2023-11-29 18:23:54 ET
Summary
- Bowlero Corp. is the leading US operator of bowling entertainment centers with 350 centers.
- The US bowling industry is a mature market with slow growth rates and high competition from digital leisure activities.
- Bowlero's aggressive growth strategy exposes it to high financial risk, making it a risky investment.
Introduction
I would not recommend investing in Bowlero Corp. ( BOWL ) at this time. Even though the company has strong competitive advantages in the US bowling industry, its aggressiveness in pursuing its growth strategy exposes it to high financial risk that could jeopardize its continuity in my view. Nevertheless, investors may earn a high return thanks to Bowlero’s capacity to generate substantial capital gains.
Business Overview
According to its latest 10K Report , Bowlero is the leading US operator of bowling entertainment centers (with 350 centers), transforming the traditional bowling alley into a dynamic and modern entertainment destination. Founded in 1997 with the acquisition of Bowlmor Lanes in New York City, Bowlero has revolutionized the bowling industry by introducing upscale entertainment concepts, lounge seating, arcades, enhanced food and beverage offerings, and exceptional customer service. Catering to individuals and group events, Bowlero hosts and oversees professional and non-professional bowling tournaments, further expanding its reach and impact.
Industry and Competitive Landscape
The US bowling market is a resilient industry that has endured the Dotcom and Subprime crises relatively well. Only during the pandemic, market revenue almost halved. Still, the market recovered after all the lockdown restrictions were dropped. Even so, the industry growth has been at a low CAGR of 2% annually, indicating a mature industry that has grown slower than the US Nominal GDP .
Bowlero 1Q24 Presentation
The industry, as a whole, competes with many other leisure activities; thus, the threat of substitutes is especially high for this industry and could be a cause of slower growth as digital leisure activities begin to steal leisure time from physical outdoor activities. Consequently, I think this limits the chance of obtaining a high and sustainable return on investment over a long-term period. Furthermore, given the historical industry growth, an expected GDP annual growth of 4.12% until 2033, and a global industry growth of 5.9% , I think the US bowling industry should grow at a CAGR of around 2-4%.
Regarding the competitive landscape, Bowlero is the dominant player, operating 350 centers. Main Event is the next largest center operator, with only 53 centers. Furthermore, the market remains highly fragmented, with around 3,500 independent centers, a perfect opportunity for an acquirer like Bowlero Corporation.
Bowlero 1Q24 Presentation
Its largest size allows Bowlero to capitalize on some opportunities that smaller operators cannot. First, Bowlero acquired the Professional Bowlers Association ((PBA)) in 2019; the PBA is the world’s largest entity dedicated to the sport of bowling and its professional competition, according to its website . Revenue from ‘League’ represented ~21% of TTM ending in February 2020. This revenue type is recurring and exclusive, as Bowlero owns the organization.
Second, as the largest player and a public company, Bowlero has access to more financial resources than any other player in the market, which allows it to acquire more centers and make structural improvements to boost revenue and profits. This generates more cash for further acquisitions, allowing the company to keep developing more centers. To illustrate how Bowlero creates shareholder value through acquiring companies, we have the following picture from its 1Q24 presentation:
Bowlero 1Q24 Presentation
Bowlero acquires a center at 4-7x EBITDAR; then it makes structural and managerial improvements, such as adding self-service kiosks, enhancing the aesthetics of the place, implementing QMS, and introducing robotic process automation. Consequently, the property value increases, allowing Bowlero to carry a sale-leaseback for a higher multiple, realizing a quick gain after the sales and generating more funds for further acquisitions. Nevertheless, even if it creates high value for Bowlero’s owners, I don’t think it’s sustainable over the long term, as the number of centers that can be enhanced is finite, and as the company grows, the effect of one acquisition is more insignificant.
Third, regarding the former point, Bowlero developed QMS (Quantitative Management Solutions) Technology. QMS allows center managers to improve their operational results by identifying weaknesses and tactics to close operational performance gaps, bringing more transparency, and facilitating the use of available operating leverage. Hence, QMS allows Bowlero’s center managers to improve operational performance. For instance, Bowlero locations tend to execute better than other entertainment locations even when revenue is lower:
Bowlero Investor Presentation July 2021
Fourth, Bowlero has invested in online gaming by developing games such as PBA Bowling Challenges and PBA Pro Bowling 2021. In this sense, the company partnered with Skillz to create Strike! to boost e-sport games in the bowling industry by connecting professionals and allowing them to compete in the closest center, driving higher traffic.
All these factors give Bowlero significant competitive advantages over all the other competitors in the industry. Furthermore, I think the low growth rates and capital requirements may keep new entrants away from the industry.
Financial Performance
At first glimpse, an investor may conclude the company is overleveraged and increasing financial risk by issuing more debt to repurchase stocks. There is no doubt the management considers the stock to be cheap in my opinion, as they designated $130 million to treasury stocks in 1Q24. I think it’s safe to say that Bowlero turned into a cannibal in the last year, as its outstanding shares have decreased from 198.1 million in 2Q23 to 171.3 million at the end of 1Q24, a 13.53% decrease in approximately a year.
