2001: Case builds for acquisitions of Spalding, Maxfli

For several years now, consolidation has been slowly squeezing the golf equipment industry. Such contraction has been rather uneventful, with only bit players falling by the side.

But the glacial pace of industry evolution is hastening, and it could dramatically alter the fate of some of golf’s biggest brands.

An explanation for the acceleration: Industry leaders are trying to achieve “superpower” status with products in every category, in part, to maximize economy of scale. And as they get stronger, the financial vulnerabilities of the weak are increasingly becoming exposed.

Several industry observers and financial analysts say the confluence of these factors make market conditions ripe for two mega-deals:

Callaway Golf Co. acquiring Spalding Sports Worldwide’s golf brands.

TaylorMade-Adidas Golf taking over Maxfli.

Principals with the four parties could not be reached or declined to comment about merger scenarios. But interviews with industry sources and financial analysts, and a review of company financial statements and Wall Street research briefings, substantiate beyond rumors that these corporate marriages could very well occur.

In both cases, the primary motive for acquisition is simply not growth for growth’s sake, but a growing belief that superior size is a prerequisite for survival in the coming years.

Such doctrine holds true even for traditional powers such as Callaway, which posted revenues of nearly $840 million in 2000. While many industry executives still publicly scoff at Nike Golf’s efforts to become a legitimate golf entity, privately they worry about the Tiger Woods-led brand that is backed by a $9 billion-a-year global sports giant.

Callaway could blunt the effects of a Nike frontal assault (Swoosh-logoed clubs are due in January), in part, by acquiring Spalding’s Top-Flite ball and club business, analysts say. Such a move would give Callaway a value-priced brand to complement its premium positioning and immediately give it new distribution channels and a leading market share position in unit ball sales. As for Spalding’s other golf brands, Ben Hogan and Etonic, Callaway could either keep them as niche properties or spin them off.

More important, analysts say a Spalding buy could help minimize Callaway’s early miscues in the ball business and give it the ammunition to develop innovative balls in the future. By producing Top-Flite balls at its $170 million Carlsbad, Calif., ball factory, Callaway would increase production at the underutilized facility, improving efficiency and justifying its investment. They also say Callaway covets Spalding’s “patent estate” - a sizable portfolio of intellectual property, in this case, ballmaking formulas.

“When Callaway was getting ready to enter the ball business, they looked at both of them (Spalding and Maxfli) for possible acquisition,” said Tim Conder, an analyst who follows Callaway for brokerage A.G. Edwards & Sons. “But they decided then to get the newest equipment and start from scratch. But it’s a tough business, and they may be reconsidering. I wouldn’t disagree with the notion that they want ball patents.”

Another industry source also suggested that Callaway underestimated the difficulty of ball development, citing its yet unresolved legal entanglement with Japanese ballmaker Bridgestone, which sued Callaway for patent infringement. (Callaway has denied any wrongdoing.)

“It is so difficult, especially for a newcomer like Callaway or TaylorMade, to develop something that is truly different and proprietary,” the source said. “There are patents on everything – for covers, for dimple patterns. . . you can’t do anything without stepping on someone’s patents. Callaway’s patent estate is probably pretty thin. They need to get with someone who is deep - Bridgestone, Spalding, Titleist, even Maxfli/Dunlop.”

Spalding becomes the obvious choice, especially because it appears its parent, Kohlberg Kravis Roberts & Co., is running out of options other than to divest itself of the sports equipment company based in Chicopee, Mass.

Though Spalding posted strong second-quarter results, it is languishing under the burden of hefty interest payments and long-term debt incurred when KKR acquired it. That load, a mix of bank debt and bonds, exceeds $500 million. In an increasingly competitive environment, analysts say it is unlikely KKR would invest further in Spalding.

“Titleist coming in with a $20 ball (HVC line) is a move aimed directly at Spalding. Nike’s value ball (Power Distance line), too, is aimed at Spalding’s core. There are people coming after their market share,” said Bruce Cripe, an analyst who follows Spalding for Friedman, Billings, Ramsey & Co. “They (Spalding management) are very competitive and very innovative. . . . But this company doesn’t have the resources that a larger company would have to put behind the products. They’re overleveraged and don’t have the money to compete dollar for dollar.

“Eventually, they’re going to have to restructure,” he said. “It’ll either have to turn some of that debt into equity or the company will have to be sold and the proceeds will have to go to the creditors.”

He said the latter is more likely because in 2003 Spalding will need to find new lenders to refinance its bank debt of $200-plus million. “The odds of that happening are very slim because there’s so much debt on this company, and if they did, it would be such an exorbitant rate it wouldn’t be feasible.”

But for all the apparent reasons supporting a Callaway-Spalding merger, an alliance between the two could be difficult to forge. Issues of price and divergent corporate cultures could just as easily nix a potential agreement.

Nevertheless, some analysts say both parties should realize that they need to make the deal, and expect it to happen sooner rather than later.

“If KKR decides to hold on to (Spalding), it could go to zero, and if Callaway thinks they can (be successful in the future) by standing pat now, they’re crazy,” said Casey Alexander, a special situations analyst who covers the golf industry for Gilford Securities. “Nike’s going to come in with guns blazing, so it would be in Callaway’s interest to integrate its acquisition quickly and make their story more important than Nike’s by the time of the PGA Merchandise Show (the industry’s largest trade expo that will be held in Orlando, Fla., Jan. 25-28.).”

More than one major deal could be completed by then.

At least three independent sources say TaylorMade is in the midst of negotiations to acquire at least a portion of the assets of the Maxfli brand from parent UK-based Dunlop Slazenger Group.

Such a deal comes as little surprise since Dunlop Slazenger has shopped Maxfli repeatedly during the past two years. Price issues as well as Dunlop Slazenger’s reluctance to part with certain assets killed previous deals. (In a related matter, sources say, former Slazenger owner Dave Branon is trying to buy back U.S. control of the brand from the parent company.)

With Maxfli’s market share declining steadily, however, Dunlop Slazenger now could be willing to unload some or all of Maxfli’s assets and accept a lower price for them. That apparently has made it an attractive play for TaylorMade, which has witnessed the stall of its own InerGel ball attack.

Two theories exist for TaylorMade’s interest in Maxfli: It could buy the venerable brand and continue to operate it, gaining instant, albeit dwindling, market share. Or TaylorMade could acquire Maxfli’s patent portfolio to develop new TaylorMade-branded balls.

“I think the TaylorMade people could care less about the Maxfli brand,” said one industry source. “TaylorMade’s feeling pretty good about themselves right now. They’re doing well with their (300 Series) drivers and irons, and now they want to make it big with their own ball. If the A10 (Maxfli’s new ball) technology is worthwhile, they’ll want it for TaylorMade, and the Maxfli brand could disappear for good.”

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