industry transactions, which does include the 2011 Acushnet transaction. In my view, that multiple was likely somewhat depressed reflecting the significant uncertainty the industry was facing in the wake of the 2008/2009 economic downturn. Today, there is much less uncertainty surrounding the industry and a number of encouraging signs that suggest golf participation may have troughed. It is also worth noting that GOLF’s shares also trade at a modest discount to the $20.45 per share fair value estimated by Acushnet in connection with the grant of RSUs/PSUs to key executives in August 2016.

 

 

Additional Risks and Mitigants:

 

There are a number of risks that are well discussed in GOLF’s recent S-1 filing, but here are a few that I believe are worth highlighting:

 

  • Acushnet is Majority Controlled by Fila Korea – Fila Korea is led by Gene Yoon who has generally had a successful track record at Fila Korea, which has helped to erase some blemishes on his resume during his early business career. Given that Fila Korea would ostensibly want to own the entire Acushnet business at some point, there is the possibility that minority shareholders might not be fairly treated in a potential future bid by Fila Korea. Nevertheless, Fila Korea’s involvement could help Acushnet capitalize on growth of the game in emerging markets in Asia where Yoon believes there are “incredible new opportunities” for the Company.

 

  • Share Overhang – There are currently 51.8 million shares subject to a lock-up including 39.3 million held by Fila Korea, but all of these shares will be able to be sold, subject to certain restrictions, six months from the IPO date. While the share overhang could create some near term pressure on the Acushnet stock price, the increased float could that could occur if the financial investors sell additional shares after the lock-up could help the Company attract a wider investor base.

 

  • Durables (golf clubs, shoes, etc.) are a Less Attractive Business – While Acushnet’s durables businesses (57% of total revenues) are not as profitable or attractive as the golf ball business it does offer some favorable characteristics. Within the golf clubs segment, approximately 40% of the irons sold are custom fit therefore they are pre sold and generate premium margins and offer favorable working capital attributes and inventory control measures. While custom fitting does require a larger infrastructure investment, it also helps to create a competitive advantage for the Company. In addition, the ongoing rationalization of equipment manufacturers and suppliers could bode well for the prospects of the industry’s established players in the durables category. There could also be opportunities to leverage the Company’s strong brand names and the recent launch of a FootJoy women’s apparel line in 2016 is one initiative to capitalize on the potential.

 

  • EAR Payout Could Prompt Executive Departures – GOLF expects to make a ~$144 million payment to several key executives during the first quarter of 2017 associated with its equity appreciation rights (EAR). The EAR payout is expected to be a big payday for a number of executives and could prompt them to retire/leave the Company. While potential executives are worth monitoring, as noted above, Acushnet has a deep bench and likely has a number of executives that could fill key roles.

 

  • FX Risk – Acushnet generates nearly 50% of its sales from outside of the U.S. and is exposed to both translation and transaction risks (nearly all of sales by its non-U.S. subs were made in local currency though ~87% of the COGS were denominated in U.S. dollars). The Company’s key currency exposures are the Japanese yen, Korean won, British Pound sterling, the Euro and the Canadian dollar. The Company does hedge its FX exposure, but it may not be enough to reduce the impact of adverse FX moves.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

  • Introduction of new version of Pro V1 and Pro V1x golf balls during 2017
  • Optimization of underlevered balance sheet
  • Ongoing improvement in rounds played supported by favorable demographic trends
  • Additional selling by Acushnet’s financial investors could help widen its investor base (increased float)
  • Formal announcement of a regular quarterly dividend (~2.5% dividend yield)
  • Rory McIlroy, currently the # 2 ranked golfer in the world, has recently decided (according to the website NoLayingUp.com) to play Titleist golf balls and wedges after Nike exited golf equipment industry in 2016
  • New commissioner of PGA Tour was recently appointed and one of his main initiatives is to broaden Golf’s reach

 

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    Description

    Investment Thesis:

