Drive Shack - Forced Sellers Create Opportunity

Drive Shack (DS) is a golf operator, formerly known as Newcastle Investment (NCT) and is managed by Fortress. NCT was previously an REIT that owned senior care facilities and made debt investments. Over the last few years, they spun off senior care REIT and are now in processing of monetizing all their debt investments. Starting Jan 1, 2017, they are no longer REIT and cancelled the dividend. They are now focused on being a golf owner / operator and are touting new concept of golf entertainment called Drive Shack – which will be similar to Topgolf.

The cancellation of the dividend led to “forced sellers” – REIT investors moving to other greener pastures for dividends. The stock currently trades at market cap of $198M. DS has preferred stock worth $60M and debt worth $160M. They also have cash of $130M and expect to realize $110M from monetizing legacy real estate debt. Netting all of this, the market is pricing golf business at EV of ~$180M. I’ve excluded golf member’s deposits from liabilities because these are long term (30 years) and are not typically refunded.

The golf business - American Golf Corp history – was acquired by DS via debt to equity restructuring in Dec 2014. Golf courses have hard time getting financing since 2008 with typical rates at LIBOR + 4%. This is because there is clearly headline risk in golf – lack of new players, high fixed costs (mowing lawn and water) , glut of golf courses built in 90’s and early 2000s, and re-zoning golf courses into housing is tough due to deed restrictions and home owner opposition, etc.

American Golf Corp makes EBITDA of $30M, and assuming 8x -10X EBTIDA we get EV = $240M to $300M, implying 25% - 40% discount to price of $180M.  This EBITDA multiple is based on ClubCorp’s acquisition of Sequoia golf in 2014. This valuation ascribes no value to future EBITDA growth from the new Drive Shack concept.

DS will start operating first location for Drive Shack in Q118, based on proven concept from competitor TopGolf. These locations will provide technology assisted driving ranges with entertainment, food and beverage options. Management expects that each location will need investment of $15M-$25M and will produce $3M - $6M of EBITDA. This is in line with estimated performance of Topgolf locations. Drive Shack also has the second mover advantage – they can learn from what works at Topgolf.

The downside is limited due to existing value from cash and American Golf Corp, and there’s a big potential upside if development of Drive Shack locations goes per plans. Its hard to put a number to the upside from Drive Shack. If the new concept is not successful, DS can stop developing additional locations and sell the Drive Shack locations to TopGolf. All of this creates an asymmetric risk – reward scenario here.

Catalysts:

There multiple shots on the goal for realizing value for DS:

1.      Growth in Drive shack concept

2.      DS could sell traditional golf business to get cash and focus only on drive shack locations

3.      Some golf courses could be developed into Drive Shack locations

4.      Market re-rates stock as new stock buyers see the value

Fortress Chairman Wesley Edens (also chairman of Drive Shack) recently bought $15M of stock.

Risks:

1.      Traditional Golf courses decline more in revenues, and operating leases can’t be broken easily. There’s sizable operating lease liability. But it is possible that DS can negotiate lease breakup fees which are lot lower than paying all remaining lease liabilities.

2.      Characteristics of a PE investment, and likely to take 3-5 years to realize its full value

3.      Realization from legacy real estate debt is lot less than management estimate of $110M

Disclosure: I own shares of DS