We are short shares of ClubCorp Holdings, Inc. Please click here to read full disclosures.
Sahm Adrangi, Chief Investment Officer, will host a conference call today, Thursday, April 7, at 4:00pm EDT to discuss the company’s report.
To participate in the conference call, dial (888) 390-3983 (US and Canada) or (862) 255-5354 (international) and reference the Kerrisdale Capital call.
A replay will be available following the call at http://kerr.co/mycc-apr7.
ClubCorp Holdings is a highly levered golf-course roll-up facing three profound challenges: a secularly declining end market, weak unit-level profitability, and no economies of scale. Founded in 1957 as a single country club in Dallas, ClubCorp now bills itself as “The World Leader in Private Clubs®,” with a portfolio of 206 locations (including two in Mexico and one in China). But as ClubCorp has grown, golf has shrunken. Golf participation, golf rounds played, and sales of golf equipment have all trended down over the past decade, while the age of the average golfer has trended up. Though these demographic pressures strain the entire industry, ClubCorp suffers further from the nature of its competition: not-for-profit, member-owned clubs that strive not to maximize the bottom line but simply to provide a good experience. As these clubs plow any efficiency gains back into additional amenities for members, ClubCorp must keep up by way of its own continuous improvements, resulting in persistently high capital expenditures and weak returns. While the premise of ClubCorp’s roll-up model is that greater scale leads to better returns, most golf-course costs are inherently local and thus difficult to centralize, as attested by ClubCorp’s own mediocre earnings and stagnant margins.
For ClubCorp shareholders, these problems are amplified by the company’s billion-dollar debt burden; at nearly 10x unlevered cash flow, it leaves the equity almost no downside support. Any economic hiccup impacting consumer discretionary spending could wipe out shareholders entirely. Yet despite its poor fundamentals and high leverage, ClubCorp shares offer investors just a 5% free-cash-flow yield – appallingly slender compensation for such massive risks.
ClubCorp’s valuation has remained so rich partially as a result of the dearth of similar publicly traded companies; in this informational vacuum, management has successfully directed the market’s attention to the most flattering financial metrics while glossing over the unpleasant long-term realities of the golf business. But our detailed industry research – including an analysis of benchmarking studies as well as conversations with more than a dozen golf-club general managers, many of whom compete directly with ClubCorp – reveals that low
margins, weak membership growth, and a never-ending succession of capex projects are par for the course. Moreover, ClubCorp clubs appear to perform worse than average, with member attrition three times the industry median and anecdotal evidence of lax course maintenance and bad customer service. Informed by this bottoms-up research, our DCF model values ClubCorp equity at just $2.75 per share, 80% lower than the current price. But with such a fragile capital structure – and large contingent liabilities not captured in our base case – ClubCorp could easily be a zero. To those who are long shares: Fore!
I. Investment Highlights
ClubCorp’s free cash flow doesn’t justify its market cap. Below we summarize ClubCorp’s capital structure and run-rate free cash flow. With so much debt piled on top of so little earnings power, ClubCorp’s equity won’t get much; debt service and capital expenditures (necessary to keep club quality from rapidly decaying) together consume 75% of EBITDA, leaving little room for genuine growth initiatives or additional acquisitions. Indeed, free cash flow scarcely covers the dividend. Today, the market values ClubCorp’s equity like a safe, stable bond; in reality, with $1 billion of debt outranking it and a multitude of fundamental flaws in the underlying business model, it’s a highly risky asset that calls for a correspondingly high yield.
|ClubCorp: Capital Structure and Cash Flow|
Source: company filings, Kerrisdale analysis
Note: Run-rate figures represent Kerrisdale 2016 estimates.
Our DCF model, which assumes a completely benign economic backdrop, values ClubCorp at just $2.75 per share, for 80% downside. A simple historical analysis produces a very similar result: since ClubCorp has only generated modest, mid-single-digit returns on invested capital –at or below a realistic estimate of its cost of capital – its enterprise value should approximate its $1.2 billion of net tangible assets. While this figure covers the debt, it leaves only ~$200mm for the equity – again leading to about 80% downside. Whatever the analytical framework, the conclusion is clear: ClubCorp’s stock price has a long way to fall before it begins to approach fair value.
Golf is in the midst of a long-term secular decline. According to the National Golf Foundation, the number of golf participants in the US fell 22% from 2005 to 2015; the number of golf rounds played at private clubs likewise fell 17%. Demographics ensure that this decline is just beginning: golf participation among the critical 18-to-34-year-old age group has fallen 30% over the past two decades.