    The recent IPO calendar does not typically represent a source of prosperous investment ideas for value investors. However, I believe the October 2016 IPO of Acushnet Holdings Corp. (“Acushnet,” “Golf,” or “the Company”) represents a rare exception. Although shares of Acushnet are up ~11% over GOLF’s formal IPO price, the IPO was priced at an ~25% discount to the mid-point of its estimated offering range (shares currently trade at an ~16% discount to the initial offering range). While some may view the tepid demand for the Company’s shares as an ominous sign, I believe the poor investor reception to the IPO is not a reflection of the Company’s fundamentals and outlook, but is primarily driven by a desire to provide liquidity to financial investors (who sold a portion of their shares in the offering) within a predetermined time span. It’s prudent to be skeptical when insiders are selling shares, but it should be noted that while GOLF’s financial Investors pared their Acushnet stakes in the IPO, the Company’s strategic owner (Fila Korea) deployed ~$265 million to significantly increase its equity stake (to 53% from 33%) in the Company at a premium, albeit a modest one, to the IPO price in a related transaction with the financial investors. Additionally, a number of Acushnet’s top insiders (management and directors) personally acquired $3.6 million of GOLF’s shares at the IPO price including $1.2 million deployed by the Company’s long time CEO Wally Uihlein. Acushnet offers a number of attractive investment attributes including:

     

     

     

     

     

     

     

     

     

    Why Does this Opportunity Exist?:

     

    Although the timing of Acushnet’s recent IPO was inopportune, I believe it has likely created an opportunity for investors to own a high quality business at a favorable valuation. As the ink was drying on the Company’s initial S-1 filing in June 2016, Golfsmith, the largest specialty golf retailer in the U.S./North America, filed for bankruptcy in August 2016. In addition to the Golfsmith news, there have been a number of other developments recently that have cast a pall over the industry including Nike’s exit from the golf equipment business (clubs and balls), the bankruptcy of a number of other golf/sporting goods retailers (Sports Authority, Sports Chalet, Lumpy’s, etc.) and Adidas’ decision to pursue a sale of most of its golf business (TaylorMade, Adams, Ashworth) owing to poor recent results. The continued drumbeat of golf course closures has also likely weighed on investor sentiment towards the golf industry. Additional factors that likely contributed to weak demand for GOLF’s shares include the limited float (just 22.2 million shares out of ~74 million were sold in the IPO with the market cap based on the float effectively placing Acushnet into micro cap territory) and uninspiring recent results from Acushnet’s high margin golf ball business. While Acushnet could have decided to not proceed with the offering given the weak demand, there was likely a strong desire for liquidity from Acushnet’s financial investors. During an October 2016 interview with Golfweek, Acushnet COO David Maher commented on pursuing an IPO amidst tough industry conditions and stated, “First and foremost, Acushnet was acquired in 2011 by Fila and some private equity partners who were investing money on behalf of the Korean Pension Fund. We knew when that deal happened that it had a five-year redemption time stamp. So, we knew we would be at this point, and this has been planned for a long while.” Acushnet CEO Uihlein also commented on the topic in early 2015 when the Company first began publicly exploring an IPO stating, "A large amount of our current private equity originated with the Korean Pension Fund. Those monies are solicited with promises of a return, a return which is tied to an exit.” In my view, the desire for liquidity coupled with an opening, albeit a small one, in the challenging IPO market, likely compelled Acushnet to proceed with the offering.

     

    While the negative industry developments are worth monitoring, I believe that they should be beneficial for Acushnet’s business longer-term. The rationalization of both manufacturers and retailers bodes well for Acushnet as it will likely lead to a less promotional environment going forward. Although the closure of golf courses makes for interesting headlines, it is important to keep this supply reduction in perspective. Since 2006, which represented the peak level of golf courses in the U.S., the supply has contracted by just 5% (through the end of 2015), which is a far cry from the 40% growth during the preceding two decades. It also warrants mentioning that during the boom years, there were a number of golf courses built to help sell houses (many developers often built golf courses to satisfy open space requirements) rather than based on any rational expectation of future demand/profit.

