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CALLAWAY GOLF COMPANY (NYSE:ELY). CFA Global Investment Challenge February 19 th , 2014. University of California, San Diego Alex Allphin, Brandon Blanchard, Chris Kwok, Sherry Pan, Vincent Lo. BUSINESS DESCRIPTION. BUSINESS DESCRIPTION.

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slide1

CALLAWAY GOLF COMPANY

(NYSE:ELY)

CFA Global Investment Challenge

February 19th, 2014

University of California, San Diego

Alex Allphin, Brandon Blanchard, Chris Kwok, Sherry Pan, Vincent Lo

slide3

BUSINESS DESCRIPTION

  • Golf Manufacture: Hard Goods, Soft Goods, Golf Balls
  • Global Business
  • ExperiencingFourConsecutive Years of Diminishing Sales, and Negative Bottom Line
  • New CEO, Chip Brewer, Initiated Turnaround Effort
  • Initiatives
    • Drive change in corporate culture
    • Refocus on the core business
    • Stabilizing market share
    • Reducing cost structure
    • Restructuring Sales Organization
    • Strengthening Retail Relationships
    • Strengthening Global Tour Staff
    • Strengthening Social Media Presence
    • Releasing More Products

Sales Breakdown By Product

Sales Breakdown By Region

Sources: SEC Filing

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide5

INVESTMENT THESIS

Key Point:

Qualitative and Quantitatively, We Do Not Expect Huge Fluctuations in Stock Price over the Next Twelve Months

Target Price: $8.57

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide7

INDUSTRY OVERVIEW

INDUSTRY OVERVIEW: MATURE CYCLICAL INDUSTRY

Current Market

  • Diminishing Number of Participants
  • Slow Growth in Golf Equipment Spending

Projected Golf Industry Growth vs Projected GDP Growth

Consumer Spending on Golf Equipment (US)

Narrow Future Prospects

  • Trailing the Economy and the Luxury Goods Industry
  • Projected Industry Growth Trails Projected GDP Growth

Sources: IMF, U.S. Congressional Budget Office, Callaway

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide8

COMPETITIVE ANALYSIS

Turnaround Objective: Stabilize Market Share and Build Up Growth Momentum

ELY Market Share Growth %

Sources: Callaway

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide10

FINANCIAL ANALYSIS

Restructuring and Cost Reduction Initiatives at Callaway:

  • Workforce Reductions
  • Sale of Non-Core Product Lines
  • Reorganization of Manufacturing and Distribution
  • Improved Debt structure:

ISSUED:

3.75%

Convertible Senior Notes

RETIRED:

7.5%

Convertible Preferred Stock

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide11

FINANCIAL ANALYSIS

  • Decreases in Net Sales Outpacing Decreases in Cost of Sales
  • GPM Forecasted to Improve 2014 and Beyond

HIGH: 44%

LOW: 30%

Net Sales

Cost of Sales

Sources: SEC Filing, Student Research

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide12

FINANCIAL ANALYSIS

Improving Operating Margins

  • SG&A Expenses Decreased by 28%From 2011-12
  • Advertising Expenses have Increased Every Year Since 2009, and Grew by 23%From 2011 to 2012

Sources: SEC Filing

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide13

VALUATION

Comparable Companies Universe

  • Source: Capital IQ, Student Research
  • Source: Student Research

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide14

VALUATION

Comparable Company Analysis – Multiples

  • Source: Capital IQ, Student Research

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide15

VALUATION

  • Discounted Cash Flow Analysis– Assumptions

Projected Revenue

Gross Profit Margin

  • WACC Calculations

Source: Student Research

Capital Asset Pricing Model

Source: Student Research

Sources: Company Filing,

Student Research

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide16

VALUATION

  • Discounted Cash Flow Analysis– Assumptions
  • REVENUE FORECAST
    • 2013: $836 MM
    • 2014: 6% Compared with the 10% Forecast On the Street
    • 2015 – 2017: 4% Straightline
  • GROSS PROFIT
    • 2013: 38.5%
    • 2014 – 2017: 40% Straightline
  • OPERATING EXPENSES
    • 2013: 38.3%
    • 2014 – 2017: 34.5% Straightline
  • INVENTORIES
    • Shorter Product Life Cycle -> Increase in Inventory (38%)
  • WACC
    • 8.88%
  • TERMINAL VALUE
    • Perpetuity Growth Rate: 4.7% (GDP Predictions for the Year 2017)

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide17

VALUATION

  • Summary
  • Weighed More Heavily Toward DCF Model Due to Lack of Direct Comparable Companies
  • Market Has Already Fairly Valued Callaway Stock