Golf’s difficulties are not some passing fashion; they stem from the sport’s fundamental qualities. Golf is expensive, difficult, and time-consuming in a world with a vast array of cheap and easy recreation options. Social change is also a headwind: gone is the era when the family patriarch could cavalierly leave his wife and children behind to spend a day golfing. In keeping with these trends, ClubCorp’s revenue per club barely grew in nominal terms from 2005 to 2015 (and declined in inflation-adjusted terms), while average members per club was flat. ClubCorp’s prospects for long-term organic growth are bleak.
ClubCorp’s business model is inherently flawed. Some stagnant businesses can still generate high returns, but ClubCorp isn’t one of them. There is a basic tension in the for-profit golf-course model: shareholders would like to wring as much revenue as possible out of each 18-hole course, but member satisfaction declines precipitously with any hint of crowding, capping the productivity of the capital employed. Moreover, in any geographic region, ClubCorp’s clubs are just one choice among many, and competitors are often member-owned non-profits perfectly willing to operate at break-even. Our discussions with industry participants suggest that ClubCorp differentiates itself from the competition primarily by targeting lower-end customers and skimping on service, resulting in much higher attrition rates and greater sensitivity to economic downturns. But this strategy has not translated to strong revenue growth, margins, or returns on invested capital, all of which are consistently low.
Running private clubs is naturally capital-intensive; the golf courses, additional athletic facilities like gyms, clubhouse fixtures, parking lots, and other tangible assets all have finite life spans and require frequent renovations to maintain parity with competitors and justify even modest increases in membership fees. While ClubCorp management likes to bifurcate its capex into “maintenance” and “ROI” – implying that the latter is non-recurring and discretionary – our industry research belies this framing, showing that an annual capital budget of 7-10% of revenues – in line with ClubCorp’s historical total capex but substantially higher than its purported “maintenance” spending – is necessary just to stay in place. Intense competition and high capital intensity are headaches in any sector, but, in a shrinking market like golf, they can be deadly.
ClubCorp’s acquisition-driven growth strategy is a value-destroying failure. Like the retailer in the old joke, ClubCorp hopes to make it up on volume – transforming the golf-course business from dud to winner by simply buying and operating many courses. But, as industry benchmarking studies confirm, back-office and other readily centralizable costs represent a small fraction of the typical golf-course budget, while key line items like on-premise labor, facility maintenance, and local marketing are difficult to buy in bulk. There’s no good reason to expect compelling synergies from a golf-course roll-up. Sure enough, ClubCorp’s profit margins – whether measured using the company’s own liberally adjusted version of EBITDA or more standard metrics – have been flat or down over the past five years, even as the number of clubs in its portfolio has grown almost 40%.
Given that ClubCorp generates mid-single-digit returns on tangible capital, paying a premium to net assets – as it has typically done in its acquisitions, resulting in $348 million of goodwill and other intangibles on its balance sheet – destroys economic value. A recent example is ClubCorp’s large purchase of Sequoia Golf in 2014. We estimate that this deal generated a 7.7% pre-tax return on invested capital (including goodwill). Yet ClubCorp’s last unsecured debt issuance priced at 8.25%, and credit spreads have widened further since then. This is a new twist on the proverbial 3-6-3 rule of old-fashioned banking (borrow at 3%, lend at 6%, and be on the golf course by 3 p.m.): borrow at 8%, invest at 8%, and own an extra golf course or three. Such a strategy expands ClubCorp’s empire but destroys shareholder value.
Overlooked liabilities could wipe out ClubCorp’s equity. In lieu of straightforward fees, some of ClubCorp’s clubs have required refundable “membership initiation deposits”; after a long but limited time period, usually 30 years, members are entitled to get these funds back. Today such deposits exceed $700 million and are carried on ClubCorp’s balance sheet at their present value of $357 million, of which $153 million is classified as current and could, in principle, come due at any moment.
Yet the market completely neglects this material liability (41% of ClubCorp’s market cap and 200% of our base-case estimate of equity fair value) on the theory that few members have asked for their money back so far. Over time, however, something has to give. Either
- members do ask for their deposits back, resulting in a cash outflow large enough to significantly impair or even completely destroy ClubCorp’s equity; or
- they don’t ask for their deposits back, leading them to be classified as unclaimed property and remitted to the relevant state governments under escheatment laws, again draining cash; or
- they don’t ask for their deposits back but ClubCorp somehow manages to evade the rules governing unclaimed property, thereby converting the deposits into taxable income and resulting in a multi-hundred-million-dollar tax bill over time – again, quite material relative to the magnitude of ClubCorp’s equity.
While investors may give ClubCorp the benefit of the doubt as long as this liability remains largely hypothetical, any bad news could quickly alter perceptions. The long-term fate of ClubCorp’s membership initiation deposits is just one more downside risk for a dangerously levered company with weak fundamentals trading at a high multiple of free cash flow.
Read our full report here.