     

    The results of Acushnet’s crown jewel golf ball business have been uninspiring in recent years including a 3.1% constant currency revenue decline during the first nine months of 2016. However, it should be noted that Acushnet introduces new versions of its Pro V1/Pro V1x line of golf balls in odd-numbered years so the 2016 performance is a bit misleading. The 2017 introduction of the latest version should provide a boost to the Company’s golf ball business. In addition, the recent decision by Rory McIlroy, who is currently the world’s # 2 ranked golfer, to start using Titleist balls (and wedges) following Nike’s exit, could also provide a catalyst for Acushnet’s golf ball business. Notably, Mr. McIlroy is not (currently) being paid to play with the Company’s products, which is a strong testament to the product’s quality/performance. It also warrants mention that there has been a great deal of consumer interest in a private label golf ball recently introduced by Costco that has created some uncertainty about the continued dominance of Titleist golf balls. However, I believe that the enthusiasm for this Costco offering will likely prove short-lived (more on this development later).

     

    Finally, while the Titleist and FootJoy brand names are well known among golfers and non-golfers alike, the Acushnet name is fairly obscure even among the sport’s biggest enthusiasts. In fact, I wouldn’t be surprised if there were multiple professional golfers that couldn’t associate Acushnet with its marquee brands even though they are paid to endorse the Company’s products.

     

     

    History:

     

    Acushnet was founded in 1910 by Phillip W. “Skipper” Young and two of his MIT college colleagues. The business was initially known as Peabody, Young & Weeks, but later became the Acushnet Processing Company, named after the town the business was established in. By 1918, the Company was the largest supplier of uncured rubber, but the Company shifted its focus in the early 1920s following a collapse in rubber prices and began producing a number of molded rubber products including bathing shoes and caps, toy boats, and hot water bottles. The Company’s golf origins date to 1932 when Skipper Young was playing golf at the New Bedford Country Club and missed a crucial putt and suspected that something was wrong with his golf ball as he believed the putt was well struck. Young had the ball x-rayed at a local hospital, which revealed that the ball’s core was, in fact, off center. Following his discovery, Young set out to develop the highest quality and best performing golf ball in the world. It took Young three years to perfect the golf ball and in 1935 the first Titleist golf ball was introduced to club professionals and professional golfers as the best ball ever made. Interestingly, even today, every Titleist golf ball is x-rayed as part of a process check that was initially implemented by Young.

     

    From its humble beginnings, Titleist has become the dominant player in the golf ball business as Titleist golf balls have been the #1 ball in professional golf for the past 68 years. The Company’s current flagship golf ball (Pro V1) was introduced in 2000 (Pro V1x introduced in 2003) and is used by two out of every three golfers across the major worldwide professional tours (PGA, LPGA, European Tour, etc.), more than five times the nearest competitor.

     

     

    While these statistics are impressive, what’s even more noteworthy is that usage of Titleist golf balls among top amateur golfers (those that are not able to receive compensation for playing the Company’s products and typically pay for the product), is even higher.

     

     

    Other key milestones in the Company’s history include:

     

    Business Overview:

     

    Acushnet is the global leader in the design, development, manufacture and distribution of performance-driven golf products, which are widely recognized for their excellent quality. Acushnet boasts a strong portfolio of globally recognized golf brands including the Titleist (#1 ball in golf) and FootJoy, which is the #1 shoe and #1 glove in golf and is also a leading global golf wear brand. Acushnet has maintained its market leading position for a very long period of time with Titleist claiming the distinction as the #1 ball on the PGA Tour for the past 68 years and FootJoy holding the top spot for shoes (past 6 decades) and gloves (past 3 decades). In addition to its flagship brands, the Company also commands the #1 wedge on the PGA Tour via its Vokey Design Wedges and its Scotty Cameron putters are a leading putter on the PGA Tour.

