About a month ago we added RCI Hospitality (NASDAQ:RICK) to our core portfolio when it fell below $50 per share. Since then, its stock price has recovered a bit, but it still remains one of our favorite investment opportunities and, as a result, we expect to keep accumulating more shares.
Today we want to highlight one of the company’s latest acquisitions as it validates our investment thesis.
For those unfamiliar with the company, RICK is essentially the only publicly traded strip club company. He buys strip clubs as if they were real estate investments, then manages them to get a return on their capital. In that sense, it is a sinful stock, much like tobacco company Altria (MO) or liquor company Anheuser-Busch (BUD).
Sin stocks generally outperform the broader stock market (SPY) as their respective markets are less competitive and benefit from a superior economy.
In that sense, we’re particularly bullish on RICK, particularly because it’s able to buy high-quality strip clubs at low multiples, earning exceptionally high returns relative to the risk it takes.
When you consider a strip club as an asset, it’s quite appealing for a number of reasons. First of all, it is good because it requires licenses which today are almost impossible to obtain. No one wants a new club in their backyard and as a result, existing clubs, especially high quality ones, enjoy near monopolies in their local markets. Second, they are high-margin businesses that generate a lot of free cash flow. Capital expenditure is limited, labor cost relatively low, and alcohol/services sell at significant markups. Finally, strip clubs are also quite resilient to recessions because people still want to party and get away from it all during economic downturns. Historically, alcohol sales increase even during recessions.
They are therefore attractive assets, but there are very few willing buyers due to reputational, regulatory and management issues. If you’re a successful business owner, your wife or husband probably doesn’t want you to buy a strip club. Likewise, if you run an investment fund, you almost certainly have LPs who don’t want you to buy those companies. Plus, running these clubs requires a very unique skill set, as you need to be able (and willing) to detect things like drug dealing and prostitution.
Although there are very few buyers, there are more and more strip club sellers. There are approximately 2,200 clubs in the United States, it’s a very fragmented industry, and a large percentage of those club owners are in their 50s and 60s. Their children are also not interested in running strip clubs in most cases, so they have to sell.
Many sellers…but only a few willing buyers…mean one thing: Buyers are getting these attractive assets at incredibly attractive valuations.
This is where RCI Hospitality (RICK) comes in.
It is the only strip club company with full-scale professional management and access to public capital to purchase the clubs from retiring owners. These are major competitive advantages and therefore RICK is generally the preferred buyer in this industry.
Of these 2200 existing clubs, RICK estimates that around 500 of them fit his acquisition criteria, and currently he only owns around 50. As such, he already has the size to conclude large acquisitions, but its market share is still small enough that new acquisitions will have a major impact on their bottom line.
And here’s the best part: RICK is able to target annual cash returns of 25-33% on its new acquisitions and this for high quality clubs dominating the market, including their real estate. This is also before any added value, which often brings returns into the 33-50% range. Let it flow!
Typically, REITs (VNQs) are satisfied if they can earn around 10% cash returns on their real estate investments. RICK usually gets triple that and that’s simply because he’s filling a void in the market by providing much needed capital to a sin industry that’s been short of it.
This brings us to one of RICK’s latest acquisitions, announced last week:
RICK acquires a strip club in Odessa, Texas. It’s just off the 338 loop of the busy National Highway and is their third strip club in Ector County, Texas. It is a one acre property with an approximately 5,000 square foot building:
We don’t have details of the deal, but as we noted earlier, RICK typically targets annual returns of 25-33%, before any value addition and with real estate. This specific deal seems like an interesting case of what adding value means in this investment niche:
1) New brand: RICK basically buys the licenses and the real estate and then renames it to PT’s Showclub. This is a brand they operate in 6 states. By simply changing brands, they can significantly increase the profitability of the club. It’s like adding a famous flag, like Hilton, to a hotel.
2) Creative financing: In this specific case, RICK will only pay $1.4 million in cash, and the rest will be paid through vendor financing. This means that the return will probably be even higher than usual, because he invests very little money in the transaction and the rest will be a loan to the seller. RICK is able to negotiate such favorable financing terms because sellers have few potential options and RICK is usually the preferred buyer.
3) Professional management: This specific club seems to have been run pretty badly and RICK is an expert at improving operations. The club will now benefit from RICK’s national buying power for all supplies (obtaining significant discounts on alcohol) and the management and marketing of the site will improve significantly. Just by looking at this club’s Instagram page, you quickly realize that the previous owner could have done much better. For example, their Instagram page menu is just a low-res photo taken with a phone:
RICK’s largest shareholder, Adam Wyden, speculated that RICK likely only paid 3x EBITDA in place, meaning the return should be exceptional after the rebranding and value addition. We will know more during the next conference call.
But the point here is this:
RICK earns phenomenal returns by buying, improving, and operating strip clubs, which are moated, highly profitable, and recession-proof assets.
We’ve featured this deal to give you an example, but RICK has purchased a total of 15 clubs over the past year, which is very significant for a company that only owns around 50.
This represents nearly 40% year-on-year unit growth, and management has noted in recent calls/podcasts that they have a full pipeline of potential deals.
They now receive many calls from club salespeople and brokers, as they have all heard of RICK’s latest acquisitions and know that RICK has the resources to close more deals.
Today, RICK has approximately $30 million in cash, and with each passing day, the cash pile keeps growing as it generates a lot of free cash flow.
$30 million may not seem like much, but for a company with a market capitalization of $500 million and the ability to close deals with vendor financing, equity, debt, and limited cash contribution, that $30 million dollars could go a long way.
Asked about their recent share buybacks on the latest Twitter spaces, CEO Eric Langan said they would continue to buy back shares but also wanted to keep a nice reserve of cash for club opportunities.
This leads me to believe that they expect to close some big deals in the second half. Otherwise, why would he want to keep so much money in a world of high inflation? Remember this is a company that has massively positive free cash flow, low capex and a fairly conservative debt structure, so there is no need for as much cash except in anticipation of new acquisitions.
I already explained that RICK is my biggest non-REIT real estate investment. I started buying it at around $15 per share in 2020, bought more up to $70 per share, and today I continue to accumulate more at around $55.
I think RICK is a clear case of an alpha-rich investment opportunity because it directly benefits from the constraints of other investors by buying assets most couldn’t buy, at valuations they couldn’t get.
Today, the company’s annual free cash flow rate is estimated to be around $80 million, giving it a price of just 7 times FCF.
The company has grown its FCF “per share” to more than 20% per year and it can continue to do so for a long time by following this investment strategy.
I have no idea how RICK will trade next month or next quarter or even the year, but looking back 5 years from now, I expect shareholders to have received very substantial returns then that it continues to compound its FCF per share at around 20% per year. and its FCF multiple also approaches 15x.
In other words, I think there is a realistic path to more than quadrupling your money in 5 years by investing in RICK.
Am I too optimistic? Maybe. But even if I’m way off, our returns should be very compelling over time.