RCI Hospitality Stock: Compelling Valuation, Strong Buy (NASDAQ: RICK)

Konstantin T./iStock via Getty Images

Thesis

RCI Hospitality Holdings (NASDAQ:RICK) is the only publicly traded strip club operator and serial acquirer. I consider RICK a solid buy at these levels and have 5% of my portfolio allocated to the company. I will briefly talk about the industries of the business, but I will primarily focus on RICK’s capital allocation strategy and how they are leveraging technology to open up new revenue streams and bolster old ones.

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

Industry

Let’s take a look at RICK’s two industries: nightclubs and sports bars. The company estimates that there are currently approximately 2,200 nightclubs in the US market, 500 of which meet their internal acquisition criteria. RICK currently operates 49 clubs in 13 different states, most of them located in major US markets. This means that RICK currently has around 2% market share and around 9% market share for clubs they deem investable. The industry is very fragmented with many small operators who have built their clubs from scratch. Many of these operators are planning to retire and are open for sale. RICK is in a favorable position as an acquirer as it is the only publicly listed company in the industry and therefore has better access to bank financing and less scrutiny from bankers, politicians and vendors.

The sports bar industry is a slow growing industry with 1.2% growth in 2019 according to RestaurantBusinessOnline. The biggest players have a few hundred slots, with Buffalo Wild Wings being the undisputed leader with over 1200 units. RICK’s bomb brand debuted in 2013 and currently has 12 units in the United States.

sports bar market share

sports bar market share (restaurantBusinessOnline)

Become an outsider

For most of the time RICK was a publicly traded company, it wasn’t an attractive investment in my opinion. It was a well-managed company that sought revenue growth above all else. Little attention was paid to cost containment or the profitability of acquired businesses. Many acquisitions were paid for with cheap stock, which diluted 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 underdog. Since then he started most earnings calls with the following quote

Our goal is to generate shareholder value by increasing free cash flow per share by 10% to 15% on a compounded annual basis. Our strategy is similar to those described in the book The foreigners by William Thorndike. He studied companies that focused on generating cash per share and allocating that cash efficiently to generate more cash. We have been applying these strategies since FY2016 with 3 different actions, subject, of course, to whether there is a strategic justification to do otherwise.

If you haven’t read “The Outsiders”, I can highly recommend it.

RICK’s capital allocation strategy is based on nightclub mergers and acquisitions, takeovers and organic expansion of Bombshells. They set minimum rates of return for all of these stocks: Acquire nightclubs only if you pay a favorable multiple (3-5x EBITDA) for a great asset that will generate high cash returns of at least 33% . Redemption of shares only if the FCF yield is at least 10% and there are no better opportunities for capital deployment. Grow Bombshells organically in good locations with high yields of at least 33%. So far, RICK has played with this simple but effective strategy and the results are outstanding.

RICK capital allocation strategy

RICK capital allocation strategy (RICK investor presentation)

Take advantage of new technologies

New technologies are part of RICK’s long-term plan to grow its business. The company develops software, explores cryptocurrencies and pushes 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 with no use and everyone talking about the Metaverse. RICK is looking to leverage NFTs to create transferable digital passes for their clubs. These passes would need to be renewed annually and would provide additional benefits to holders. Right here you can see a tweet from their Project NFT Tip-N-Strip ad specifically aimed at Miami NFT Week visitors. They did similar promotions for the Miami Bitcoin 2022 conference and a few of RICK’s clubs recently started accepting Bitcoin as payment.

admire me

OnlyFans has been a private equity success story over the past few years, recording approximately $2.4 billion in revenue over the past 12 months. RICK hired developers to create their competitor: AdmireMe.

The website was built with a limited investment of less than $1 million and they will have an 11% turnout for all spend on AdmireMe. The platform is designed to enhance club business by giving artists the opportunity to build an online audience and bring them into the club. or to offer offline customers additional services through the app. The app is currently in beta and is expected to roll out later this year. The timing is however uncertain as originally the development team was exclusively Ukrainian.

spread the word

The final part of RICK’s digital technology strategy is to establish a better social media presence for both its operations and the business. As an anti-ESG (adult entertainment and alcohol) investment, the company seeks to secure a better investor base. Beginning in February, CEO Eric Langan actively engaged with investors on Twitter. They will also host the first-ever Live Earnings Call in Twitter Spaces on May 9. I applaud this transparent way of interacting with every shareholder and not just with analysts as most companies do. The company is also hiring new social media managers to increase the reach of operational activities.

CEO of RICK on Twitter

CEO of RICK on Twitter (Twitter @RicksCEO)

Evaluation

Based on its capital allocation strategy, RICK’s mission is to grow free cash flow per share, so of course I’m going to look at free cash flow performance to assess RICK stock. Due to Covid closures, RICK has not opened all clubs for the past few months. With most things back to normal, CEO Eric Langan expects around $8 FCF per share, leaving us at a 13% return on free cash flow, within the range the company is looking to buy back. actions. In the following image you can see that Eric Langan was recently asked about small buybacks, even though the company is sitting on a $40 million cash pile and the 10% FCF yield buyback criteria are filled. RICK currently sees plenty of opportunities to open new bombs and acquire new clubs, which they prefer at 33-100% cash back on cash back, versus a 13% return on cash back via buyouts.

Langan asked about takeovers

Langan asked about takeovers (Twitter @RicksCEO)

Conclusion

I consider the current yield of 13% to be a very attractive level to buy a growing business with lots of real estate, a well-defined capital allocation strategy and a growing moat. I currently hold 5% of my portfolio allocated to RICK and am looking to increase my allocation in the future as the company continues to perform.

About Myra R.

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