     

    The following provides a breakdown of the Company’s sales by product group, operating segment and geography:

     

     

     

     

    Recent Background and Ownership Structure:

     

    During 2010, Acushnet’s former parent Fortune Brands became the target of activist investor Pershing Square/Bill Ackman. At that time, Fortune Brands was a conglomerate consisting of a spirits business (Jim Beam), a home and hardware business (Moen, MasterLock, etc.) and a golf business (Acushnet). Ostensibly under pressure from Ackman, Fortune brands announced a plan in late 2010 to separate into three businesses. As part of the decision to streamline its operations, in 2011 the hardware business (Fortune Brands Home and Security) was spun off and Acushnet was sold to a consortium led by Fila Korea and Mirae Asset Private Equity, the largest private equity firm in South Korea. The consortium acquired Acushnet for approximately $1.2 billion valuing the business at approximately 10.4x EBITDA. Acushnet’s management team, led by its long-time CEO Wally Uihlein, remained with the Company following the transaction.

     

    On November 2, 2016, Acushnet completed its IPO at $17.00 per share selling a total of 22.2 million shares to the public including 2.9 million of shares sold pursuant to the full exercise of the underwriters’ option to purchase additional shares. In conjunction with the IPO, in a separate transaction, Fila Korea (via wholly-owned subsidiary Magnus Holding Co.) agreed to purchase 14.8 million shares (~20% of Acushnet’s outstanding shares) for ~$265 million from a group of financial investors at 1.05x the IPO price. As a result of the transaction, Fila Korea's stake in Acushnet increased to 53% from 33%. The following provides an overview of the Company’s ownership structure following the IPO, the aforementioned Fila Korea Transaction, and a series of other transactions including the conversion (to equity) of the Company’s Convertible Securities (Notes and Preferred Stock):

     

    Acushnet Ownership Structure Post IPO and Related Transactions

     

     

     

    It is also worth highlighting that several members of Acushnet’s top management and board also acquired shares during the IPO, purchasing $3.6 million of shares including $1.2 million deployed by CEO Uihlein.

     

     

    Attractive Target Market:

     

    Although the global commercial opportunity for golf encompasses more than $85 billion annually, Acushnet’s addressable market, comprised of golf equipment, golf wear and golf gear, represents a $12 billion market (at retail) or approximately $8 billion of wholesale sales. The U.S. represents more than 40% of GOLF’s addressable market with Japan and Korea collectively accounting for about 30%. While there are approximately 50 million golfers worldwide that play over 800 million rounds annually on more than 32,000 golf courses, Acushnet’s target market is the approximately 8 million dedicated golfers globally (~4 million in the U.S.) who devote considerable resources (time and money) towards improving their game. These dedicated golfers play 25 rounds or more a year and spend an average of $1,200 a year on their game.  Outside of the U.S. the dedicated golfer in markets such as Japan and South Korea typically spend double that amount. Although dedicated golfers in the U.S. represented just 15% of U.S. golfers, Acushnet believes they accounted for more than 40% of rounds played and approximately 70% of all golf equipment and gear spending in the U.S. during 2014. While the number of rounds in the U.S. played declined between 2006 and 2014, Acushnet believes that the number of rounds played by its target market of dedicated golfers was relatively stable during the overall industry decline.

     

     

    Consumable Products Drive Recurring Revenues:

     

    Golf equipment manufacturers are not necessarily associated with delivering strong levels of recurring revenues. However, Acushnet is an outlier since it derives a large percentage of its revenues from consumable products including golf balls and golf gloves. During 2015, these products accounted for 43% of Acushnet’s overall sales. Golf balls are truly a consumable product as it is estimated that American golfers lose ~300 million golf balls each year. Even if golf balls are not lost during a golfer’s round, they are subject to quick obsolescence during the normal course of plays since they are typically struck by golfers at swing speeds upwards of 115 miles per hour. Acushnet commands an approximate 50% share of the top grade wholesale golf ball (~$1 billion) market and a near dominant position (~66%) of the premium performance segment, which represents roughly half of the top grade market. It is very rare to find the premium priced product (Titleist golf balls retail for ~$48 per dozen representing an over 20% premium to many of its competitors’ premium offerings) in a particular industry is also the volume leader. During 2016, Titleist launched the MyProV1.com online shop to enable consumers to create and purchase their own personalized Pro V1 golf balls. Acushnet believes the website will further drive repeat purchases of the Company’s product.