Bowlero 1Q24 Presentation
Nonetheless, the company has issued debt bearing a high variable interest rate (>7%), and after the stock repurchases, the equity fell to $41.78 million from $155.22 million, whereas the total long-term debt is $1,276.37 million . If we compare the total debt with the free cash flow generated in FY2023 ($68.5 million), Bowlero will take eighteen years to repay its long-term debt fully. However, investors should recall that Bowlero benefits from selling its improved properties, and the company closed a deal with Vici Properties , in which Bowlero will receive $432.9 million ($404.8 million in cash proceeds) in exchange for selling 38 properties in a sale-leaseback agreement. The cap rate will be 7.3%, lower than the debt interest rates. However, even if the cap rate seems high, the company only paid approximately $150 million for those projects, so it secured a substantial gain by selling the properties. Moreover, a gain of roughly $282.9 million will undoubtedly improve the look of the balance sheet in the next quarter. Finally, the cash proceeds will cover the expected M&A investment of $160 million in FY24.
Regarding growth, Bowlero is experiencing a deceleration in growth, but it’s not as bad as it looks in its financial statements. For instance, in 4Q23, revenue decreased by 10.57%, but if the effects of an additional week were adjusted, the total bowling center revenue increased by 2.4% . Similarly, the 1Q24 revenue decreased primarily due to testing new prices and promotions by the management, which ended badly. However, management reversed those changes, and comparable sales returned to positive numbers in October (for more information about new promotions and sales strategy, I highly recommend you to read the 1Q24 earnings call transcript)
Author's Elaboration with data from SA Author's Elaboration with data from SA
Nevertheless, the company is undeniably facing a softer consumer environment as sales are growing slower than in FY2023, which was positively affected by the bowling industry's broad and sharp recovery after the pandemic. Comparable sales decreased in the last two quarters, however, by a low percentage (2.61% in 4Q23 and 5.48% in 1Q24).
Author's Elaboration with data from SA
Furthermore, according to Bowlero’s guidance, the company expects to grow its top line by 10-15% in FY24 (excluding service revenue in FY23). Moreover, analysts estimate Bowlero sales to be between $1.14 billion and $1.16 billion, implying a YoY growth rate of 8.49% if we take the midpoint ($1.15 billion). Both guidance and analysts’ estimates are similar. Regarding the guidance , management assumes a flattish comparable sales growth, which could be slightly positive, seeing the current trend and the risk of a recession. However, October comp sales had recovered thanks to the renewal of promotion activities, and the bowling industry has endured economic contractions relatively well.
There is a worrisome picture regarding profitability. Even if the third and fourth quarters tend to be the weakest as the operating leverage is lower, the last two quarters were awful. Gross margin stood at 19.57% in 1Q24, as labor, depreciation, rental, utilities, and maintenance costs increased faster than revenue due to inflationary pressures and accelerated growth, according to its last 10Q Report . Labor costs (which comprise 25% of total cost) expanded as the company hired new staff and increased salaries to support the growth and take advantage of the following two quarters, which have historically been the strongest.
Author's Elaboration with data from SA Author's Elaboration with data from SA
Similarly, SG&A expenses expanded 16.2% YoY owing to higher pay rates and staffing to support the growth. Therefore, the operating margin continued to fall to 2.15%, insufficient to pay interest expenses. Nevertheless, the management still estimates the company can have an EBITDA margin of 33.5% , which implies an operating margin of ~18%; I consider that unlikely as the margin compression has gone too far to be recoverable in an environment with a softer demand.
Additionally, the decrease in profitability enlarges financial risk, as the company had an interest coverage ratio of barely 1.80 in FY23, together with a lower profit margin and a higher rental expense from the Vici agreement ($31.6 million per year), which I believe will jeopardize the capacity of the company to respond to crisis and potentially its continuity. In addition, I believe the management was clear in the last earnings call that they would invest part of the proceeds from the Vici agreement in new acquisitions, conversions, and accelerating the construction of new buildings. Therefore, I expect Bowlero to spend more than $160 million on acquisitions and more than the expected $125 million in Capex. Even if they can earn a high return after selling the properties, I think they are getting overexposed to financial distress risk.
Consequently, if something in the financial markets ‘breaks,’ originating a crisis and a recession, or simply the interest rates turn back and start rising again, then Bowlero will be in a vulnerable position in my view, potentially destroying value for shareholders.
Finally, I think the management is doing a decent job with the acquisitions and sale-leaseback agreements. Still, the opportunities to grow this way are limited to the number of available centers. The company seems too aggressive in this type of growth, which is evident, in my opinion, when they are increasing its financial leverage even in an environment of high interest rates.
Investor Takeaway
I believe not losing money is more important than earning it in the financial markets. That’s why even if I consider Bowlero to have strong competitive advantages in the US bowling industry, its aggressiveness in pursuing its growth strategy exposes it to high financial risk that jeopardizes the company's continuity in case of a financial disaster. The bowling industry has remained stable even during economic contractions (except during 2020), which may reduce the general risk; however, I consider that financial markets can offer more appealing opportunities with better return-risk relationships than Bowlero. Furthermore, earnings per share could be volatile as sales-leaseback deals are not recurring in nature, and the company relies on them to expand its bottom line, as revenue will hardly grow fast as the company is in a mature industry, which led analysts to estimate annual growth rates only in the high single digits. Therefore, I don’t think Bowlero is a good investment, given its financial exposure.
For further details see:
Bowlero Corp.: Strong Competitive Advantages, But Excessive Financial Leverage