2023-03-27 18:13:57 ET
Summary
- Bowlero is the largest operator of bowling centers, operating under the Bowlero, AMF and Bowlmor brands.
- The company has had decent stock performance and revenue growth over the last years.
- A looming recession may become a problem for Bowlero as the company does depend on consumers.
- Strange accounting mechanisms make valuing the stock properly difficult until preferred stockholders become common stockholders.
- The company has some potential in the future to be slightly more than just a bowling company, but it's contingent on management decisions.
Introduction
Bowlero ( BOWL ) is a strange company in the way that it has multiple classes of stock, strange accounting mechanisms that aren't seen all too often and a questionable level of profitability. The company on a revenue basis has performed rather well, but I do believe that it is a good idea to cash in some gains while the economy and the stock sorts itself out as we may be headed into a recession and the company probably won't have as great a performance as analysts originally thought.
The path forward is currently split between a recession affecting the company and its profitability badly or the company managing to become profitable and boosting shares further.
Company Profile
Essentially, Bowlero is the biggest player in the bowling space boasting the two big brands of Bowlero (formerly Brunswick) and AMF. The company originated from a merger between the original AMF Bowling Worldwide and Strike Holdings, the former of which had filed for Chapter 11 bankruptcy.
Bowlero also owns the Professional Bowling Association ((PBA)), which is the governing body of professional 10-pin bowling and hosts all kinds of tournaments, which are viewed by many fans around the world.
Based on their most recent 10-K filed in September of 2022, their long history has proven to be a business model that can grow over time, barring abnormal events such as the great financial crisis ((GFC)) of 2008 and COVID-19.
I like how unique the business is, considering it's a dedicated bowling corporation, but it has some key flaws I'm starting to notice right out of the gate. First, the company operates for their consumer's discretionary income, which is becoming spread out very thin among various entertainment companies as are theme parks, cinemas, video games, other sports, cruises among other attractions in the entire world. This means that Bowlero will likely be greatly affected by a terribly weakened consumer.
The Growth Story
Bowlero's growth story feels like one of a company that came out of bankruptcy and is now back on track scoring significant growth over time with their new strategy. While the prior bankruptcy aspect is something to be concerned about, I believe that management might be at least on to something with their current moves to improve cost efficiencies and customer loyalty.
To start off with a quote, here's what CFO Brett Parker has to say about Money Bowl back in the company's Q1 2023 earnings call :
We successfully initiated a pilot of a skill-based gamification app called Money Ball that we believe can transform the performance of our centers by deepening engagement with our guests.
The description provided explains that Money Bowl is an application that allows bowlers to take on challenges and earn prizes in return for the completion of such. The challenges vary for all the difficulty levels, but regardless provides a unique value proposition for the company, their shareholders and the customers as well.
For the company, that means that players will be more incentivized to play more often in their bowling alleys to cash in some sweet rewards. They will also be incentivized to improve at the game if the prizes increase in amount for more difficult tasks, such as breaking 200 or achieving a Turkey. This means that the company will see potentially higher revenue streams and wallet share as more players are more focused on playing to improve and get more rewards.
For shareholders, this can potentially mean some additional growth over time during good conditions for consumers, and potentially achieving profitability. Should the rewards be fair for both the company and the player, the player can also benefit by nabbing some extra cash along the way and having additional reasons to play the sport, as they now have goals to achieve.
The second advantage, QMS, is more of an administrative assistant that helps managers work better and more efficiently. Page 9 of their presentation helps provide more color onto what QMS is.
QMS essentially is made to allow managers to understand where they can improve their operational performance across various metrics. The idea is so that each individual location can be benchmarked against similar and relevant peers to find out areas in which they can improve on and execute a proper plan. Like Parker described, it is their "operating system."
I believe this boasts a major competitive advantage that can allow for the creation of a new operating segment should management find it reasonable to go forward with this thought. The likelihood of this happening is further boosted by the fact that management has been evaluating the potential for third-party licensing of the software.
Additionally, we believe QMS has significant third-party commercialization potential, which we continue to evaluate on an ongoing basis.
With these two competencies working together, they boast a slightly better advantage against their peers as they leverage their size and power to offer better incentives for their customers to prefer to go bowling at one of their locations rather than spend the day or night in the house or at some other place like the mall or its other stores.
I believe the phase of exiting COVID-19 is over and now as investors should probably look forward to what happens this year as the company is not a great performer during recessions. While in prior earnings calls like Q4 of 2022 investors were more focused with workers returning to office, currently it seems that management is acknowledging in their Q2 2023 earnings call that indeed investors are now concerned with inflation, a weakening consumer and a recession.
Many arguments I presented in a prior article I wrote for Cedar Fair ( FUN ) titled " Cedar Fair Trades Below Valuation, But Macroeconomic Concerns Remain " still remain. While there is a potential for third party licensing opportunities for Bowlero when it comes to QMS, their business remains "simple, but risky."