     

    An attractive aspect of Acushnet’s golf ball business is the diversification of its customer base with over 25% of its golf ball revenues derived from corporations that purchase logoed golf balls. The Titleist brand boasts a strong global reputation associated with being a premium brand so it is no surprise that corporate customers account for a large percentage of Acushnet’s golf ball sales. There’s probably no easier way to lose a current or prospective client than by sending them a dozen Condor golf balls. While the amount of golf ball revenues that Acushnet derives from corporations has declined from pre financial crisis highs (management indicated that current corporate golf ball sales are about 80% of their peak levels), the business continues to provide a nice repeatable revenue stream for the Company and management is working on a number of initiatives to drive further growth in this segment of the market.

     

    Golf Balls are Acushnet’s largest and most profitable segment accounting for 36% of revenues during 2015, but ~55% of overall profitability reflecting segment margins that are ~600bps greater than company averages. The following provides a summary of Acushnet’s revenue and profitability by segment during 2015:

     

    Acushnet Generates Strong Financial Results – Free Cash Flow Underappreciated

     

    Acushnet’s attractive consumables business that commands outsized profitability helps to generate strong financial results. Over the past five years Acushnet’s revenues have increased at a 3% CAGR (6% constant currency) while EBITDA has increased at a 12% CAGR with EBITDA margins increasing by 400 basis points (14.3% vs. 10.3%). During GOLF’s 2016 IPO roadshow, management cited its new golf ball manufacturing plant in Thailand (opened 2013) as the largest source of the improved profitability.

     

     

     

     

    Although the Company’s reported (as detailed in its S-1 filing) free cash flow appears uninspiring, a closer look at the numbers reveals a business with strong free cash generating abilities. During Acushnet’s private equity stay, interest payments associated with the Company’s convertible notes and 7.5% bonds (redeemed in July 2016) consumed a large amount of the Company’s cash flow. With conversion (to equity) of the convertibles and the redemption of the 7.5%, the Company’s free cash flow generation profile has improved markedly. The following table illustrates Acushnet’s free cash flow as reported and with an adjustment for the interest payments on the aforementioned securities.

     

     

     

    As a testament to the Company’s strong and consistent free cash flow generation, I would point to the Company’s intention (not formally announced yet, but detailed in its S-1 filing) to pay a quarterly dividend expected to aggregate to $35 million annually (~2.5% dividend yield). It is worth noting that the dividend level also reflects Magnus’ desire for cash flow in order to pay off a loan that is backed by a portion of its Acushnet shares (the loan was utilized to increase Magnus’/Fila’s stake in Acushnet). In my opinion, Acushnet’s strong free cash flow generation coupled with its underlevered balance sheet (net debt/EBITDA of just 1.5x) could enable the Company to return a significant amount of additional value to shareholders. During its private equity stay, Acushnet operated with a significantly higher debt load so the Company is no stranger to successfully managing through outsized debt levels. Accordingly, I would not be surprised to see the Company add a moderate amount of additional leverage to fund a special dividend or outsized share buyback. Perhaps Acushnet will look to retire a large block of shares held by the Company’s financial investors when the lock-up period expires.

     

     

    Favorable Customer Mix Supported by Exclusive Relationships:

     

    With over 50% of Acushnet’s U.S. sales coming from on course golf shops, there are no major customer concentration issues (no individual customer accounts for over 10% of Company sales). For example, Troon Golf is believed to be the largest manager of golf courses globally, though the ~270 courses it manages represents less than 1% of the world’s golf courses. The success of the Pro v1 franchise has enabled Acushnet to expand and deepen its relationship with on course golf shops (over half of GOLF’s U.S. sales) via exclusive relationships (for golf balls) that have helped the Company maintain its commanding golf ball market share. As a testament to the meaningful entry barriers of these exclusive relationships, I have provided below an excerpt of the testimony given by Callaway Vice President of Product Management of Golf Balls at Callaway Golf in 2008 as part of Callaway’s then patent suit against Acushnet (bold my emphasis):

     

    “When these on-course golf shops enter into exclusive arrangements with Acushnet, it makes it  more difficult, and sometimes virtually impossible, for Callaway Golf to sell its golf ball products in these outlets without those shops risking the loss of the benefits  associated with the Acushnet program. Callaway Golf continues to experience this problem today when trying to sell its golf ball products to certain on-course golf shops.”

