Is Rick's Corporate Air Fleet Reason To Sell?

Dec.20.13 | About: RCI Hospitality (RICK)

Rick's Cabaret's (NASDAQ:RICK) spending decisions has come under scrutiny since the disclosure of its $3.231M Cessna Citation Mustang jet purchase during their quarterly earnings ending in March 2012. Rick's detractors claim this is just another example of CEO Eric Langan using Rick's to fund his life of excess at the detriment of shareholders. The argument being that a company that has traded under $100M market cap for most of the past half-decade has no business needing a corporate jet, much less a fleet. Should shareholders be worried about the CEO mismanaging company cash to provide for outlandish perks?

The history of the Rick's fleet began in February 2008 (timing of events taken from respective 10Ks Long Term Debt notes) with the purchase of the 6 occupant Eclipse 500 which they bought for around $2M. At that point, Rick's just recently took over Tootsie's in Miami, and was breaking out of its Texas roots. Two years later, Rick's added the 4 passenger Cessna 400 Corvalis for $734K (price taken from Wikipedia) when they began clustering clubs in Dallas.

However, it was the purchase of the Citation Mustang in February 2012 that sparked outrage and accusations of corporate excess. The purchase of the Citation Mustang happened around the same time the Eclipse 500 would be mostly depreciated. The Eclipse 500 sold for $1.245M (taken from 2012 3Q 10Q cash flow - proceeds for asset sales….I assume the plane was the majority of this line item) and proceeds were used to pay off remaining debt. Rick's put up $538K out of $3.218M (2012 2Q 10Q) paid for the Citation Mustang, financing $2.68M at 8.15% (2012 10K). Rick's in August 2013 registered a third aircraft under their subsidiary TT Leasing LLC with the FAA for a Cessna TTx (the modern version of the Corvalis TT), it is possible that Rick's plans to sell the depreciated Corvalis TT soon. Note: Since the fate of the oldest plane is unknown, I will not assume Rick's will operate 3 planes.

So is Rick's just depreciating almost $4M worth of Cessna hardware to impress the ladies, or is the fleet a wise business decision? The answer really comes down to a function of how much Rick's uses their fleet. Let's focus on something we can all relate to and isn't as lofty as an airplane. Unfortunately, the term corporate jet is the literally a metaphor for corporate waste!

Is owning a car for our personal mobility a wise financial decision? Assume we financed a $20K car at 5% for 5 years, approximately a $385 monthly payment. If we use this car on a daily basis to go 10 miles, we pay about $170 (300 miles at $0.565 per mile) in gas and maintenance per month. If we didn't have a car, our next best option might be to call a taxi and pay about $4 a mile (I used my average daily commute as my basis, 5.1 miles for $20). Our monthly commute now costs $1200 versus the car option of $555 a month. Clearly car ownership is looking like a great idea. Assume we live in a city with great mass transit, and only need a car for our weekly shopping. Under this scenario, we could even splurge on renting a car for about $75 a day (checked my local rates with Hertz and Avis) up to 5 times a month, and still do better than owning a car.

If one buys a luxury car, the economics change significantly and make it harder to justify car ownership. Well, it should be clearly noted that Rick's didn't splurge on top of the line planes. The very light jet market is an entry level business jet. Though it is more comfortable and luxurious than flying Southwest, it can hardly be considered over the top. There isn't even enough room for a stripper pole in the Citation Mustang. Furthermore, Rick's doesn't need to maintain pilots to fly their planes since both the CEO and EVP are pilots.

Does Rick's actually fly enough to warrant plane ownership? During conference calls and investor conferences, the CEO offered anecdotal evidence of actively visiting clubs from Los Angeles to New York City to Miami, especially when new clubs start up. A majority of Rick's revenues are generated outside of driving range from the corporate headquarters in Houston. Then there is the aspect of evaluating acquisition candidates. Shareholders can only hope management does several club visits during their due diligence before ponying up a couple million on a new club. Much less, for every club Rick's does buy, there are probably several they passed on. It is clear that the Rick's management team is constantly moving around the nation.