60%

Perpetuity Growth

$ 7.53

Target Price:

$8.57

40%

Comparable

$10.12

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide19

INVESTMENT RISK

Remote Occasional Probable

Probability

Negligible Marginal Critical

Impact

Business Description

Investment Thesis

Industry & Competitive Analysis

Financial Analysis & Valuation

Investment Risk

slide20

INVESTMENT RISK

Sources: SEC Filing, Student Research

slide22

CONCLUSION

Recommendation:

HOLD

Extremely Competitive Marketplace

Industry Growth Trails GDP Growth

Effective Turnaround Strategy

Improved Product and Marketing Strategy

Target Price: $8.57

slide25

Q & A

Presentation Slides

Business Descriptions:

Business Descriptions

Investment Thesis:

Investment Thesis

Industry and Competitive Analysis:

Industry Overview

Competitive Analysis

Financial Analysis and Valuation:

Financial Analysis

Reconstruction and Cost Reduction Initiative

Net Sales and Cost of Sales

Operating Margin

Valuation

Comparable Company Universe

Comparable Company Analysis – Multiples

Discounted Cash Flow Analysis – Assumptions

Discounted Cash Flow Analysis – Assumptions II

Summary

Investment Risk:

Investment Risk Chart

Investment Risk

Conclusion:

Conclusion

slide26

APPENDIX

Appendix Slides

Investment Thesis:

Business Description:

Company Profile and Key Ratio

Sales Breakdown

Sales Breakdown 2

Industry and Competitive Analysis:

Brand Rating

Number of Golfers in U.S. and Europe

Luxury Goods Market vs Golf Market Growth

Golf Company Profiles

SWOT Analysis

Porter’s Five Forces

Index of Consumer Sentiment

Financial Analysis and Valuation:

Financial Analysis

Net Income Disaggregation

Pro Forma Key Financial Ratios

Pro Forma Income Statement

Pro Forma Balance Sheet

Pro Forma Cash Flow Statement

Cash Flow Outlook

Efficiency and Profit Margin

Valuation

Perpetuity: Sensitivity Analysis

DCF: Key Assumptions

Comparable – Key Ratios

Discounted Cash Flow Analysis – Build Up

Investment Risk:

Investment Risk Chart

Conclusion:

Miscellaneous:

Stock Price Timeline

slide27

COMPANY PROFILE & KEY RATIOS

Resources: SEC Filing

slide30

GOLF COMPANY PROFILE

Sources: Student Research

slide32

PORTER’S FIVE ANALYSIS

Resources: Student Research

slide33

EFFICIENCY & PROFIT MARGIN

Efficiency and Profit Margin Show Improvement

Select Financial Ratios, Actual and Projected

Sources: SEC Filing

slide35

2012 NET INCOME DISAGGREATION

Sources: SEC Filing, Student Research

slide36

COMPARABLE KEY RATIOS

Figure 1: Comparable Company Analysis

  • Source: Capital IQ

Figure 2: Comparable Company Key Ratios

Source: Capital IQ

slide37

SENSITIVITY ANALYSIS

Resources: Student Research

slide38

STOCK PRICE TIMELINE

Sources: Yahoo Finance, Google Finance

slide39

INVESTMENT RISK CHART

Sources: SEC Filing, Student Research

slide40

SALES BREAKDOWN

Figure 1: 2012 Sales Breakdown by Product

Figure 2: Sales Breakdown By Country

Source: Callaway

Sources: SEC Filing, Student Research

slide41

SALES BREAKDOWN

Sources: SEC Filing

Sources: SEC Filing, Student Research

slide42

INDEX OF CONSUMER SENTIMENT

Sources: University of Michigan

slide43

PRO FORMA FINANCIAL RATIOS

Sources: SEC Filing, Student Research

slide44

PRO FORMA INCOME STATEMENT

Sources: SEC Filing, Student Research

slide45

PRO FORMA BALANCE SHEET

Sources: SEC Filing, Student Research

slide46

PRO FORMA CASH FLOW STATEMENT

Sources: SEC Filing, Student Research

slide47

LUXURY GOOD MARKET VS GOLF INDUSTRY

Sources: SEC Filing, Student Research

slide49

CASH FLOW OUTLOOK

Cash Flow Outlook Improving

  • 18.4 CapEx Spending
  • 26.9 M from Asset Sales
  • 46.8 M Proceeds from Convertible Notes
  • 11 M Dividends Paid
  • 122.9 Net Loss from Operations
  • Positive Future Net Income
  • Increasing CapEx Spending
  • Steady Dividend Maintained

Sources: SEC Filing