The Refinancing Iceberg Under Golf’s Titanic

Jim Koppenhaver is a long time friend of The GolfBlogger who runs a very thoughtful, data driven golf consulting company called Pellucid. His Outside the Ropes newsletters, available to the public for a nominal fee are always worth reading—I recommend them highly.

The latest issue had an article on the coming golf course refinancing Tsunami. I read it with such morbid fascination that I thought it deserved a wider audience and I got permission to share it here:

Golf’s Next Wave: The Refinancing Tsunami

While sharing a lunch with a retired industry veteran and colleague at the Golf Industry Show a few weeks back, he dropped a line on me that almost made me swallow my fork: “Between now and 2013, $1.7 trillion dollars of golf course loans will come up for refinancing.”  I knew there were a lot of loans coming due but I had never thought that the sum could have a “T” at the end of it.  The next day, while waiting for an Answers on the Hour session on the GIS floor on the topic of course financing to begin, I again saw him and had to ask him to take me through the assumptions and math again to get to $2T dollars.  To be fair, his calculation is not just the golf assets but also includes real estate, hotels etc. associated with golf but, as former Illinois Senator Everett Dirksen used to say, “a million here and a million there, and pretty soon you’re talking about real money.”

We didn’t really resolve it to at least the 9 figures level of accuracy but it did hammer home a very real point; the next significant shock wave for the golf industry will be this refinancing tsunami which will be a lot of action compressed into a relatively short period of time.  Couple this with the current challenge we’re facing as an industry valuing golf courses and banks viewing golf as a “toxic asset” and it’s safe to say that we may finally have the catalyst to drive more than 200 course transactions annually in our near future.  For a change, we’ll focus on just three primary facets to this:

• The math behind at least $1B of golf course refinancing within the 2011-2013 time horizon
• How the current cashflow crunch of golf courses could lead to valuation vagaries which compound financing challenges
• How this could be a significant industry challenge (or opportunity potentially for cash buyers with patience and any expertise in the maintenance and marketing of golf courses)

Like the tragic situation in Indonesia several years ago, I’m afraid that more than a few in the golf industry are down on the shoreline picking up starfish left abandoned by the receding water completely unaware of the imminent peril.  It may also be that the smart people have already started running for higher ground and the question is did they start early enough and are they fleet enough of foot to outrun the inevitable math of financing?

Let’s do the math; how much refinancing could there possibly be?

While my source has requested to go unnamed, he did point me to several others in the industry with whom he’s connected and corroborated his facts and math.  My colleague Stuart Lindsay has mentioned on more than one occasion that there’s a similar “day of reckoning” still ahead for commercial real estate as it relates to financing.  In simplest terms, the world of financing changed somewhere in mid-2008 and any loans or lending terms that bridge that gap are going to wake up in a whole new world when they come due.  I can tell you from personal experience as well (on a much smaller scale) in that Pellucid is currently in the midst of refinancing our initial small business loan taken out back in 2001 and we’re having to bring cash to the table of that transaction not due to the performance of our business but rather due to much more stringent criteria of cashflow to debt imposed pretty unilaterally by all the banks we’ve engaged in this process.

Back to the golf industry level, $1T dollars is a lot of money and you’ve got to refinance a lot of golf courses to get to that number.  My question was, “How is it that so many golf courses could come up for refinancing at the same time?  Haven’t they been on a relatively even trickle of initial loans and standard 7 or 10 year terms that would spread out the refinancing?”  His response, which made sense in retrospect, was that his sources were telling him that an inordinate number of golf courses went to “the money window” in the 2000-2005 period during the banks’ “money grows on trees” phase and when golf was in favor as an asset class.  This makes sense in that this was also the period where we were building all these Public-Premium new course gems and the pre-2000 courses were feeling the pressure to “spruce up” so that they could “price up” and reap the revenue windfall that everyone was going to realize because golfers had been willing to ante up 5-10% more annually to play golf for no apparent reason (other than that was the price increase imposed by the majority of facilities).  There was only one flaw with that logic:  What happens when you’ve invested $2-$5M in that renovation, clubhouse expansion, [fill in the blank with your own facility’s 7-figure project during that period] and your pricing power goes south as the supply glut catches up and the golfer’s figure out that nothing else in their life, especially not their income, home, investments or net worth, is rising at that pace?  The answer is you get hung with debt service and tread water waiting for the next rounds or revenue increase.  And, what if that period of absorption is longer than the term on your note?  Finally, what if your amortization period on your 10-year note is 20 years so you haven’t really paid that much principal either?  As Stuart Lindsay says, “Oops.”

