RICK - RCI Hospitality: My Single Largest Investment

• I invest heavily in strip clubs.
• Market-dominant strip clubs enjoy high barrier to entry and profitability.
• RCI Hospitality is consolidating the strip club sector, earning high rates of return over its cost of capital.
• We see a path to 20%+ annual FCF per share growth, and yet, RICK stock is priced at just 7.4x FCF.

RCI Hospitality ( RICK ) is the only publicly listed company that specializes in the ownership and management of strip clubs:

I have 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 recently, the company announced that it would buy 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 has noted that they buy $100k of shares every day on autopilot, and will keep doing so as long as their share price remains below $65, which represents a 10% FCF yield. Today, the share price is $49, and earlier this year, the share price was briefly above $90.

I have been accumulating more shares in my company's account, and recently, we also added it as a position to our Core Portfolio.

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 bullet points:

• Deeply Discounted Valuation: The company is currently generating about $6.5 per share of free cash flow per share, pricing it at 7.4x. If you adjust for their recent club acquisitions, the ongoing buybacks, the opening of new Bombshells locations, and the impact of Covid, the largest shareholder of the company, Adam Wyden, estimates that the free cash flow per share is around $10 per share, pricing the company at 4.8x its free cash flow. The management has a clear capital allocation policy that prioritizes buybacks whenever their free cash flow yield exceeds 10%, and therefore, they are today buying back shares at the moment.

• Moated Assets: Strip clubs are moated assets that enjoy high barrier to entry because 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 sort of grandfathered in and enjoy a quasi-monopoly in their local market. Moreover, 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. While the profitability of these clubs will vary over time, it is likely to remain strong and grow in the long run since everyone wants to party, but the supply of such places is strictly limited. Therefore, I believe that the earnings quality of the business is superior to that of restaurant chains like BJ's ( BJRI ), Olive Garden, Texas Roadhouse ( TXRH ) and Cheesecake Factory ( CAKE ).

• Extremely Lucrative Roll-up Play: Despite being moated assets, strip clubs sell for low multiples of 3-5x adj. EBITDA, allowing RICK to target 25-33% cash-on-cash returns on its new club acquisitions. The reason why the multiples 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 these as it would hurt your ESG ratings. If you are a private equity fund, you probably have at least some limited partners that don't want you to buy strip clubs. If you are a rich local entrepreneur, your wife (or husband) probably does not want to buy the local strip club... And even if you could, the expertise that's needed to run a successful strip club is highly specialized as you need 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 stock components.

• Access to Public Capital: As noted previously, RICK is the only acquirer of strip clubs with access to the public equity markets. That's a huge advantage because it greatly accelerates the growth story. RICK can take its own stock and sell it to buy strip clubs at huge positive spreads. In the REIT world, you would be happy with a 200-300 basis point spread over your cost of capital, but RICK commonly gets a multiple of that. Just earlier this year, it was priced at 10x FCF, which coupled with debt put its cost of capital at ~8%, and it can buy clubs targeting a 25-33% cash-on-cash return. The spreads are massive and RICK has a large pipeline of potential club acquisitions. Today, it owns around 50 of them, and it bought 13 of them this year alone. RICK has identified at least 500 clubs that it could target for acquisition in the USA.

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