Should consumer sentiment overall continue a freefall or stagnate and Bowlero's smaller customers start to cut spending on leisure, this can place a dent on their overall earnings. Businesses will also begin to cut back on spending too, which may end up affecting the event side of their business.
The only possible place of certainty that may help Bowlero in a recession is their league play, and the fact that they are the largest bowling alley operator, who just so happens to own the PBA. Professional bowlers will need to visit bowling alleys often enough to keep their skills honed regardless whether there's a recession or not, and more often they should have at least some cash on the side reserved for the sport.
Recent Earnings
Looking at their most recent earnings report will help provide some insight as to how their financial conditions look under the hood. While I have talked about their earnings calls, their assets, revenues and cash flows will provide the truth behind their operations.
Starting with their most recent 10-Q , I'll make a point to emphasis their long-term liabilities:
Their liabilities have increased mainly because of their earnout liability. However, what is that? An earnout is essentially a provision in a contract that allows the sellers of a business to receive money from a sale if certain conditions are met.
As an example, we'll use Bowlero's acquisitions of two bowling centers in Florida . While the terms are undisclosed, we can use example numbers to provide a perspective of what an earnout may be like in a case like this.
Their current cash and cash equivalents stand nearly at $80 million. Let's say that the acquisition was to be valued at around $40 million dollars for both centers, which make collective revenues of around $20 million. Since an acquisition like that would run Bowlero's cash to the ground, they can agree on an earnout provision where $20 million cash is paid upfront while the other $20 million is paid in two sums of $10 million for every time the bowling centers double their revenues. This provision would then be registered as a liability as they have a financial responsibility to pay out to the original owners of the acquired company whenever those achieve the established goals.
It can be anywhere from revenues, earnings and any other metric that the two parties agree on, but the important thing is that Bowlero would still theoretically owe money for the acquisition, just not in the traditional sense like debt would be known for. Instead, the liability is conditional and if the performance goals are never met, the liability I assume would stay there forever.
I believe that what matters here is that Bowlero uses these provisions carefully as to not overload themselves with massive lump-sums for great performance. It is a useful technique that can certainly remove some of the weight of Bowlero's continued acquisitions, but I believe investors can take some caution if this metric starts to affect profitability. As mentioned earlier, their $80 million in cash is less than what the total liability represents, and this is the fastest growing liability they have as they expand.
Outside of that, their long-term debt is relatively massive with interest expense amounting to over $25 million. Have they been decreasing their overall debt to better handle this?
I wish I could say yes, but no - their long-term debt has increased slightly according to the 10-Q and as you can see in the chart above, there hasn't been much to comfort shareholders with the level of risk this company has with debts.
The biggest problem lies too in the fact that their interest expense has increased quite a bit, along with other structural problems that may be exacerbated if the stock crashes.
Currently, the stock has multiple classes of stock and multiple kinds of stock. For common stock, we have class A and class B, while there's also a preferred stock category that came to be when ISOS Acquisition and Bowlero first merged.
The details of this reads that their perpetual convertible preferred stock would have a 5.5% dividend yield and a convertible price of $13 that is mandatorily executable after 2 years once the stock price is at or above $16.90 by then.
This will indeed incentivize the company to provide value to shareholders if it wants to reduce their dividend expense registered on their balance sheet, but this would create a problem of dilution. In the end, there is no happy ending since the preferred stock would be a liability for common stockholders and even then, there's still a second class of stock.
And so, in a complete view, the company would need to keep improving margins to be able to provide a positive net profit margin here.
Is there anything cheerful about their earnings? Yes, and to be honest, it's more cheerful than the overall market outlook.
For one, their revenues have grown faster than their cost of revenues, which means that there is an expansion in operating margin year-over-year. Meanwhile, the company has registered a significant decrease year-over-year in administrative expenses, including the six months of the current fiscal year.
This provides a significant benefit to their operating profit as it stands at around $60 million. This is a serious win for the company that I believe is worth acknowledging as it shows that their financial conditions have improved and outperformed their 2019 results. At the rate we're seeing, I believe it's reasonable to expect the company to break $1 billion in revenues and potentially have operating profits above $100 million (which is a generous estimate as I believe it could be higher, like above $150 million).
However, that's what's stated in their earnings statement. If we head over to their cash flows statement, we can see something here:
One may wonder why they still register a larger net loss in the operating side. Well, it's possible that some items are not counted for in the earnings statement, which may have affected net income positively. Another possibility is that this is a mistake, but since their cash flow statement should provide insights as to where their cash was distributed or obtained from, it is possible that net income is displayed lower than it would for GAAP purposes.
