RCI Hospitality (NASDAQ: RIC) is the only publicly listed company specializing in the ownership and management of strip clubs:
I previously highlighted RICK as my largest non-REIT investment, but never included it in our core portfolio at High Yield Landlord because it only pays a 0.4% dividend yield, which is too low for our yield-oriented strategy.
But the company recently announced that it will be buying back ~5% of its capitalization, which is essentially just another way to return capital to shareholders. As such, the adjusted yield is now ~5.4%. The CEO noted that they are buying $100,000 of stock every day on autopilot and will continue to do so until their stock price remains below $65, representing a 10% FCF yield. Today the stock price is $49 and earlier this year the stock price was briefly above $90.
I have accumulated more shares in my company’s account and we recently added it as a position to our core portfolio as well.
Why am I so bullish on RCI Hospitality?
I encourage you to read our full investment thesis to understand why I like it so much, but here’s the thesis in 10 points:
- Deeply discounted: The company currently generates about $6.5 per share in free cash flow per share, valuing it at 7.4x. If you adjust for their recent club acquisitions, ongoing buybacks, the opening of new Bombshells locations and the impact of Covid, the company’s largest shareholder, Adam Wyden, estimates free cash flow per share to be around $10 per share, setting a price of the company at 4.8 times free cash flow. Management has a clear capital allocation policy that prioritizes buybacks when the free cash flow yield exceeds 10%, and therefore they are buying back shares now.
- Moated assets: Strip clubs are moat assets that enjoy a high barrier to entry, as it is almost impossible to open new ones. They require licenses that are extremely difficult to obtain, and no one wants a new strip club in their backyard. As a result, the existing clubs are kind of grandfathered in and enjoy a quasi-monopoly on the local market. Also, RICK targets only the highest quality strip clubs that are thriving. A good example would be Tootsie’s in Miami, which is the largest strip club in the world, or Rick’s Cabaret in Manhattan. Although the profitability of these clubs will vary over time, it is likely to remain strong and grow in the long term, as everyone wants to have fun, but the supply of such places is strictly limited. Therefore, I believe the business’ earnings quality is better than restaurant chains such as BJ’s ( BJRI ), Olive Garden, Texas Roadhouse ( TXRH ), and Cheesecake Factory ( CAKE ).
- Extremely profitable recruiting game: Although they are assets, strip clubs sell for low multiples of 3-5x adj. EBITDA, allowing RICK to target a 25-33% return on cash on new club acquisitions. The reason the ratios are so low is simply that there are no natural buyers for these assets. If you run a public company, you probably don’t want to buy them, as it would hurt your ESG ratings. If you’re a private equity fund, you probably have at least a few limited partners who don’t want you buying strip clubs. If you’re a rich local entrepreneur, your wife (or husband) probably doesn’t want to buy the local strip club… And even if you could, the expertise needed to run a successful strip club is highly specialized, as you have to be able to sniff things like drug dealing, prostitution, racketeering, etc. Most investors don’t want that headache and as a result there are only a few potential buyers and RICK is the only one with access to public capital and a great reputation for closing deals with large cash or liquid equity components.
- Access to public capital: As previously noted, RICK is the only strip club buyer with access to the public stock markets. This is a huge advantage because it greatly accelerates the growth story. RICK can take his own stock and sell it to buy strip clubs at huge positive spreads. In the REIT world, you’d be happy with a 200-300 basis point spread on your cost of capital, but RICK typically gets a multiple of that. Just earlier this year it was valued at 10x FCF, which together with debt put its cost of capital at ~8% and could buy clubs targeting 25-33% cash returns. Spreads are huge and RICK has a large pool of potential club acquisitions. Today, she owns about 50 of them, and this year alone she bought 13 of them. RICK has identified at least 500 clubs it could target for acquisition in the US.
- Seller Financing: Because RICK is the preferred buyer of strip clubs and there are only a few competing buyers, RICK enjoys strong bargaining power with potential sellers and is able to negotiate attractive terms beyond price itself. As an example, he often gives only a small cash component as part of the deal and structures a large portion of the sales price as seller financing with 6-8% interest rates. Sellers like it because it allows them to unlock the value of their clubs, exit operations and still earn a return on their club while deferring some of the taxes. And for RICK, that’s great because it increases the return on equity even more and allows him to grow even faster if he has to put up less money to buy those assets.
- Owns real estate: RICK owns almost all of his real estate, which provides a hedge against inflation as well as some added security. The value of this real estate is significant and growing, as much of it is in developing markets in Texas and Florida where people are moving. As an example, Tootsie’s is over 75,000 square feet of space.
- A clear capital allocation policy: RICK is strictly focused on growing its free cash flow on a per share basis. Management always brings this up on every conference call and in its presentation to investors. Their policy is to buy back shares when their free cash flow yield exceeds 10%, and they only target new acquisitions if there is a significant spread.
- Possible Bombshells spin-off: RICK also owns a military-themed sports bar concept called Bombshells. It works especially well in markets like Texas. Today they have 11 locations and expect to at least double that number in the next 2-3 years. The return on invested capital is even higher than that of strip clubs and now they are also starting to franchise, generating fees and royalties. Today, Bombshells already generates 30% of RICK’s revenue, and eventually RICK could potentially spin off Bombshells into a separate entity to unlock shareholder value. It has been speculated that the Bombshells alone could be worth RICK’s entire market cap.
- Skin in the game: Insider ownership is close to 8%, and most of that is owned by the CEO, who continues to buy dips to this day. He has publicly noted that he has ~95% of his net worth invested in stocks and has no plans to sell. On the contrary, he keeps buying more and more.
- Fast growth at a very low cost: The attractiveness of an investment mainly depends on its valuation, risk and growth. RICK’s price is extremely low, it has moat assets and has rapid growth prospects ahead of it. Since the company introduced its capital allocation policy in 2016, it has grown free cash flow per share by 16% annually, even including the pandemic, and may continue to do so for a long time. Yet the company is valued at a 14% free cash flow yield, which is very cheap for a company growing at this rate. Its rating factor could be doubled and it would still not be expensive. Do I know what its stock price will be in a year? I have no idea, and the recession, of course, could temporarily hurt his business (although strip clubs do enjoy some resilience to recessions). But do I think RICK will be trading much higher in 5 years? I’m very confident it will and that’s all that matters to me.
You can read our full investment thesis by clicking here. This is my largest position overall and I will now begin to accumulate stocks for our core portfolio as well.
If you would like full access to our portfolio and all our current best offers, feel free to join us for 2-week free trial in High Yield Investor.
We are the fastest growing and best rated stock pick service on Seeking Alpha with 2500+ board members and a perfect 5/5 rating from 500+ reviews:
You won’t be charged a penny during the free trial, so there’s nothing to lose and everything to gain.