     

    Although Callaway has experienced market share gains in the golf ball category in recent years, the share gains (premium category and above as discussed below) do not appear to have come at the expense of Titleist, but rather from other industry competitors.   

     

     

    Improving Industry Fundamentals and Favorable Demographics Bode Well for Acushnet:

     

    The news surrounding the golf industry has generally been awful over the past 10 years or so with golf course closures, retailer bankruptcies and declining participation dominating the headlines. While course closures and retailer bankruptcies experienced in recent years reflect some challenges the industry has experienced post the financial crisis and Tiger Woods scandal, a portion of the industry rationalization reflects a healthy correction of the supply excesses that built up during the industry’s boom times.

     

    While golf participation in the U.S. has yet to finally stabilize (currently at ~24 million golfers down from ~30 million in 2005), there are signs that the industry may be in the early stages of a recovery. Although the number of annual rounds played in the U.S. declined for much of the 2006-2014 time frame, rounds played were up 0.4% through the first 9 months of 2016 following a nearly 2% increase in 2015. Meanwhile, there are a number of encouraging stats that bode well for the long term health of the game. There are still a significant number of baby boomers that have yet to retire and rounds played increase significantly in retirement. On average, golfers in the 18-34 age range play 15 rounds per year, while those aged 50 to 64 and 65 and above play 29 and 51 rounds per year, respectively. While headlines suggest that the sport may be in a long term secular decline in the U.S., recent data provide reason to be optimistic. The number of beginning golfers in 2015 (2.2 million) was up 47% from 2011 levels with millennials (age 18 to 29) composing largest single age group of beginners. In addition, the number of junior golfers (age 6 to 17) in the U.S. has grown from approximately 2.5 million golfers in 2010 to approximately 3.0 million golfers in 2015. The recent appointment of a new commissioner of the PGA Tour could help sustain this momentum since one of his main initiatives is to broaden golf’s reach.

     

    While developed markets will likely represent the majority of Acushnet’s growth for the foreseeable future, emerging economies, such as those in Southeast Asia, present a great deal of longer term potential. Management believes there are a number of emerging market countries that have the necessary attributes to embrace the game including:  a sizeable middle-class population; educational infrastructure; places to play and practice; professional success that inspires the local golfers; and corporate support.

     

     

    Deep and Talented Management Team:

     

    Acushnet boasts a talented management team that has significant industry and company experience with members of its senior management team averaging 19 years experience with the Company. The Company is led by 41 year Acushnet veteran Wally Uihlein, who has served as the Company’s President and CEO since 1995. In 2005, Mr. Uihlein received the PGA of America’s Distinguished Service Award, the organization’s highest honor. As a further testament to the Company’s depth, approximately 50% of Acushnet’s ~2,500 U.S. associates have over ten years of employment with the Company.

     

     

    A Closer Look at the Golf Ball Business – Addressing a Key Risk:

     

    There are two developments worth monitoring with regard to Titleist’s golf ball market share including Callaway’s recent market share gains and the recent introduction by Costco of a Kirkland Signature golf ball. Callaway has increased its golf ball market share by 350 basis points over the past 5 years with its share rising a further 220 bps (to 13.7%) through the first 9 months of 2016 thanks to the success of its Chrome Soft premium golf ball. However, it appears that its share gains (premium and above) have not come at the expense of Titleist, but likely from other competitors (Nike, Bridgestone, Srixon, TaylorMade).

