Feasibility analysis of acquiring Callaway Golf Company

¶ … acquisition of Callaway Golf Company. Financial statements and other industry related information of Callaway is assessed and potential acquirers are advised to delay the decision by at least two quarters of length of time to evaluate the long-term direction that the company is heading towards after good performance in only two quarters of 2013. The criteria for assessing company's performance are discussed before making final observation regarding potential success of Callaway in 2013. Lower than industry average financial performance and negative EBT force the analysts to decrease the likelihood that this firm is a good target of acquisition.

Callaway Golf Company is an American company that is based in Carlsbad, Calif., USA and the company was founded in 1982 by Ely Reeves Callaway Jr. The company operates worldwide with Chip Brewer as CEO of the company. The company is a golf sporting goods firm that markets, manufactures, and sells golf sporting goods such as golf life style goods, golf equipment and kits, and golf related accessories. The company is known to be the largest manufacturer of golf clubs in the world. An assessment has been conducted regarding acquiring Callaway Golf Company. Analysis criteria have been developed in order to guide the decision of acquisition based on rational grounds.

Industry context, product attributes, supply network, and other characteristics related to company operations of Callaway have been assessed. Financial performance of the firm sis also assessed. Following recommendation is made by the analysts.

The company is performing well in the last two quarters of the current fiscal year but has been below industry average in context of earnings before tax and gross profits. It is advised that the decision to acquire Callaway shall be prolonged and final decision regarding the acquisition shall only be taken after a yearlong assessment of company's long-term direction and growth as well as profitability potential.

Introduction

This paper is aimed at presenting an acquisition feasibility report to acquire Callaway Golf Company. To make decision regarding merger or acquisition requires a careful analysis of a company's performance in respective business sector along with its assets and financial reports. Not only a company shall display above industry average financial performance but also maintain appropriate level of cash flow and liquidity. Following section provides background information regarding Callaway Golf Company and the development course that Callaway covered since its inception.

Background

Callaway Golf Company is an American company that is based in Carlsbad, Calif., USA and the company was founded in 1982 by Ely Reeves Callaway Jr. The company operates worldwide with Chip Brewer as CEO of the company. The company is a golf sporting goods firm that markets, manufactures, and sells golf sporting goods such as golf life style goods, golf equipment and kits, and golf related accessories. The company is known to be the largest manufacturer of golf clubs in the world. Company's revenues during last five years are as follows. Callaway's common stock is listed at NYSE with stock symbol of 'ELY' having 6967 common shareholders as of 28 Feb, 2013 (Callaway, 2013). The main products that Callaway sells are Drivers, Irons, Fairway Woods, Wedges, Balls, Hybrids, and other golf related accessories. Following is the four-year revenues of Callaway Golf Company. The revenue detail indicates that company's net sales have been decreasing over a period of last four years since year 2008.

2012 = $834 million, 2011 = $886 million, 2010 = $967 million, 2009 = $950 million, 2008 = $1,117 million

Nonetheless, company's Q1 and Q2 earnings of year 2013 indicate that $288 million increment in company's earnings for Q1 took place whereas this was $285 million for the same quarter in 2012. After weak signs in net sales, gross income, and operating expenses, the company has now reported having improved sales and operating expenses in Q1 and Q2 of 2013. Specifically, Callaway's product lines tagged as Versa line and X Hot remained highly profitable (Bloomberg, 2013). The company is known for its Golf range of products, tools, and accessories and has managed to expand its operations worldwide. The company has also signed various service and product contracts with professional and amateur golfers to promote the brand. Since company's brand is well recognized in the professional golf sport, the company now plans to expand the scope of its operations. Potential merger or acquisition by an industry related firm is also under consideration by the board of governors of the firm.

Analysis method

While carrying out an analysis for acquisition of Callaway Golf Company, there are many criteria that must be met for recommending the company for acquisition. Following criterion was taken as benchmarks against which the target company's (Callaway Golf Company) financial performance and other indicators will be assessed.

Industry related

The industry from which the company to be acquired belongs should not depend on cyclical incomes. This reduces the overall profitability and growth of the company. The company should also be mainly a manufacturing concern. This allows flexibility in operations by controlling quality, cost, and distribution of products. The manufactured products must be value oriented that enhances the barriers to enter the respective industry (Haunschild, 1994). The main manufactured product of company to be acquired shall be retail product that enables the management to achieve high turnover of sales. It is observed that professional golf tournaments are arranged in winter season whereby amateur and professional golfers are also sponsored by respective firms to promote their brands.