Thus Rick's appears to have a need to fly, but do they really need two planes? This is a little harder to dissect, but from previous conference calls, we do know that the Corvalis TT is used for trips around Texas and the Citation Mustang is for trips outside of Texas or carrying larger groups. Both planes have about the same range around 1,300 miles with only 2 occupants. The Corvalis TT carries up to 4 occupants, 102 gallons of fuel and has a max cruising speed of around 270 mph. Whereas, the Citation Mustang holds 6 occupants, 385 gallons of fuel and can cruise up to 390 mph. The Corvalis TT is thus significantly cheaper to fly, only burning 25% of the fuel that the Citation Mustang, but travels 120 mph slower. At the max range, that equals out to saving an hour and a half on travel time. At full occupancy, the Corvalis TT range declines significantly, whereas the Citation Mustang sees only a marginal reduction in range due to increase passenger weight. With two executives serving as pilots, this also allows the executive team to visit different clubs at the same time.

The Corvalis TT is the more economic plane of the two. In the same sense of comparing a compact car to an SUV, if you only have one or two occupants. We will assume Eric uses this plane when he visits clubs by himself or with one other executive within or near Texas. The following is the cash flows of the Corvalis TT modeled out (models are meant to be more of a back of the envelope calculation) for the next six years and the present value and difference of flying to Midland, TX, from Houston versus flying Southwest.

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The model clearly shows that during the first years of Corvalis TT ownership, it is the down payment on the plane which is the economic limiting factor of plane ownership, but the MACRS depreciation schedule reduces this impact. This example shows the cheapest commercial option to Midland. Southwest does one direct flight a day to Midland, so odds are, Eric would have 1 to 2 hour layover in Dallas each trip (United has direct flights, but flying out of IAH and would result in hour plus drive and have same economics as Southwest). And to get the optimal $300 fare, Eric would have to know weeks in advance of a trip to Midland. The plane also gives the option of bringing another manager along with only a slight increase in fuel cost. With the Jaguars acquisition, trips like this are probably fairly common now. Dallas flights have better economics on Southwest ($200 round trip, cheapest possible rate and 2 hours of idle time) if only Eric went once a week. Southwest would be cheaper by about $100K over 6 years, but extra passengers and more frequent flights would reduce and eventually eliminate the difference. It is reasonable that Eric could make the flight daily, since it is about an hour flight (some people have longer commutes to work with traffic on a daily basis).

The Citation Mustang on the other hand, is a more expensive plane to operate. But should be looked at in the context of its purpose, to carry multiple occupants at once. It would never be economical to use the Citation Mustang if just Eric was flying alone, just as a SUV isn't the most efficient mode of transportation for the daily work commute. The next model shows the cash flows for going to Miami (Rick's greatest revenue source) with 6 occupants assuming they bought tickets within 48 hours of the trip.

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Will Ricks' management fly to Miami 52 times a year, probably not…..but the fares are similar for Los Angeles or New York City. They might also do multiple stops in one trip (the Houston to NYC route according Cessna's site is slightly outside the range of the Citiation Mustang at full occupancy). Just like an SUV, the Citation Mustang uses significantly more fuel than the Corvalis TT which impacts the economics. Though if Rick's flew first class to equal the comfort of the Citation Mustang, the plane would be significantly more favorable. But for the most part, the Citation Mustang's biggest economic impact is the down payment on the plane, as the Corvalis TT. Note: Loan is 5 year loan, but decided to assume it continued longer since management would either refinance loan or swap the plane out once mostly depreciated.

The biggest benefit to Rick's of its own fleet of planes, is time savings. This goes beyond Eric sitting idle at the airport waiting for a flight. Rick's operates clubs into the early morning hours. Management could easily jump on a plane in the afternoon, and make it to the club in time to check out operations during evening until closing. Having access to their own planes, means they can leave town even at 3am. The other benefit is in some locations they can land significantly closer to clubs. In the Corvalis TT example, several of the Jaguar clubs would be hour plus away from a regional airport serviced by an airline.

The overall cost without taking in externalities is minimal to shareholders. The corporate fleet is really just another example how Rick's management figures out how to optimize another cost associated with their business. The fact the corporate fleet adds convenience is just a bonus that could pay dividends. Is it not better for the shareholders if management gets actively involved with an underperforming club ASAP versus 3 weeks when they can get a cheap fare? While there is some personal usage of the planes and Rick's could be more open in the financial handling of this, there is also a significant business need for Rick's to justify the plane purchases. The corporate fleet by no means is a sign a mismanagement that should cause shareholders to pass up such a great opportunity for long term gains!

Disclosure: I am long RICK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.