Description

RICK is the largest strip club operator, and it also owns a poorly performing restaurant chain, Bombshells.

Strip clubs (in the locations RICK targets) are generally very good businesses because it’s difficult (or impossible) to get a permit to build a new strip club in most locations that you would want to own a strip club.  As a result, supply is constrained allowing the existing operators to earn attractive returns on capital.  And there aren’t many buyers of strip clubs, especially large ones, making RICK the only natural buyer providing it with the opportunity to deploy capital at attractive returns.

Tootsie’s is a great example.  RICK bought the club in 2007 for $25M.  At the time, they were projecting annual revenue of $18M and EBITDA of $8.8M.  This was just an acquisition of the operating business, not the real estate.  The lease had extensions through 2034 but later, in 2015, RICK acquired the real estate under the club.  In 2019, Tootsie’s revenue was ~$26M and EBITDA was ~$12.5M.  In 2022 revenue increased to $39M.

Tootsie’s highlights three key points about the business: (1) The ROIC on acquisitions is very attractive given the inability to finance acquisitions with bank debt and the very limited universe of interested buyers.  There isn’t much maintenance capex, so EBITDA less taxes is pretty close to unlevered FCF.  In the case of Tootsie’s, the going in unlevered FCF yield was >20% (using the then effective tax rate of 35%).  (2)  This isn’t a high-growth business, but it’s a stable business (man’s desire for lap dances hasn’t changed much over time).  From 2008-2019, Tootsie’s grew revenue ~3.4%/year, a bit above inflation.  (3)  The recently terrible SSS #’s are comping off a surge in demand in 2022 (Tootsie’s steadily grew revenue from $18M to $26M over a decade, then surged to $39M post-covid).

More recent acquisitions:

Lowrie – This was an 11-club, $88M deal signed in July 2021.  The clubs produced $14M of EBITDA on $40M of revenue in 2019.  Management expected to get that up to $17M of EBITDA.  So, on an unlevered basis, that would put their after-tax yield around 15% on the deal, including the real estate. But they financed $32M of the purchase price with a seller note and commercial real estate debt collectively costing <6%.  On a levered basis, I put it at about a 20% FCF yield. 

Baby Dolls – This was a 5-club, $66.5M deal signed in December 2022.  The clubs from this deal are expected to earn $14-16M of EBITDA annually once the 5^th location reopens this year.  The deal was financed with a $25.5M 10-year seller note at 7%.  So, on an unlevered basis, that would put their yield around 17% on the deal.  On a levered basis, the FCF yield is closer to 25%.

Management thinks there are around 500 clubs that meet their acquisition criteria; these two deals acquired 16 clubs.  There's a long runway to deploy all of the FCF produced by the business into similar acquisitions earning 20-25% FCF yields which should enable them to exceed their target of growing FCF per share by 15%+ annually without any SSS growth.  In the 8 years that they've had a capital allocation strategy focused explicitly on growing FCF per share by more than 15% per year, their FCF/share CAGR has been 18.8%.  

Valuation:

In calendar Q4 2023, they reported $17.5M of adjusted EBITDA, which is $17M deducting SBC.  After $4M of interest expense and $1.5M of maintenance capex, that’s $11.5M of pre-tax earnings, i.e., $46M run-rate (pre-tax).  They have $6M of EBITDA coming from 3 clubs under remodel that are about to reopen, so call it ~$52M pre-tax run-rate including those clubs.  After tax, it’s ~$42M FCF with Bombshells contributing nothing (more on this below).  I think the Bombshells real estate is worth ~$75M (and contributing nothing to earnings currently), so if they sold it to pay down debt at 6.6%, that would bump FCF up to ~$46M assuming the operations are worthless.  The market cap right now is $526M, so it’s an ~8.75% FCF yield.  

That gives no value to the Blackhawk casinos that management plans to open later this year.  They’ve spent ~$10M of a total ~$20M budget and if all goes according to their plans, the casinos could add another $10M+ of FCF annually.  I put pretty high odds on this being successful, which would mean we’re really getting a 10%+ FCF yield at the current price.

That also gives no credit to managements goal to cut $8M/year out of expenses. I doubt they can cut that much, but given the SSS trends recently, it wouldn’t surprise me if there’s a couple million dollars of cost cutting opportunities in the nightclubs.

So why is it down 40% over the last ~14 months?

1. Bombshells has been a disaster, and a distraction, taking up the majority of time on recent earnings calls despite being a minority of the business.  In calendar Q4 2021, Bombshells earned income from operations of $2,800,000 from 11 locations.  Fast forward to calendar Q4 2023, and its income from operations was $86,000 from 13 locations.  Making matters worse, Bombshells owns most of its real estate, so it’s substantially unprofitable when factoring in rent.

The good news is, RICK’s CEO doesn’t have an ego, is focused on creating shareholder value, and recognizes the poor performance. He said on the last call “we are also considering any and all options to improve performance that potentially includes seeking an operational partner [for Bombshells] or selling the business.”  Commenting on where he sees the business in two years, he noted “I’d like to see whether the Bombshells chain is going to be able to grow into a very large franchisable chain or whether we’re going to look at having private equity take that out from us and take our efforts and energies and put them someplace else.”  In response to a question regarding whether they’ve hired an outside advisor to help facilitate a Bombshells transaction, he said “We are working with an outside group right now as well as done a few things on our own as well.  So when we say we’re exploring everything, I mean we’re looking everywhere.  We’re talking with lots of people.  But… as far as listing and whatnot, we haven’t gone as far as listing them for sale at this point because right now we are really kind of hoping we can find either the right partner… or making the changes we’ve done internally and seen if that is going to make a difference in a quick enough time period for my liking.”

I think any transaction that monetizes Bombshells and eliminates or reduces the distraction it causes would be a positive catalyst for the stock and free up capital for club M&A.   

2. Comps for the legacy nightclubs (those owned in 2019) have also been bad.  SSS for all nightclubs (excluding Baby Dolls) were down 7.2% YoY in the most recent calendar Q4 and the legacy nightclubs are only up low single digits since calendar Q4 2019.  Management has blamed this on macro uncertainty and weakness in their blue-collar business.  I buy that to an extent; if you have to choose between high grocery prices or more lap dances, I guess the groceries win.  But I also speculate that there’s been some loss of business over time to online options (i.e. OnlyFans).  Ultimately, I don't think you need SSS growth to do well at this price if you belive there's a long runway to continue acquiring clubs on terms similar to recent acquisitions.  

The summary is, I think Bombshells is a distraction that gets monetized in the near future, leaving us paying 10-12x FCF for a good business in a predictable industry with a runway to deploy capital acquiring other clubs at 4-5x FCF.

Catalyst

Sales or monetization of Bombshells.

M&A.