One aspect of life that has managed to survive, and even thrive, during the pandemic has been outdoor activities and entertainment. Golf fits within this theme perfectly. After all, you can play solo, you can distance as much as you want, and you need no mask to be on a golf course. One theme that has taken a strong hold in golfing over the last decade has been upscale driving ranges, and Topgolf lands at the top of the list.

One company that seized an opportunity to get into Topgolf was Callaway Golf Company (NYSE: ELY). The company now owns approximately 14% of the parent Topgolf Entertainment Group.

Despite ambitions of a potential initial public offering in the past, there are reports out that Callaway is talks to buy the remaining 86% or so. While the Wall Street Journal’s report suggests that the deal could value Topgolf at $2 billion or more, there is a lot at stake here.

This brings a major opportunity for Callaway. It also brings major risk in the coming years. The company could be leveraging itself into pain if the economics shift or if it commits too much capital, and shareholders probably do not want to face massive dilution,

Callaway Golf became an investor in 2006 after Topgolf’s U.S. debut in 2005. In 2017, Callaway was reported to have increased its stake and the new 14% stake was said to be at $290 million in total for a #2.1 billion valuation. Other investors have been listed as Dundon Capital Partners, WestRiver Group, Providence Equity Partners, Fidelity Research and Management also made an investment in 2017.

The Topgolf venue now includes more than 60 locations around the globe, more than 50 of which are in the United States. This includes owned and operated venues in the United Kingdom, and the company claims to serve more than 23 million guests each year.

On top of the Topgolf Media unit, Topgolf also acquired Toptracer in 2016 as a technology company which introduced the ball-tracing technology used in televised golf tournaments. This can be used on-site for visual training as well.

One interesting aspect about a sale price of $2 billion or more is that Bloomberg had reported at the start of 2020 that the party-themed driving range venue was looking to list itself as a public company a $4 billion valuation after working with investment bankers. One kicker in the deal that could be an issue is that the same report pointed out that Top Golf had $525 million in outstanding debt and that the company planned to open new locations in Canada, Mexico and the United Arab Emirates.

Callaway Golf has a lot at stake here. Even after an initial gain in its shares faded away on Tuesday, its current market capitalization is just under $2 billion. Its 2019 revenue was $1.7 billion, up from $1.24 billion in 2018 and $1.05 billion in 2017. And at the end of 2019 it had just $106 million in cash and total debt of $759 million. Refinitiv is forecasting 2020 revenues to be down 12% to $about $1.5 billion, with a recovery back to almost $1.7 billion in 2021.

Unless Callaway keeps the current investment funds outside of the majority holder (and brings on additional capital) then this will be adding leverage to Callaway’s balance sheet. There are obviously many more venues that Topgolf can go into both in the U.S. and internationally.

The business is very attractive, but it is not defenseless. Topgolf’s so-called “moat” is not very wide for its locations. This allows any company that can afford it to open up nearly identical party-themed golf driving ranges, with restaurants, bars, putt-putt courses and any additional entertainment venues they choose.

Callaway’s brand has been expanded by its Topgolf investment. A report from the Motley Fool indicated that Topgolf’s $500 million or so in 2016 sales could reach $1.8 billion in 2020. That was of course pre-pandemic, but it gives an idea of what the scope of this potential merger could be. Callaway would also have some serious decisions to make on in-store and online branding versus an exclusive model or an inclusive model that also includes other brands for golf equipment and the lucrative apparel departments.

If Callaway ends up owning all or the majority of Topgolf it may help assure that its pipeline of sales is set for the future. Then again, Callaway could try lightening up on some of its brands that it deems less profitable and force competitors into paying for access in a myriad of methods. Callaway also owns brands like Odyssey for putters, OGIO for golf bags, TravisMathew in sportswear and accessories and Jack Wolfskin in apparel.

If Callaway wants to do this deal to purchase the rest of Topgolf, the market reaction seems to be more amenable to a deal that doesn’t cram down too much debt that would endure over the coming years and decades.

Wall Street seems confused about how Callaway Golf would pull this merger off without heavy dilution or without major leverage. Its stock was up as much as 9% briefly on Tuesday, but the stock was last seen trading down more than 25 at $19.45 in the final minutes of trading. Its 52-week range is $4.75 to $22.33. The Refinitiv consensus analyst target price is $23.30.

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