Got the Shaft? Live with It

— Most companies live by the old axiom: "Don't put all your eggs in one basket." It's the rationale for diversification -- entering disparate businesses in an effort to spread risk. But diversification carries risk too. Does a company know how to manage different kinds of enterprises? Will the company take on too much debt in making acquisitions?

A few companies follow Mark Twain's advice: "Put all your eggs in the one basket and -- WATCH THAT BASKET." Stick with what you know best, and don't be tempted to jump into whatever Wall Street thinks is sexy at the time.

There are risks of this nondiversification approach too. A company might watch as the eggs in the basket rot and become a victim of obsolescence, crushed by a competitor that, say, comes up with a noncholesterol egg. Or people's appetite for eggs may fall sharply.

In the sports-equipment industry, three San Diego County companies have sharply different ideas about toting eggs. Aldila, a maker of graphite (carbon-fiber-based composite) golf shafts, is essentially nondiversified -- a follower of Twain's philosophy. Callaway Golf, which makes golf clubs, balls, and clothing, is diversified within the golf industry. Acquisition-crazed K2, Inc., is diversified within the entire sports industry, making skis, snowboards, mountain bikes, sportswear, paintball products, baseballs and gloves, and fishing equipment, among many things.

Aldila's conservative strategy is paying off, while Callaway and K2 have tummy aches trying to digest past unwise acquisitions. Aldila stock has soared from $1.24 in 2003 into the $30s. "Good stocks still hold their ground in bad markets," says San Diego's Bud Leedom, publisher of the California Stock Report. The overall market has been creamed in May and June, but Aldila kept its ground. Its earnings are surging, so it's still reasonably priced, says Leedom. He ranks it the second-most-appealing stock in the state.

The company lost $56 million between 2001 and 2003 but then made a combined $21 million in 2004 and 2005. The momentum is building. Last year, sales zoomed 46 percent and profits 44 percent. Its first quarter of this year was the best in the company's history: sales shot up 17 percent from a year earlier and earnings soared by 28 percent.

Through the grim years, "Aldila stayed true to what it is good at," says Leedom, who specializes in analyzing companies in the golf business. "When things aren't going well, a lot of companies go out and make acquisitions."

Aldila not only kept concentrating on golf shafts during the bad years but also set up a plant in Wyoming for making carbon fiber for golf shafts. Now there is a shortage of materials for graphite shafts, and Aldila has a leg up on the industry.

In the late 1990s and the early 2000s, golf-club makers were producing club heads made of exotic space-age metals such as titanium. The club makers just wanted pedestrian shafts as cheaply as they could get them. From 1990 to mid-2002, the average selling prices Aldila got from club makers plunged by 64 percent. Sales and profits sank.

Then a funny thing happened. In the late 1990s and into the early 2000s, the major golf-club makers -- including San Diego County's Callaway Golf, TaylorMade, and Cobra -- made clubs that did their jobs too well. Using these clubs, golfers hit the balls too far. Golf-course managers complained that their courses were getting obsolete and there was no room to lengthen them.

So the United States Golf Association ruled that some of these modern clubs had too much spring: the ball jumped off them too fast. Later, the association ruled that manufacturers "can't make club heads too large," says Leedom.

All of a sudden, "the golf-club makers found they could get a higher average selling price if they talked about the virtue of the shaft," says Leedom. In the bad years, there had been a shakeout in the shaft industry, and Aldila now had an excellent position. It also had an excellent brand, NV, that has been joined by TC Pro and others.

Analyst Eric Barden was recently quoted in saying that Aldila is one of his favorites because the company depends on "strong, sustained income growth of high-end consumers." And that's what the U.S. economy is producing as the rich get richer and the poor -- well, they don't play golf that much.

Aldila sells 18 percent of its shafts to Carlsbad's Callaway Golf. Callaway has not kept all its eggs in one basket and has suffered as a result. All along, it has brought out new models of golf clubs at a prodigious rate. "These products generally sell significantly better in their first year after introduction than in the second year," says Standard & Poor's. "New products can render prior successful designs obsolete, putting pressure on selling prices and profit margins of older products." And the availability of older clubs at a low price reduces the demand for new clubs.

In the early part of this century, Callaway brought out a club with a carbon-fiber head. "Golfers were so accustomed to the sound of ping from a metal wood; this sounded like a thud, like a bad shot," says Leedom. "There was no rhyme or reason for this introduction. It was an absolute disaster that showed for the first time that Callaway had internal issues."

In the late 1990s, as its golf clubs were doing very well, Callaway decided to take advantage of its strong brand and go into golf balls with its own name on them. Those balls have been reasonably successful, but in 2003, Callaway bought the Top-Flite brand, along with ragtag manufacturing facilities, out of bankruptcy. Callaway has been losing money on golf balls at a rapid rate, although Standard & Poor's thinks the losses may end this year. "Callaway thought it was buying a great brand but had to make all this investment because the Top-Flite infrastructure was falling apart," says Leedom. "It wouldn't have been worth it if Callaway had gotten Top-Flite for free. It was a horrible acquisition."

Because of such moves, Callaway has been up and down. The stock peaked at almost $40 in 1997, is now selling below $15, and has been below $10. Earnings have been spotty. Last year's were one-fifth of 2002's, although Leedom is high on current management.

There is one good thing: Callaway has diversified only within the golf industry. K2, Inc., has rapidly bought up leisure companies in a wide variety of fields. It is loaded with debt: the financial-analysis firm Morningstar gives K2 a grade of D-minus for its financial position. Last year, paintball and other adventures got it into trouble, and it took a $212 million loss. Morningstar gives the company a D-minus for profitability too.

K2's stock almost hit $33 in 1997 and now sells below $12. The company made "a series of desultory acquisitions," says Jon D. Markman of Other analysts question executive compensation policies. Despite last year's big loss, chief executive Richard Heckmann got a salary increase from $550,000 to $690,385. His bonus went up from $550,000 to $595,000. He also got $913,000 because other people in the company were using his private jet. These are "ludicrous compensation policies," says Tim Beyers of Motley Fool.

But at least neither Callaway nor K2 is a conglomerate -- the kind of company that will buy anything that is for sale: bank, railroad, whorehouse, cigarette maker, airline, liquor store. Almost all such companies eventually get egg on their faces. Some, like Tyco and Enron, wind up with some of their executives in the slammer.

Share / Tools

  • Facebook
  • Twitter
  • Google+
  • AddThis
  • Email

More from SDReader


Log in to comment

Skip Ad