Callaway Golf Co. and the Topgolf Entertainment Group, a major U.S.-based operator of golf driving ranges, have agreed to merge in an all-stock transaction. It’s an interesting way of creating a vertically integrated operation, without offending Callaway’s wholesale partners and it bears some similarities with what Peloton has so successfully implemented in the home fitness sector.

On the other hand, the merger has been criticized by both Moody’s and Standard & Poor’s. Both rating agencies noted that it would significantly raise the debt-to-Ebitda ratio well above five times through 2021, before possibly declining afterwards if Topgolf generates some income. They both acknowledge the fact that Callaway will be better able to promote its brand to Topgolf customers, but Moody’s, which has decided to downgrade Callaway’s corporate family rating, noted that it has not been particularly successful with acquisitions made outside its core golf business. Callaway bought Jack Wolfskin nearly two years ago.

By Topgolf’s account, the merger will “fully fund Topgolf’s growth plans.” It will also allow the combined company to “benefit from a compelling family of brands” through retail, venues, e-commerce, digital communities and other channels” and put together a sales, marketing and partnership infrastructure to “drive traffic, increase same venue sales and accelerate conversion of new business opportunities,” generating long-term opportunities” to “distribute content across connected screens for instruction, fitness and lifestyle.”

The combined company will be issuing about $2 billion in new shares. The transaction is subject to shareholder and regulatory approval but should be completed by early next year. Callaway already holds a 14 percent stake in its counterpart, as well as an exclusive golf partnership agreement covering all Topgolf venues. Its initial investment dates to 2006, six years after TopGolf’s founding. Other owners include Providence Equity Partners, WestRiver Group and Dundon Capital Partners. Reportedly, plans for an initial public offering went south with the Covid-19 pandemic.

According to Topgolf, Callaway will now be issuing about 90 million shares of its common stock to the other shareholders of Topgolf. Once the deal is done, Callaway’s shareholders will end up owning about 51.5 percent of the combined entity, and non-Callaway Topgolf shareholders about 48.5 percent, on a fully diluted basis. Meanwhile, Callaway will be assuming Topgolf’s net debt, which lies in the neighborhood of $555 million. Topgolf’s equity value stands at about $2 billion.

The combined company’s board is to consist of 13 directors, three of them appointed by Topgolf shareholders. Chip Brewer, Callaway’s president and chief executive, is to retain his titles and reign over the combined company. Dolf Berle is to remain CEO of Topgolf until the merger is completed and then resign. John Lundgren, Callaway’s chairman, will be chairman of the combined company, with Erik Anderson as vice chairman. Topgolf will continue to operate out of its headquarters in Dallas, Texas.

Topgolf declares itself to be “in the early stages of its growth,” with “more than ten years of planned unit growth opportunity” at its U.S. venues, “just 2% addressable market penetration” at its venues elsewhere in the world, and one percent penetration in its Toptracer Range business. This refers to the Topracer ball-tracing system the company developed for televised golf coverage. The system has been expanded over the past three years to some 7,500 Topgolf driving ranges, where it combines with a mobile app for ball-tracing in actual golfing.

Over those three years the Topracer business unit has enjoyed revenue growth of 233 percent. Topgolf overall reports about $1.1 billion in revenue for 2019, which represents 30 percent growth at a compound annual rate since 2017. The company operates 63 venues – what it calls “open-air, climate-controlled bays” – and has plans to open more around the world. According to Golfweek, there are 33 in the pipeline. The company drew about 23 million customers in 2019, more than half of whom were self-described non-golfers. Topgolf also operates the World Golf Tour mobile game, which counted 28 million members as of 2019.

The combined company’s revenue mix should break down as 30 percent golf equipment, 46 percent Topgolf activities and 24 percent softgoods. It is projecting revenues of about $3.2 billion by 2022 and annual growth of about 10 percent thereafter.

Callaway itself, which also owns the Ogio, Travis Mathew and Jack Wolfskin brands, is projecting third-quarter sales for the current year of $476 million, for a year-on-year increase of 12 percent.