So let’s look at the math and see if we can’t find a number somewhere between where Sam Hines thinks it ought to be and where I think it’s going to land.  The basic math is pretty simple, it’s the values you plug in for the two components that are fuzzy and leave lots of room for error and debate.  Below is a table outlining what you need to get to my colleague’s number and how my best estimate lays down against it:

As you can see, I’m still having trouble finding the math to breach the $1T mark but both of the above are very big (and scary) figures.  There was some good-natured give-and-take between my colleague on I regarding what supports a higher vs. lower estimate.  His primary support for an average loan value north of $10M was 1) It includes golf associated real estate (and we know there was an abundance of that during the 2000-2005 era)  2) The bulk of the facilities being put in the ground weren’t your garden variety affordable golf types and 3) a number of the existing facilities making renovations actually took the opportunity to refinance the balance of the original loan at more favorable terms so it’s not just the amount of the renovation that was financed.  So, the next act of this golf industry “play” is that a large number of golf facilities that have somehow survived the rounds and revenue downdraft by working harder and cutting expenses will now face a valuation event.

Valuation in an unstable market, like catching daggers.
I also had the opportunity during GIS to attend a few of the educational seminars on the NGCOA side of the equation.  One that was both enlightening and puzzling was put on by the Society of Golf Appraisers (SGA) in which current valuations and methods were discussed.  The enlightening part was a section called The Investors Tour and The Lenders Tour.  On the Investors Tour were ranges and averages of deals which the combined SGA membership (25 in total as listed on the leave behind) have worked on as well as the contribution of figures by other non-SGA entities.  Some of the key stats included were Cap Rates, Net/Gross Income Multipliers and Discount Rates.  On the Lenders Tour were similar facts such as LTV ratios, Interest Rates, Call and Amortization Periods etc.

Where it got more puzzling for me as a relative financial novice (hard to believe that an analyst isn’t more knowledgeable or proficient in finance but I’m not) were the relatively wide spreads in the range of high-to-low values for several of the key measures (i.e. Cap Rates from 6%-16%, wow!).  In statistics, this wide a range generally means one of two things:  1) The set you’re studying isn’t very predictable or 2) The metrics you’re using aren’t very reliable.  Just to be clear, this section isn’t a commentary or indictment on the SGA, they’re one of the few bringing any data to the table and, like Pellucid most times, when you bring facts and they’re not pretty, you sometimes get shot at simply for being the messenger.  Stuart Lindsay contends that the above Cap Rates range isn’t unreasonable as it floats and reflects the interest rate environment but I’m thinking that the interest rate environment hasn’t moved much over the past couple of years and has been generally favorable so that shouldn’t be the major contributor to the wide spread if we’re talking about deals in the past 2 years or so.  He also astutely points out that “the lower percentage Cap Rates are also present when the buyer feels there is significant upside due to bad current management or the anticipation of a turnaround in a given industry. Everybody wants to buy at the bottom, it’s just a question of guessing when the golf industry has bottomed out.”

Here’s where I think the collision of refinancing needs and challenging valuations is going to get exciting (that’s being generous, the word that first came to mind was “ugly”).  We documented in the 2010 State of the Industry that at least 4 of the 8 NGF-defined golf course asset classes are “in the red” at the actual cashflow level (below EBITDA after factoring in CapEx, Interest expenses etc).  Let’s just say that the “average” public course is doing $1.5M (the overall average is just under $2M but that includes private clubs and resorts which pull the average higher than the universe I’m considering) and, if they’re doing well, they’re making 10% Net Income Margin (so $150K, that’s a pretty good feat in today’s environment).  The two in vogue primary valuation methods discussed at the GIS session were Gross Income Multiplier (GIM) and Net Income Multiplier (NIM).

Let’s start with the GIM approach which appeared to be the frontrunner currently among those participating or observing “deals” in 2010.  The SGA Investors Tour range for GIM was 0.5-3.0 with an average of 1.4 (people in the room concurred that having positive cashflow was recognized with a GIM at or above 2.0 while negative cashflow courses were more likely to land in the 1- 1.25 range).  So, our average public facility gets a valuation of $2.1M.  On the Lender’s side, the LTV range was 50-100% with an average of 66% which means that this facility could reasonably finance about $1.4M in a new loan.  If they’ve still got $2M+ on the existing loan, they’re now in a $600K “cash call” position (ouch).  What confuses me in the GIM valuation is why you’d ever value a course losing money on its Gross Revenue.  The SGA and members of the audience countered with the fact that, if you have a course that’s losing money, there is no good NIM approach to valuation so you just have to value it based on the revenue-generation capability.  In other words, in these situations the buyer is buying simply on their superior operational, marketing or cost-containment skills, not necessarily on the existing value of the operation.

Turning to the NIM approach (seems to make more sense to me in the current environment but does leave a number of courses in the red out of the valuation game), the SGA scorecard range was 5-13 with an average of 7.9.  Using our same average public course above, this would yield a valuation of $1.2M and, using the above LTV, yields a loan of only $780K which translates using the above example of $2M+ in outstanding debt in a $1.2M cash call (double ouch).  Unless I miss my guess, few if any of the existing owner/operators have that kind of change lying about or accessible and the banks have little or no interest in being flexible in the current environment (heck, several of them already own mini-portfolios and they’re starting to get some market concentrations just like the management companies so, depending on the location, they might actually be “leaning in” to the conversation of taking it back).

Significantly more transactions ahead as the irresistible force meets the immovable object.

