Can Callaway Land You on the Green?

Though sandtraps lurk, if you're a long-term investor, chances are good that the golf-equipment maker will reward you

By Gene Marcial

As golfing season gets into full swing, Callaway Golf (ELY ) comes to some investors' mind: Is it time to buy shares of the leading designer and maker of high-quality and innovative golf equipment, best known for its line of oversize Big Bertha clubs?

To analyst Joe Yurman of Bear Stearns, the answer is no for investors aiming for short-term gains, and yes for those with long-term goals. His frank and split rating is designed to present the whole picture, says Yurma, about the maker of premium-price golf clubs for both the professionals and weekend golfers.

In the past, Callaway has been dogged by rumors that it was likely to be acquired. And now that the stock has come under more downward pressure, talk has resurfaced that "the company could be vulnerable to a takeover," says one big investor, particularly if it falls to the 15-a-share level. Callaway plunged to as low as 11 on Sept. 27, 2001. It's now trading around $17.70.


  Some investment strategists make the case that rather than sell to the likes of Fortune Brands, a diversified maker of golfing products, Callaway management might instead launch a leveraged buyout, offering in the low- to mid-20s per share. They note that management is already buying back stock. On May 6, 2002, Callaway's board authorized the repurchase of shares "from time to time in the open market or in private transactions of up to $50 million."

The company says it expects to complete the repurchase by yearend. Management already owns 13.2% of the company, so buying back more shares would work well toward a management-led LBO.

Yurman agrees that the stock could head further down. He worries that with the season at hand, the large golf-products companies that aren't stand-alone outfits will flood the market with sales promotions. Among those rivals with well-heeled parents are Nike (NKE ), Fortune Brands' Titleist, and Addidas' Taylor Made. "Companies that have the financial wherewithal to buy market share could prove troublesome for stand-alone golf companies like Callaway," says Yurman.


  In such a situation, Callaway faces an almost no-win environment, says Yurman. He adds that investors with shorter-range goals "may be able to find more attractive entry points to the stock." In other words, he expects Callaway shares to drop further from its current price, as increased competitive pressure squeezes the company. Callaway makes a variety of golfing products under the Big Bertha, Hawkeye, and Odyssey brands, including titanium drivers, fairway wood clubs, irons, wedges, putters, and HX blue and red golf balls.

Last summer, Taylor Made offered discounts and extended promotional programs to retailers. Some of Callaway's products, particularly its Hawkeye VFT clubs, lost market share amid such campaigns. Competitors are apt to redo such aggressive marketing campaigns this year, warns Yurman. Callaway has had to drop the price of its Hawkeye VFT recently to allow it to compete more effectively with Nike's new driver, he notes. The Nike club more than doubled its market share in March, says Yurman.

Callaway's new HX ball, however, gained impressive market share during its first two weeks on the market, handily beating the competition. In June, Callaway is rolling out a new HX two-piece blue and red ball (as opposed to the three-piece HX balls, introduced in March). "We expect the new balls to retail in the low- to mid-$30s," per dozen, says Joseph Dzamesi, an analyst at independent research firm B. Riley who has a neutral rating on Callaway. The three-piece HX balls sells in the mid- to upper-$40s. Pricing the new HX balls lower, says Dzamesi, should allow Callaway to gain overall market share.


  Why does Bear Stearns' Yurman continue to recommend Callaway to long-term investors? He says it's a good company for anyone "looking to own a solid cash-generating business with one of the best brands in the industry." Yurman believes the stock will be worth at least 25 a share within 12 months. He expects Callaway to earn $83.3 million, or $1.21 a share, in 2002 and $93.6 million ($1.36 per share) in 2003, up from 2001's $58.3 million ($1.02).

The stock is trading at 14 times Yurman's estimated 2002 earnings, in line with Callaway's 10-year average multiple. And on a cash-flow basis, it's trading at 6.2 times his 2002 EBITDA (earnings before interest, taxes, depreciation, and amortization) estimates of $191.9 million, below its average historical multiple of 8. Callaway has $67 million in cash and equivalents on hand and no debt.

To insulate itself from stiff competition, Callaway has put in place new promotions, such as a "preferred-retailer" program, to help boost sales. These retailers are required to meet specific targets on inventory levels, product placement, and product knowledge. They run the risk of losing their Callaway account should they fail to meet those targets.

So, while Callaway could well find itself in a short-term sandtrap, Yurman thinks that investors who stick with the company all the way to the 18th hole will emerge as winners, thanks to Callaway's cash-strong and debt-free position, and its innovative products. Getting a nice premium in a takeover or LBO wouldn't be so bad, either.

Marcial is BusinessWeek's Inside Wall Street columnist

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