RCI Hospitality: You Can Teach An Old Dog New Tricks

Summary

  • In 2016, RCI changed its capital allocation strategy and is now an attractive investment.
  • RCI is leveraging technologies to enhance an old industry.
  • The company is trading at a very compelling valuation and is a strong buy at these levels.
Mädchen Strip Club blau Neon Zeichen und Frau Silhouette

Konstantin T./iStock via Getty Images

Thesis

RCI Hospitality Holdings (NASDAQ:RICK) is the only publicly listed strip club operator and serial acquirer. I consider RICK a strong buy at these levels and I hold 5% of my portfolio allocated to the company. I will briefly talk about the company's industries, but my main focus will be on RICK's capital allocation strategy and how they leverage technology to open up new revenue streams and strengthen old ones.

Throughout the article, I will mainly refer to RCI Hospitality Holdings by their more common name: RICK.

Industry

Let's have a quick look at RICK's two industries: Nightclubs and sports bars. The company estimates that there are currently around 2200 Nightclubs in the American market, 500 of which meet their internal acquisition criteria. RICK currently operates 49 clubs in 13 different states, with most of them in the top US markets. This means that RICK currently has roughly 2% market share and around 9% market share for clubs that they deem investable. The industry is highly fragmented with many small operators which built their clubs from the ground up. Many of these operators are looking to retire and are open to selling. RICK is in a favorable position as an acquirer because they are the only publicly listed company in the sector and thus has better access to bank financing and less scrutiny from bankers, politicians, and sellers alike.

The sports bar industry is a slow-growing industry with 1.2% growth in 2019 according to RestaurantBusinessOnline. The biggest players have a couple of hundred locations with Buffalo Wild Wings being the clear leader with 1200+ units. RICK's bombshell brand started in 2013 and currently has 12 units in the US.

sports bar market share

sports bar market share (restaurantBusinessOnline)

Becoming An Outsider

For most of RICK's time as a publicly-traded company, it wasn't an attractive investment in my opinion. It was a decently managed business that was seeking revenue growth above all else. Little attention was paid to cost controls or profitability of the acquired businesses. A lot of acquisitions were paid with cheap stock, diluting shareholders. The stock didn't really go anywhere for two decades.

RICK stock chart

RICK stock chart (Google)

In 2016 something changed: Founder and CEO Eric Langan became an outsider. Since then he started most earnings calls with the following quote

Our goal is to drive shareholder value by increasing free cash flow per share by 10% to 15% on a compounded annual basis. Our strategy is similar to those outlined in the book The Outsiders by William Thorndike. He studied companies that focused on generating cash per share and allocating that cash effectively to generate more cash. We have been applying those strategies since fiscal 2016 with 3 different actions, subject, of course, to whether there is a strategic rationale to do otherwise.

If you haven't read "The Outsiders" I can strongly recommend it.

RICK's capital allocation strategy is based on nightclub M&A, buybacks and organic expansion of Bombshells. They set hurdle rates for all of these actions: Acquire Nightclubs only if you're paying a favorable multiple(3-5x EBITDA) for a great asset that will generate high cash on cash returns of at least 33%. Buyback shares only if the FCF yield is at least 10% and there are no better opportunities to deploy capital. Organically grow Bombshells in good locations with high cash on cash returns of at least 33%. So far RICK has played by this simple but effective strategy and the results are outstanding.

RICK capital allocation strategy

RICK capital allocation strategy (RICK investor presentation)

Leveraging New Technologies

New technologies are part of RICK's long-term plan to grow its business. The company is developing software, exploring cryptocurrencies and pushing for a better social media presence.

An Old Industry Meets Web 3.0

Web 3.0 is all the rage right now, with NFTs selling for millions of dollars without any utility and everybody talking about the Metaverse. RICK is looking to leverage NFTs to create digital, transferable passes for their clubs. These passes would have to be renewed annually and have additional perks for holders. Here you can see a tweet from their NFT project Tip-N-Strip advertising specifically towards visitors of the Miami NFT week. They did similar promotions for the Miami Bitcoin conference 2022 and a few of RICK's clubs recently started accepting Bitcoin as payment.

AdmireMe

OnlyFans has been a private equity success story over the last few years, taking in around $2.4 billion of revenues in the last 12 months. RICK hired developers to create their competitor: AdmireMe.

The website was built with a limited investment under one million dollars and they will have an 11% take rate for all spending on AdmireMe. The platform is designed to enhance the club business by giving entertainers the chance to build an audience online and bring them into the club or to offer offline clients additional services through the app. The app is currently in beta and is expected to roll out later this year. The timeline is uncertain though because originally the development team was exclusively from Ukraine.

Getting The Word Out

The last part of RICK's digital technology strategy is to build a better social media presence, both for their operating business and for the company. As an anti-ESG investment(adult entertainment and alcohol) the company is looking to get a better investor base. Starting this February CEO Eric Langan actively engaged with investors on Twitter. They also will host the first-ever live Earnings Call in Twitter spaces on May 9th. I applaud this transparent way of interacting with every shareholder and not just with analysts as most companies do. The company also is hiring new social media managers to increase the reach of the operating businesses.

RICKs CEO on twitter

RICKs CEO on twitter (Twitter @RicksCEO)

Valuation

Based on its capital allocation strategy RICK's mission is to grow Free Cash Flow per share, so of course, I will look at the Free Cash Flow yield to value RICK stock. Due to Covid shutdowns, RICK hasn't had all clubs opened for the last trailing months. With most things going back to normal CEO Eric Langan is expecting around $8 of FCF per share, which leaves us at a 13% Free Cash Flow yield, within the range where the company is looking to buy back stock. In the following picture, you can see that Eric Langan was recently asked about the small buybacks, even though the company is sitting on a $40 million cash pile and the 10% FCF yield buyback criteria are met. RICK currently sees a lot of opportunities to open new bombshells and acquire new clubs, which they prefer at 33-100% cash on cash returns, compared to a 13% yield on the cash via buybacks.

Langan being asked about buybacks

Langan being asked about buybacks (Twitter @RicksCEO)

Conclusion

I consider the current 13% yield a very attractive level to be buying a growing business with a lot of owned real estate, a well-defined capital allocation strategy, and a growing moat. I currently hold 5% of my portfolio allocated to RICK and I'm looking to grow my allocation in the future as the business continues performing.

This article was written by

I am a young, self taught investor that found an obsession in analyzing companies. I am finishing my bachelor of science in Business Informatics and am looking to include my expertise in investment decisions. I mainly look for great capital allocators, Spawners and companies with deep, widening moats. The only investment horizon that interests me is the long term. Follow me on my journey to financial freedom.
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Disclosure: I/we have a beneficial long position in the shares of RICK either through stock ownership, options, or other derivatives. 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.

Additional disclosure: This is not financial advice.

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