I continue to be amazed at how few courses are transacting in the current environment and how long the red ink has been allowed to flow.  I think my colleague’s clarion call however is on the mark and this wave of refinancing coming due in a short period of time will be a stronger catalyst to either transact or allow a higher number of courses to go dormant.  Someone once commented to me that the secret of Robert Dedman Sr’s success was that he didn’t buy until there was “blood in the streets.”  While I didn’t personally or professionally know the man, it seems to me that he would be quickly warming up to the current industry environment on the facility owner/operator’s side.

I’ve been watching the recent transactions and looking for a pattern regarding who or which types of corporations might be lurking in the shadows patiently waiting for the opportunity to build the foundation for the next golf course ownership empire.  Currently it seems like a fragmented assortment of individuals with varied interests and motives buying properties on the “spot market” at depressed prices in situations where they know the course or the surrounding geography.  Given that most of the management companies have reverted to the more cashflow steady operational (vs. ownership) model, I don’t see any of them jumping into the pool in a big way as this tsunami crests on the beach.  Many municipalities are financially handicapped (some actually on life support like Stuart’s home state of Wisconsin) so they’re off the “white knight” list vs. earlier in this decade when they saved a meaningful number of courses from the plow or seed.

Sticking with our often contrarian nature (consistently in good times and in bad), I do see this next cycle as one of opportunity for a limited number of investors or corporations.  If I’m right, it’s also going to trigger another domino effect within the industry as facilities that were previously attempting to run as $70 weekend fee golf courses will now potentially be able to be run as $30-40 weekend fee golf courses based on the devaluation as a result of the (forced) transaction.  Stuart pointed out that in market analysis work we’ve done for clients over the years here in the Chicago market, we’ve seen this price compression as the range for Public-Value (Pellucid’s mid-range value segment) has gotten smaller and smaller annually and with more facilities being classified in this tighter bulls-eye around the middle.  That will be a sad day for the responsible business owner of the previously $30-$40 competitive course which will now be forced to compete on “good looks” or significantly superior marketing to offset the fact that his formerly $70 competitor now has a new balance sheet which allows it operate profitably at $40-$50. This potentially brings another round of price compression to the industry on the facility side before being able to see the light of dawn on the horizon.  If this plays out the way I’m envisioning it, Third Party Marketers (TPMs) may have to share the industry spotlight of “the great force of evil” because the discounting effect of price compression may equal the 50% discount we currently dread but it will happen across 4,000 courses, not the 2,000 courses currently using TPMs.

For the aforementioned patient, capitalized, intelligent buyer (with some plan for operational and marketing excellence), they’ll be in an advantaged position to ride that wave of price compression and have more control of their destiny than the existing operator.  That said, I’m not betting all my money against the existing smart operators that have figured out how to survive and manage their finances through the chaos of the past decade and still found a way to survive.  Much like Pellucid, you have to respect the dogged persistence and intelligence needed just to survive and make it up as you go.  Only a miraculous recovery in the housing or commercial real estate market or a dramatic return to health by a majority of municipalities will stave off what I think is inevitable; an increasing number of courses will transact or die in the next 2 years.  Anyone want to take odds on either of the above scenarios playing out?  For what it’s worth, I think my colleagues who are calling this scenario have it right, all that we don’t know is how many, how much and when.

If I were King.

I can’t resist using this as a soapbox to say that I believe Pellucid will be either informing or evaluating the next generation of investors/buyers looking to capitalize on this potential window of opportunity.  What will be interesting to watch is whether the lending institutions in this next cycle finally figure out that when you pay <$1K for a market analysis and <$5K for an appraisal, both of which have to be completed within 2 weeks and involve a site visit, you’re not going to get a very good evaluation of the strengths and weaknesses of said property. Up to now that hasn’t seemed to matter but I figure if the lending institutions don’t figure it out, the investors/buyers will and it will get driven by that side of the buy/sell equation. As Jim Dunlap pointed out in his article on industry “winners & losers” in an early edition of The Pellucid Perspective, somewhere in this cycle the people who do market analysis and appraisal have to benefit as the volume ramps up to previous levels (only difference is previously we were collectively churning out evaluations of new properties, now it’s going to be measuring some number of the existing properties for coffins…).

The other element coming out of this cycle will be the continuation of the trend of increasing importance on facility marketing skills to survive the shifting competitive and golfer perceptions landscape. We have several things in the queue to play an increasing role in that regard from our Voice of the Local Golfer surveys to Customer Franchise Analysis linked into multiple Point-of-Sale providers’ capabilities. If the new investors/buyers hang their hat solely on the hook of the economic differential and operational parity it will provide the existing operators with the marketing angle through which to drive a truck and still survive. If the new investors/buyers leverage economic advantage, operational parity and at least marketing parity (that’s a pretty low bar currently), they’ll leave the existing operators precious little room to maneuver and allow slim margin of error to basically survive. It’s not pretty and, in some ways, I hope that I’m wrong but much of the hypothesis I’ve outlined in this edition is simply supply/demand, economics and time. We’ll revisit this at the end of next year and see what we got right and what eluded our grasp of the facts.

---

If you liked this article, subscribe to Pellucid’s Outside The Ropes