Product

Product: The product of Target Company must be unique and need to have an established leadership position in the market niches in which the company serves. The product must be differentiated and provides ample value for its customers to encourage repeat purchases.

Technology: There should be minimal technology processes involved in the manufacturing of product. Since technology rapidly transforms, such products having high technology input require the acquiring company to significantly invest in technology platform that might not be possible within short time of acquisition (Sirower, 1997). Although, there is not much technology involved in manufacturing of golf products, recent development in the industry pertaining to the manufacturing of golf sticks that are increasingly made light weight and with more grip, there are signs of technology reliance in the manufacturing process.

Financial: Gross margins of target of acquisition shall be equal or above 25%. Annual sales that are above $20 million are considered to be good enough for acquisition of companies. The corporate legal structure of the company shall allow the acquiring entity to assume controlling ownership of the company.

Distribution: The Company having established distribution channel may help the acquiring company to leverage this pre-established network without having to invest in supply chain management of new firm.

Strategic: The Company that has to be acquired should have non-core units of business as well and these non-core units of Callaway Golf Company shall provide diversities for corporate expansion.

Customer retention: It will also be assessed that whether or not Callaway Golf Company will be able to retain its existing customer base or will the acquisition of company impact this aspect. A good acquisition ensures that Target Company does not lose its existing customers so that estimated profitability can be maintained in future. It is observed that although Callaway has remained industry leader in golf products, there are some new firms that have effectively pitched their products against those of Callaway by employing sales, marketing and personal relations techniques, following is the typical process after which a company is acquired.

Fig 1

Source: (Very & Schweiger, 2001)

$-118 million

In a similar case study, the negative EBT displayed that the company ultimately got liquidated and did not continue operating. Fig 1 shows the EBT of Alitalia, Italy's former flag carrier airline (Beria, Niemeier & Frohlich, 2011). Fig 1

Source: (Beria, Niemeier & Frohlich, 2011)

This implies that the managers of the company may have to resort to short-term measures for making the company accounts attractive enough for potential buyers of the company for making a reasonable bid. Although Callaway's 2013 financial indicators are better as compared to the previous years after 2008 but considering the fact the 2008-2012 are being assessed for analyzing the company performance, performance of the company was not found satisfactory. Over production is also an issue when corporate managers have to show that COSG has been controlled and brought down. Roychowdhury (2006) argued that companies have persistent negative EBT may use real activities to manipulate earnings. Some firms may reduce the discretionary funds to improve the reported earnings as well. Such practices are usually executed prior to the start of due-diligence process for acquisition of the company. To mitigate such threat of any deliberate intervention made by Callaway's management, the acquiring firm should effectively conduct a financial audit whereby financial statements shall be reviewed and any abrupt earnings shall be taken into consideration. Goldstein, Ju and Leland (2001) argued that in order to correctly assess the debt and profitability of firm, variable costs shall be subtracted from revenues of the firm. If the variable costs are under reasonable limits, the company' negative EBIT may not be the only criteria to assess the financial health of the company.

Conclusion

Analysis of Callaway Golf Company financial statements and other documents indicate that despite having differentiated products and an elaborate network of distribution through retail stores and company owned network of supply, the company was not able to maintain appropriate level of gross margin above 25% of the net sales made by the company. Earnings before taxation were also below industry average and negative EBT was reported during all the four years of assessed financial data. The company does have loyal customer base but could not maintain a level of profitability that would have been desirable for the acquiring entity to commit upfront capital for acquisition and restructuring of the company.

Recommendation: It I s hereby recommended that acquiring firm shall wait for another one fiscal year before the long-term trend of Callaway's financial and fiscal performance is established. Since 2009, the company has reported negative EBT and decreasing net sales. On the other hand, Q1 and Q2 earnings and other financial indicators show that company has started regaining its position in the industry by increasing its sales and gross profits. In order to make a carefully developed decision, the acquiring firm shall observe financial performance of Callaway and assess the potential improvement at year end. Committing huge capital an acquiring Callaway Golf Company may pose risk for the long-term growth of the company.