New York-based Drive Shack (NYSE:DS) owns and operates innovative golf entertainment venues in the U.S. Its "social driving ranges", which are popular with the millennial and Generation Z crowd, put golf-related challenges at the center of a good excuse for people to get together and eat, drink, and play games. Think of it as a larger scale, golf version of Dave and Busters (NASDAQ:PLAY)
Drive Shack's second division is American Golf, a golf course entity that owns 61 professional-grade golf courses including the iconic PGA National.
The upstart $124 million market cap company is the lesser-known competitor of Dallas-based Top Golf which is reportedly planning an IPO. Top Golf has a first mover's advantage having been founded in 2000, a couple years before Drive Shack, and has grown into a global company with entertainment-focused golf venues in the U.S., Australia, and the U.K.
Drive Shack had a significant head start in the public markets having launched its IPO back in October 2002. Since then the stock has struggled to stay on the fairway although a surge in investor interest in mid-2018 drove the stock to a peak above $8 per share.
Pandemic Closures Par for the Course
Today the stock trades at less than $2 per share. Like other leisure companies, Drive Shack's operations have been severely disrupted by the COVID-19 pandemic. The company closed all its entertainment venues and most of its golf courses starting in mid-March. Spending was curtailed with hourly employees and managers furloughed, bonuses deferred, and rent deferrals negotiated.
A strong performance in the first two months of 2020 was halted by the virus outbreak limiting first-quarter revenue growth to 13%.
In the wake of the pandemic there are legitimate concerns around whether there will be enough demand for Drive Shack. Inflicted with cabin fever, many Americans are chomping at the bit to whack golf balls and toss back a cold one. Others are more hesitant.
In addition to customer traffic uncertainty, costs for PPE and other safety measures will exert financial pressure and restrictions on venue capacity have the potential to limit Drive Shack's revenue potential. If social distancing constraints become more permanent than transitory, the company would generate far less revenue from corporate events, fundraisers, brunches, and other large gatherings.
While these factors have the potential to slow near-term growth, Drive Shack should ultimately emerge as a winner in the leisure space. Under the assumption these headwinds are temporary, the company's business model is flexible enough to adapt to the post-pandemic environment. Management has noted a post-pandemic strategic shift that includes the accelerated development of its reservation platform, games tailored to smaller group sizes, and mobile food and beverage ordering from golf bays.
Bringing (Miniature) Golf to the City
Despite the looming presence of Top Golf there appears to be plenty of room for another entrant. Traditional driving ranges and miniature golf businesses represent a highly fragmented market in the U.S. Technology-driven, socially-oriented adult golf entertainment businesses such as those operated by Top Golf and Drive Shack are few and far between.
Drive Shack's core driving range assets include sprawling golf entertainment venues in Orlando, Raleigh, Richmond, West Palm Beach. All have reopened in recent weeks except for the flagship Orlando site. Four additional core venues are slated for 2021 or 2022 openings including Chicago, New Orleans, Manhattan, and Newport Beach.
The more intriguing side of the business, however, is the smaller "urban box" venues that are under development. The concept behind these venues is to bring golf to the cities. They are a modern take on miniature golf complete with automated scoring technology, DJ's, food, and bars in a high-energy setting.
The urban box development is the reason for investors to get excited about the stock because it is Drive Shack's biggest growth opportunity. Compared to the core Drive Shack venues which are estimated to generate EBITDA development yields of 10% to 20%, the urban box business model projects capital returns of 25% to 35%.
The company is planning to have its first two urban boxes open early next year. This includes a 36-hole venue in Dallas (boldly located in the heart of the competition) and an 18-hole site in Charlotte. Drive Shack is targeting the build-out of at least 50 urban box venues by the end of 2024. This is the key differentiator for Drive Shack.
Good Survive and Thrive Potential
Drive Shack is in a good financial position to weather the current economic storm with a manageable level of debt and $14 million of cash on its books. As the economy improves, this will support its investment in growth opportunities including deferred Drive Shack construction and golf course projects.
Interestingly, President and CEO Hana Khouri is a former Top Golf executive who played a large role in the opening of more than 20 Top Golf venues. This growth can be replicated at Drive Shack.
Yet at this stage of the pandemic, much uncertainty remains around how the economy recovery unfolds. Pent-up demand for socialization and entertainment suggests leisure companies like Drive Shack will be among the companies that benefit most from normalization.
Drive Shack is undoubtedly a speculative investment, but at 0.4x sales and interesting growth prospects, the timing looks reasonable for the high risk, high reward leisure play. The relative stability of the golf course business is a comforting anchor for the company's higher growth ambitions.
Investors seeking an entry point may want to take advantage of the recent pullback in Drive Shack before the clubhouse gets crowded.
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