     

    Titleist and Callaway Golf Ball Market Share

     

                                                                                   Source: Golf Datatech via Callaway Investor Presentation

     

    In 2016, Costco introduced a Kirkland Signature line of golf balls that have garnered a great deal of consumer interest. The Signature golf balls sell for ~$15 per dozen compared to ~$48 per dozen for Titleist’s premium (Pro V1/Pro V1x) offering. Costco’s website states that "All Kirkland Signature products must be equal to or better than the national brands and must offer a savings to our members" and their golf ball offering appears to live up to its mission statement of delivering a high quality product. According to multiple tests run by golf website My Golf Spy, the Kirkland ball performed as well as (if not better) than the Pro V1 golf ball in multiple categories. While the Kirkland introduction is worth monitoring, I’m skeptical that the ball can gain meaningful traction without any tour endorsement or distribution outside of Costco’s existing stores. In addition, Costco’s potential golf ball traction could prove to be short lived as a result of Titleist’s commitment to new product development. Acushnet spends a significant amount of resources on R&D each year (an average of $44 million during the past three years) and its Titleist golf ball division currently has a team of 80 scientists, chemists, engineers and technicians in support of new technologies to bolster its competitive advantage. As a testament to the Company’s R&D prowess, Acushnet currently has nearly 1,200 active U.S. utility patents in golf balls including 918 golf pall patents issued between 2011 and 2015 representing 44% share of all golf ball patents issued during that time. The next closest competitor (in terms of patents issued over the past five years) is Bridgestone with a 17% share.

     

    Utility Patents: 2011-2015

     

     

    Given the significant amount of R&D investment that Titleist makes in its golf ball business, I would not rule out the possibility that the Kirkland ball is in violation of existing patents though I’d only be speculating at this point. According to the Titleist website, there are currently 67 patents associated with the 2015 version of the Pro V1x golf ball and 54 patents associated with the Pro V1 ball suggesting that the proprietary nature of the ball is likely very well protected. In addition to its R&D spending, the ~$202 million that GOLF spends each year to market its products (tour endorsement, advertising, etc.) could be tough for a new brand to overcome.

     

    Another factor that may make it difficult for the Costco offering to make serious inroads is the industry’s so-called “pyramid of influence.” According to this axiom, the game of golf is learned by observation and imitation, and golfers improve their own performance by attempting to ape top golfers. Accordingly, golfers are not only influenced by how top golfers swing, but what clubs they swing with and balls they swing at. Despite the potential to deploy significant resources at a golf ball offering, I believe that it is highly unlikely that Costco would invest in the resources (sales force, R&D, tour endorsements, etc.) to become a formidable industry participant.

     

     

    Hidden Assets:

     

    Acushnet currently owns most of the real estate associated with its operations. In total, The Company owns over 2.5 million square feet of buildings including its 223k square foot corporate headquarters located in Fairhaven, Massachusetts. It is also worth noting that the Company owns 30 acres of land that is utilized for its testing facility located near San Diego, California. While not necessarily a significant source of value, the real estate assets are likely understated on the Company’s balance sheet since most of the real estate has been owned for many years. In addition, the Company’s owned real estate could provide some additional financial flexibility.

     

     

    Valuation:

     

    At current levels, GOLF trades at less than 9x trailing EBITDA. It should be noted that I have adjusted the Company’s enterprise value to reflect ~$145 million in payments associated with Acushnet’s equity appreciation rights (EARs) that are expected to be settled in cash during the first quarter of 2017. Additionally, I have modified the Company’s reported adjusted EBITDA amount by ~$10 million to account for incremental public company costs. In my view, Acushnet’s valuation does not reflect the Company’s strong portfolio of brands and cash generating abilities with shares trading at a discount to recent precedent transactions including Fila’s acquisition of the Company in 2011 at ~10.4x EBITDA (~1x on EV/Sales basis) and TaylorMade’s acquisition of Adam’s golf for ~11.1x EBITDA (~0.8x EV/Sales) in 2012. In my view, GOLF should command a premium valuation to the aforementioned industry transactions, which does include the 2011 Acushnet transaction. In my view, that multiple was likely somewhat depressed reflecting the significant uncertainty the industry was facing in the wake of the 2008/2009 economic downturn. Today, there is much less uncertainty surrounding the industry and a number of encouraging signs that suggest golf participation may have troughed. It is also worth noting that GOLF’s shares also trade at a modest discount to the $20.45 per share fair value estimated by Acushnet in connection with the grant of RSUs/PSUs to key executives in August 2016.

