RCI Hospitality Holdings, Inc. (NASDAQ:RICK) : Trash and Treasure

Tobias CarlisleStocksLeave a Comment

RCI Hospitality Holdings, Inc. (NASDAQ:RICK), at $11.72, is the eighth cheapest stock in the Small and Micro Cap Screener with an acquirer’s multiple of 5.57. RCI, formerly Rick’s Cabaret International, Inc., operates nightclubs that offer live adult entertainment, restaurant, and bar services primarily for “businessmen” in the United States. It operates adult nightclubs under the Ricks, Rick’s Cabaret, Tootsies Cabaret, Club Onyx, XTC Cabaret, Temptations, Jaguars, Downtown Cabaret, Cabaret East, Cabaret North, Bombshells, Ricky Bobby Sports Saloon, Vee Lounge, and The Black Orchid names.

If you can get over the yuck factor, there’s a lot to like about the business and the company. It’s got a $120 million market cap, and with net debt of $64 million, an enterprise value of $184 million against $33 million in TTM operating earnings, up 40 percent yoy (sales are up 20 percent).

Long only, growth-at-reasonable-price investor 

Summary

  • RICK is the only publicly-traded adult entertainment company with 40 clubs across the country and is the industry leader.
  • RCI’s 40 strip clubs account for only 1% of the total clubs in US market, let alone the 75 billion dollar global market opportunity.
  • High FCF enables the company to act upon multiple catalysts that can unlock significant shareholder value.
  • RCI is undergoing a significant market buyback that should give the stock a floor in the short term.

Where does Melvin see the value? Here’s the adjusted PE:

The adjusted earnings per share that does not include the legal settlement fees came in at 50 cents per share. Using this EPS without any implied growth in the coming quarters gives an annualized rate of $2 per share. With a $12 share price currently, this puts RICK’s P/E at about 6. As of most recent report,

Halfway through the year, total revenues are $75 million, that’s up 19%. Non-GAAP EPS is $0.96, that’s up 23% and adjusted EBITDA is $20 million, that’s also up about 23%.

Given an industry leading position with presumably the most favorable financing terms in the industry, a forward P/E of 6 seems extremely modest even as it is a sin stock.

And the enterprise multiple:

Using an Enterprise Value of 185.5 million (124 M (market cap) +71.5 M (long-term debt) – 10 M (cash – estimated)) gives an EV/EBITDA of only 4.6. Given YOY EBITDA growth of 23% in first half of the year, I believe RICK should be trading at 10 times EV/EBITDA. Given the fact that it is a sin stock, I apply a 30% discount to the valuation leading to a 7 times EV/EBITDA. Using this method, I believe there is an upside of ~70% from current valuation. Alternatively, I believe the stock should at least trade at 10 times annualized earnings. With an annualized EPS of $2 this would imply a $20 share price, which would imply a 67% upside.

Removing the sin stock discount:

I believe that if RCI can stick to its core operations of clubs and organically grow its business without any future lawsuits, it could largely overcome this sin stock discount. Many large players in tobacco with long histories of solid earnings growth such as PM, MO, LO and others have P/E ratios far excess of RCI’s. The sin stock discount is fair now given the current lawsuit ending, but if RICK can avoid future lawsuits, I see no reason for RCI to earn below market multiples on earnings thus possible, further expanding share price projections above. RICK also has less cyclicality than defense and gambling stocks, which earn higher multiples thereby indicating that RCI should earn at least market average valuation if it is able to achieve solid top and bottom line results in the future.

The Robust Energy acquisition makes no sense, but sucky managers do silly stuff like this all the time. This is one of the main risks:

Robust energy segment – The acquisition of robust energy drinks was one of my main contentions with buying the stock earlier. I believe RCI should not be in the energy drink business as it has no real relation to the core operating business of operating strip clubs and distracts management from core business. Furthermore, I did not like that management used cheap shares as part of the acquisition, which went in high contradiction to management claiming shares were cheap with the buyback program. With that being said, I am glad management has seemed to make a few steps to create value since the deal is done. (Direct from conference call transcript.)

  1. We launched a distribution program in Florida in April with Southern Wine & Spirits. Southern is the country’s largest wine and spirits distributor and operates in 35 states.
  2. We are negotiating a manufacturing agreement to significantly lower the cost of product. As we mentioned before, we currently import Robust from the UK.
  3. Robust is in the process of launching a fourth flavor, pineapple, which was requested by customers.
  4. We reached an exclusive agreement with Legends at Toyota Stadium in Dallas to serve Robust. Toyota Stadium is the home of FC Dallas which has been growing in popularity.
  5. Management stated that next quarter they will break out Robust energy segment. Increased transparency is a great step from an unfocused management team that seems to be taking the right steps currently.

There are some good catalysts:

Stock Buyback – RCI used 1.9M in the last quarter to buyback ~2% of the float and has another 7 million in share buyback program left. If the remainder of shares were bought at current price of $12, RCI would retire ~5.5% of the float. Retiring over 5% of outstanding shares on a highly profitable business will enable bottom line to become even more robust as well as put a temporary floor on the shares until the buyback program is completed.

Paying down expensive debt – RCI announced that it has fully paid down the debt taken in association with the Tootsie acquisition, which was financed at 14% interest. Management estimated that paying off this debt will free up $4 million in cash on an annualized basis. Cash flow should be further increased from newly acquired loans from community banks at 5-6% interest rate. Paying down this debt in conjunction with refinancing 9-13% loans into the 5-6% range will significantly lower the interest expense thereby freeing up more cash flow.

High free cash flow – RCI has FCF of 15 million on an annualized basis, which makes the stock trading at only 8.26 times FCF, which I believe will prove to be a conservative figure. The retirement of Tootsie acquisition debt, new financing at significantly lower rates, and decreasing overall leverage will create a significant increase from already strong free cash flow. Strong cash flow can be utilized for expanding core operations, reducing expensive debt, new acquisitions, and should be a major factor towards share price appreciation. I believe if management can continue to restructure their capital base to a lower cost, they will unlock significant shareholder value.

 

Company ripe for activist takeover – Given the moat and market opportunity RCI has, I believe there is tremendous shareholder value that can be created by simply operating existing clubs and acquiring new ones with strong free cash flow generated from operations. While I believe management can do this on their own, they continually deviate away with restaurant purchases and the energy drink acquisition. I believe an active investor with a significant portion of shares could take control or influence the company to the point where club acquisitions are the company’s only focus and create significant shareholder value.

Read more at Making Promiscuous Profits With RCI Hospitality – RCI Hospitality Holdings, Inc. (NASDAQ:RICK) | Seeking Alpha

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