On Buying What You Know

by JT McGee

I’ve never been good at golf. My relationship with golf transcends a few hours and a few weeks working at a golf course after which I was promptly…err, “let go.”

But I know more about the golf business than most people. Promise.

It’s not overconfidence. It’s just the fact that I had a huge portion of my net worth invested in a golf company. For months I studied the business, thought about its economics, then plowed a huge amount of money into a single golf company, Adams Golf. Few people think about business, even fewer obsess with the golf business.

I often get sick before I buy a stock. I retreat into my room, I’m unusually quiet, and I do things that just aren’t me. I hate losing money, and love making it. These rituals may make me crazy, but I think they add to my ability to manage money. I want to know everything I can before I open a new position. To invest a significant portion of my net worth into a company I had to know this business inside and out. I think I know it pretty well.

Information as a Commodity Product

Information is a commodity product. Thanks to the internet, people sell it at the low, low price of free. However, information when synthesized is the most valuable thing in the world. Knowing something isn’t worth a damn thing in this world; knowing something and applying it will make you rich.

I’m talking about golf today because I saw a piece that laid out the thesis for an investment in Callaway Golf. You don’t have to know golf to know that name.

Adams Golf’s CEO left for Callaway when Adams was bought out. I know Adams Golf like I know the back of my hand. Actually, I probably know Adams better than the back of my hand.

A lot of people are getting into Callaway because Chip Brewer went to it. They see Chip Brewer’s success at Adams and believe it will translate into a turnaround and huge profits at Callaway Golf. I don’t think this is the case – not one bit.

I have a different memory than the stock market does. You see, I remember Chip Brewer’s compensation scheme. I remember Chip Brewer being incentivised to make management level decisions that weren’t always aligned with Adams’ shareholders. I remember Chip Brewer talking about EBITDA when he should have been concerned about ROIC. He got paid on sales and justified it with EBITDA. As an investor, I get paid by ROIC. I remember a growing cold war on the Adams Golf board of directors that led to the Adidas buyout.

Despite all of the above, I still think Adams Golf was the best company I will ever see in my life. A true Peter Lynch/Ben Graham play. It was a growing business in a stagnant industry (Peter Lynch) trading at less than its working capital (Ben Graham.) My biggest regret in life will be not having $100 million to take the company private for myself.

Adams Had What Callaway Doesn’t

You really cannot measure the value of a company on a quantitative basis. I’m sorry – ditch the calculator. Your math isn’t valuable until you use your five senses first. You can fiddle with a calculator after that.

Comparing Callaway to Adams is the very definition of comparing apples to oranges. First, Callaway is big and Adams was small, so Callaway’s performance is tied more to the prevailing winds in the golf industry. I don’t care how big of a motor you put on a sailboat in 20 mph winds. Fact is the sails will eventually win.

Second, Adams had a growth strategy (advertise the hell out of your products) that is unworkable for Callaway.

Barron’s thinks Callaway is a bargain. I think it’s a bargain for a reason.

On Qualitative Investments

Adams Golf had one awesome product and then a line-up of halfway decent clubs. Its hybrid was remarkable; it was an industry leader.

That hybrid is the difference between Adams Golf and Callaway. Adams got in people’s golf bags with its hybrid. Once people played its hybrid, their bags slowly held more Adams Golf-branded clubs. The same players went from one Adams Golf club to 14. That’s growth, baby!

Adams Golf had excellent marketing. It sponsored several players, including the best female golf player in the world. It was really a renegade in a very conservative, very backwards looking sport where prestige is everything. Adams Golf had about as much prestige as a Geo Metro.

Callaway has prestige. It has a brand. It’s the Goldman Sachs of golf. People know it and they know its products. It’s easy to think Chip Brewer can duplicate Adams’ marketing successes in Callaway because, frankly, he has a headstart on the brand issue. If you do something once, odds are better than average that you can do it again.

Except for the fact that Callaway is already well known. It already spends heavily on advertising. It has huge marketshare in golf clubs.

What’s Callaway going to do to revive itself? I’m not really sure.

People bought Adams hybrids then they bought Adams’ other clubs. People already buy full Callaway golf bags. There’s the problem. End of discussion. Adams grew by selling more clubs to the same number of people. Callaway will have a hard time selling more clubs to the same number of people.

If Chip Brewer is going to duplicate his success at Adams, he better hope for an improving golf market. He better hope that more people play golf tomorrow than play it today.

No CEO has the power to make more people play golf. A CEO can easily make more people play its golf clubs when less than 10% of the market uses them. Its much easier to double 10% of a pie than 51% of it.

Quantitatively Cheap

So, yeah, Callaway sells at less than book value. And it is streamlining its business by ditching golf balls (terrible move; balls are the only consumable golf product – repeat sales!). And the economics of sporting equipment favor conglomerates, so Callaway is probably a buyout play.

But as a standalone, it’s not a good company. It’s not in a good place. And no matter how cheap it is by the numbers, the qualitative tells a completely different story. Callaway needs growth in golf to grow. Callaway needs people to spend more on high end golf clubs to make money.

I don’t like those two bets. I don’t like Callaway. Justify it however you want quantitatively and passively qualitatively, but the fact is that Callaway isn’t a company that sells 1 club and could soon sell 14. It’s a company that sells 14 clubs and needs to find more people to buy those 14 clubs. It’s different where it matters and that’s why its no Adams Golf.

{ 5 comments… read them below or add one }

101 Centavos November 23, 2012 at 08:30

That’s the thing about talented leaders and the factors for their success. All the stars need to be aligned for that success to be replicated elsewhere. Would Brewer be more successful in another industry altogether?

Reply

JT November 24, 2012 at 17:54

Hard to say he’d be worth much outside of golf. It’s basically in his blood seeing as his dad won a few amateur tournaments and he himself had been part of the PGA at one time. I mean, this guy’s business is golf. I don’t think he’d be excited by anything else.

At any rate, Callaway’s stars are aligned very differently. Adams talked a lot about growing market share since it was a logical next step in building the company. Callaway is talking market share too, even though it has a substantial part of the market by product lines. I run scared from any company that sells a premium product with a well-known brand talking about growing market share. Scary.

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Brick By Brick Investing | Marvin November 27, 2012 at 15:22

Sounds like a good short candidate.

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carlito December 13, 2012 at 11:49

this article was awful. adams golf was once a great stock to own though, that is for sure. also who refers to yani tseng as a “golf player”, that’d be “golfer”. Lastly, adams golf didnt have enough money for advertising. i dont know where you got the idea that were big advertisers, because they werent.

Reply

JT McGee December 14, 2012 at 13:58

They spent quite a bit on endorsements. Relative to their size and working capital requirements, they were pretty big advertisers.

Who cares if they’re golfers or golf players?

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