     

     

    Additional Risks and Mitigants:

     

    There are a number of risks that are well discussed in GOLF’s recent S-1 filing, but here are a few that I believe are worth highlighting:

     

     

     

     

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise do not hold a material investment in the issuer's securities.

    Catalyst

     

    Messages


    Subjectcolor from jpm
    Entry01/26/2017 10:07 AM
    Membercan869

    in case you don't get:

    GOLF – M. Boss takeaways from mgmt meeting @ ’17 PGA Show; 1) GOLF mgmt sees the new base-line go-forward run-rate for the golf industry as "flat to low growth."  2) Wally Uihlein cited inventory across all channels as the cleanest in recent memory driven by a combination of more rational behavior from industry peers and consolidation of distribution points selling lower-quality merchandise, inc. off-price. On cadence, industry disruption will continue from a sell-in perspective through 1Q17 given 79 net Golfsmith closures (DKS keeping open 30 out of 109 in total) citing spring weather as a wild card with organic growth expected to improve in 2H17. 3) Looking ahead, mgmt outlined its lineup of 1H17 initiatives across clubs and gear.  4) Pricing on the new Pro V1 spring launch will be unchanged in the US (price increase overseas given FX) w/mgmt comfortable w/its current ~20% premium today bolstering a key point from our 11/22 initiation being plateauing industry pricing (~100bps in FY17/18 versus 2-3% in FY14/15). Illustrative of the price elasticity for innovation in the industry, management cited strong sell-through of Costco's Kirkland Signature golf ball, but only at $15/dozen or ~70% below current ProV1 pricing. 5) The Industry X-Factor - Confirming our recent fieldwork, the key takeaway from TaylorMade at the 2017 PGA show in our view was a more segmented product approach (woods + irons + putters) and rational pricing architecture. With a more/less zero-sum game industry growth backdrop, we continue to see Taylor Made as the multi-year X-factor worth watching (put up for sale by adidas in May 2016). Worth watching – Taylor Made is launching its 5-layer TP5 tour level golf ball in March coinciding with a heavy launch campaign noting the 1/25 announcement that Tiger Woods signed a multi-year endorsement deal to play TM clubs.  


    SubjectJust one golfer's perspective
    Entry01/26/2017 12:53 PM
    MemberHoudini

    Thanks for the interesting write-up. I don't have a strong view on the stock as of yet, but as an avid golfer who has played clubs/balls from all of the major brands, I'd just add:

    -The actual success of the Kirkland ball does not concern me as much as what it represents. If a quality ball can be sold at a fraction of the price and very quickly get a viral audience, perhaps the barriers to entry in the ball market are eroding? In no way does this mean that Titlest does not have a valuable stranglehold on golf clubs across the country, but I think the trend is to more consumer information found via the internet, which can bypass the pro shop advantage. I've always thought the ball side of the business is much more attractive than the clubs, but if consumers start to realize there are other options out there that are probably better for their game anyways, that would be concerning to me. Do you have market share data on balls for 2016?

    -I think PXG's entrance into the golf market suggests low barriers to entry on the club side as well. It was founded in 2014 and already has a dozen serious golfers playing the clubs in professional events. 

    -Callaway seems to be crushing it. Their recent "Epic" driver/fairway woods launch is not only a major breakthrough in technology that I would expect to take significant share, it has also had an amazing marketing program behind it. It is hard for me to know how many of their YouTube tests are paid versus just amateur reviews, but I cannot remember any product launch having so much hype behind it. I would predict Callaway to gain a lot of share in drivers/woods over the next year. 

    -I think it is also a slight negative for Titleist that neither of Nike's two major starts chose Titleist clubs. Tiger is using Taylormade clubs and a Bridgestone ball. Rory is using Callaway clubs and a Titleist ball. This could also put pressure on Titleist's clubs market share over the couple of years.

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