Rick's Cabaret: A Winning Strategy in Adult Entertainment

| About: RCI Hospitality (RICK)

*Warning: Rick's Cabaret (NASDAQ:RICK) is a chain of strip clubs. If owning them makes you uncomfortable, then this is not the stock for you, though we think it looks cheap.

Key Points

  • Rick's acquires clubs at EBITDA multiples lower than their own, known as a "roll-up" strategy
  • The company could receive a windfall court case that will add significant earnings
  • An economic recovery should help Rick's, even if it is a recession proof business

A little background information

Rick's isn't a new comer at all. Originally founded in 1983, the company IPO'd in 1995, and just four years later, CEO Eric Langan took the helm. He claims to have founded his first club with $40,000 from selling an antique baseball card, and is memorablly quoted as saying that he didn't really know what he was doing, but it's not hard when you have naked women around and you are selling overpriced beer.

Currently, the company operates 22 clubs in several markets of the country, and just recently announced the purchase of a controlling interest in a nightclub near downtown Omaha (though we aren't sure if Warren will be on hand for the opening).

Easy Money?

The company isn't at all big, with a market cap hoovering in the low $80 million range and revenues of $83 million in 2010 (note that RICK has rarely traded lower than it's sales),

The strategy is simple: buy up a club for 2-5x EBITDA and roll it into Rick's and it should accrete to earnings and RICK keeps its historical multiple of 8-10x EBITDA. Rick's also improves operations, as not surprisingly, several independent clubs suffer from theft and employees skimming off the top.

Well, Not Quite

Unfortunately, management tends to issue quite a bit of stock warrants and stock to acquire these clubs, which means they don't issue a ton of debt (good) but they do dilute earnings fairly significantly (bad). The share count increased fro 6.2 million outstanding in 2007 to 9.7 million shares today, an increase of over 50%!

Furthermore, management hasn't always made the wisest of purchases. A club located in Las Vegas, though it had the potential to be a goldmine, suffered the same fate of the city, contributing about $500,000 in losses some quarters, according to management (individual clubs aren't broken down, but management gives good information on conference calls).

Additionally, the way numbers management receives from club owners may not be all that accurate, so they may end up paying more than they'd like to for clubs.

Texas Tax settlement could prove fruitful

Rick's has quite a few locations in the highly profitable areas of Dallas and Houston. For the last two years, Rick's has been paying a $5/head tax on each customer. However, the law has been challenged, and the Texas Supreme Court should make a decision by the end of 2011. A reversal will lead to a few million in free cash flow, and could increase traffic in Texas clubs.

Additonally, any sort of economic boost, should bring in more people to strip clubs, especially Rick's, which tend to be a bit higher end.

We think Rick's is worth $16 a share, and maybe more.

in millions of currency units Year 1 Year 2 Year 3 Year 4 Year 5
Fiscal Year 2007 2008 2009 2010 2011 2012 2013 2014 2015
Total Revenue 32 58 76 83 85 89 93 98 103
Total Revenue, YoY% 80.9% 30.9% 9.4% 3.0% 4.4% 4.6% 4.8% 5.0%
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We aren't forecasting a huge growth in top-line revenue, but we do see quite a bit of a jump in profitability...

in millions of currency units Year 1 Year 2 Year 3 Year 4 Year 5
Fiscal Year 2007 2008 2009 2010 2011 2012 2013 2014 2015
EBITDA 6 17 16 -3 22 25 26 26 26
EBITDA Margin % 18.2% 30.0% 20.5% -3.0% 26.0% 28.4% 27.5% 26.6% 25.7%
EBITDA, YoY % Growth 198.3% -10.8% -116.1% -988.5% 14.3% 1.2% 1.3% 1.4%
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Given a downside of $10, we think RICK provides one of the best risk/rewards available on the market.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RICK over the next 72 hours.