RICK - Ace River Capital Q3 2023 Quarterly Letter

2023-10-14 03:00:00 ET

Summary

• Ace River Capital Partners, L.P. returned -22.85% in Q3 2023, while the S&P 500 and Russel 2000 Indexes returned -3.3% and -5.1% respectively.
• The fund's top position is RCI Hospitality (RICK), a publicly traded owner of adult nightclubs in the US.
• Drive Shack and MarineMax are the second and third largest positions in the fund, offering high upside potential and opportunities for growth.

Dear Partners & Friends,

For the third quarter 2023, Ace River Capital Partners, L.P. (the “Fund”) returned -22.85%. Over the same period, the S&P 500 ( SPX ) and Russel 2000 ( RTY ) Indexes returned -3.3% and -5.1%, respectively.

Strategy

My goal is to maintain a concentrated portfolio of small and micro-cap companies with unique advantages and growth potential within their respective industries. The aim is to hold them for the long term. Finding such companies requires significant time and effort. Due to the scarcity of suitable opportunities, constraints on time and resources, and opportunity costs, I will take substantial positions in the companies that meet my criteria and pass my risk/reward assessment. I do not subscribe to wide diversification and only research and follow a limited number of companies deeply. I will not spend much time on a company if I am unwilling to take a substantial position and have the conviction to add to that position on weakness. This approach requires a lot of research and patience. There will be long periods of inactivity with few trades, and I will rarely hold more than 5 companies at a time. I will normally aim to have one short position. The short position will usually target a much larger company than the small and micro-cap companies held as long positions. This strategy accepts short-term volatility in pursuit of higher, long-term, tax-efficient returns.

Top Position

The fund’s top position is RCI Hospitality ( RICK ). RICK is the only publicly traded owner of adult nightclubs in the US. Currently they own 56 clubs across 13 states and an additional 13 sports-bar restaurants with the “Bombshells” concept that has recently begun franchising. With few municipalities issuing new adult entertainment licenses these businesses function as local monopolies with excellent unit economics. The Bombshells segment works well as an alternative investment if no attractive acquisitions are available, and the share price is trading higher than the repurchase target range. (See Capital Allocation Strategy below).

The stock has seen a large drawdown of 40% from its highs in the 90s earlier this year. The company has estimated its FCF for FY24 to be in the $68M-$78M range and provided the slide below in its Q2 earnings presentation.

With the stock trading at $52 at the time of writing, it is well under the lowest presented buyback target price in the range of $72-83. This represents greater than a 10% conservative cashflow yield since the company targets a min 10% FCF yield for repurchases, and the stock is substantially under this target. The market seems to have reacted negatively to the recent same-store sales comparisons and economic outlook. The same-store sales comparisons are negative when compared to the post Covid bounce period. With all segments profitable and a clear capital allocation strategy, RICK continues to be my top pick for the next 5-10 years.

Second Largest Position

Drive Shack ( OTCQX:DSHK ) is a unique and innovative leisure and entertainment company that offers guests an immersive experience through its state-of-the-art driving ranges, golf courses, and now, its latest offering – The Puttery mini-golf venues. The company has gone through major disruption and changes in the last year, with its delisting and the appointment of a new CEO and CFO. The last quarter it was able to report its first profit as predicted with the addition of a couple recent Puttery venues. I will be watching closely as the next few quarters should either serve as a foundation for lift off or present the pitfalls to bankruptcy. I believe the upside is extremely high from this point and the likelihood of the company stabilizing presents a great asymmetric risk/reward opportunity moving forward.

Third Position

MarineMax ( HZO ) operates a vertically integrated boat and yacht company with manufacturing, retail sales, financing, insurance, all the way down to maintenance and storage operations. The company has a strong portfolio of marinas and is in a great position to be able to roll up additional retailers, marinas, and storage facilities. I do wish the company would provide more information on its capital allocation strategy and how it thinks about the decisions to target retailers, real estate/marinas, or share repurchases. This would provide foresight for investors and keep management accountable for decisions. RCI Hospitality has a capital allocation strategy slide mentioned earlier in this letter, that is the type of thing I would love to see from MarineMax . I will attempt to bring this up to management. Until I can gather more information about the capital allocation strategy this will remain my lowest conviction holding but trading at just 3x cash with a strong position in the high margin/high cost segments of the boating industry I like the entry point.

Thank you for reading. Please reach out for any reason.

Nicholas D’Agnillo

Nick@AceRiverCapital.com | 401-499-3935

IMPORTANT DISCLOSURES

In General: This letter is for informational purposes only and is intended to provide an overview of the investment strategy and performance of Ace River Capital Partners, L.P. The contents of this letter should not be construed as investment, legal, tax, or other professional advice.

No Offer to Purchase or Sell Securities: This letter does not constitute an offer to sell or a solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of a confidential private offering memorandum.

No Tax, Legal, Accounting or Investment Advice: The contents of this letter are not intended to be, and should not be construed as, tax, legal, accounting or investment advice. Prospective investors should consult with their own advisors as to the tax, legal, accounting or investment consequences of an investment in any product described in this letter.

Performance Information: The performance information provided in this letter is based on internal calculations and is subject to revision. Performance results may vary depending on the timing of investments and disinvestments, as well as other market conditions.

Past Performance: Past performance is not a guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for an investor’s portfolio.

Risk of Loss: All investments involve risk and there can be no assurance that any investment strategy will be successful. The value of an investment may fluctuate, and an investor may not get back the amount invested. Changes in economic, political or other market conditions, as well as issuer-specific events, may have a material impact on the value of a security or a portfolio.

Portfolio Guidelines/Construction: The portfolio construction and investment guidelines for Ace River Capital Partners, L.P. are based on a proprietary investment process that seeks to identify undervalued securities and maximize returns while minimizing risk. The portfolio is actively managed and may be changed at any time without notice to reflect changes in market conditions or the manager’s assessment of individual security or market prospects.

Index Performance: The performance information provided in this letter may be compared to a benchmark index for purposes of illustration. The benchmark index is not intended to represent the performance of any investment product and does not reflect the expenses associated with the management of an actual portfolio.

Logos, Trade Names, Trademarks and Copyrights: All logos, trade names, trademarks, and copyrights referred to in this letter are the property of their respective owners.

Confidentiality/Distribution of the Letter: The information contained in this letter has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This letter and its contents are confidential and intended solely for the recipient. It may not be reproduced or redistributed without the prior consent of Ace River Capital Partners, L.P."

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