If one looks closely, depreciation and amortization as well as the changes in the fair value of earnouts are the main drivers to the upside, implying a non-cash compensation or refund as what may be implied in earnout liabilities. However, since I'm limited in knowledge for earnouts, I may be wrong about how they are adjusting their earnout liability. Earlier I said that their purchases could be adding to the liabilities, while over here it appears as a positive thing. The adjustment also appears as an expense in the income statement, and so it is up to you what to make of it.
For me, I believe they might as well assist in reflecting how much cash was being used. It could be implied that they are registering the net purchase in their acquisitions shown on their investing activities, but since that number is close to $80 million, it would imply Bowlero paying close to zero for the acquisitions (relative to their revenues; $8 million is still a large number).
I'd say their earnings look alright, but the overall macro-environment still does not promise bullishness. There's a handful of more unique accounting items that make it challenging to the best of my knowledge to understand what is going on with the company, despite being a rather simple business.
Valuation
With all things considered, it is best to move forward to determine a valuation for the company.
So far, the only worthwhile expectation on a non-GAAP basis for earnings lies ahead in 2024, where the company can potentially make $0.60 per share.
Meanwhile, their fiscal year of 2022 was practically obliterated on a non-GAAP basis with a massive loss that exceeds Bowlero's all-time high share price.
If we take that $0.60 as granted, we can use that into our calculation for Bowlero's potential stock price for that year, however I caution against using this as an investment thesis as we're overall talking about a fiscal year that ends around the middle of 2023.
The company has positive equity as of Q2 of 2023, however that equity belongs to preferred shareholders. What we are left with is a deficit as shown below:
A $58.2 million deficit would then result in a deduction per share of around $0.36 when using about 162.5 million shares of both Class A and Class B common stock for the calculation.
I would likely use the currently displayed EBITDA shown on Yahoo! Finance as the current EBITDA numbers. These are calculated by S&P Global Market Intelligence, whose methodology of calculating it may be different from the company. However, I believe using these metrics will be suitable for the time being.
Their EBITDA stands at $314.9 million, which can be rounded out to $315 million. I cannot use any free cash flow calculations as I currently calculate their free cash flow to be negative (mainly due to their investing activities).
Revenue is usable here on a trailing twelve months ((TTM)) basis, much like is shown on the above image and the following chart:
However, lowering valuations due to their current equity situation is a rather complicated situation, as they have positive equity, but it is attributed to preferred shareholders. This keeps underlying the importance of the mandatory conversion clause for their preferred stock, as it is the only way to remove that class of stock and have that equity properly attributed to normal stockholders and further incentivize purchasing the company.
For the time being, I would reduce their revenue multiple to 3x from the usual 4x and EBITDA to 4x from 5x. Their non-GAAP EPS valuation would also be reduced slightly to 18x instead of the usual 20x. I will provide a valuation accounting for a normal situation if preferred stock were to be removed, for context.
Value | Multiple | Valuation (Current) | Valuation (Normalized) | |
Revenue ttm | $1029M | 3x | $18.64 | $25.33 |
EBITDA | $315M | 4x | $7.39 | $9.69 |
non-GAAP EPS 2024 estimate | $0.60 | 18x | $10.44 | $12 |
This takes into account their per-share price targets for each. Two of the valuation metrics show that Bowlero is currently overvalued and trading at a high premium for the macroeconomics that it faces.
However, what happens if we combine all metrics together with equal weighting? This gives us a target price of $12.16.
The closing price of Bowlero as of the time of writing stands at $14.84, and so Bowlero is currently trading at a premium of $2.72 compared to its fair value. If preferred stock were to be removed, for comparison, the target price would instead be $15.67.
The good news is that if Bowlero were to trade above $16.90 by July when it would be reasonable to expect the two years since the preferred stock were issued to have passed, this valuation would then come in effect, but it would still then imply a premium of around $1.23.
So, for the time being, acknowledging the current circumstances and where Bowlero may be headed over the remainder of 2023, it is fair to provide a price target of $12 in my view.
Conclusion
Bowlero is a somewhat strange company when it comes to accounting, but it is a pretty good business idea with some noticeably good execution as far as the current times are concerned. It is outperforming some peers on the revenue side of things, but their GAAP earnings leave something to be desired.
A possible recession (at minimum) can leave a serious dent in future prospects for the business if consumers stopped Bowling for a determined period of time. While the current time remaining for preferred stock to exist is slowly vanishing, a crash could make it so that preferred stockholders aren't forced to convert into common stockholders. If anything, they're incentivized not to thanks to the dividend.
Bowlero has appreciated quite a bit since its bottom, and even if you bought the company as the special purpose acquisition company ((SPAC)) the entity was prior to the ISOS and Bowlero merger, you'd still be on the green. It would be a fair choice to at least let go some of the position while the economy sorts itself out (or self-destructs these next few years).
As such, I will rate the company as a Sell for now with a price target of $12. Nothing wrong with cashing in gains, or to have a very small position just in case. As always, do your own due diligence.
For further details see:
Bowlero Is On A Split Path To Profitability