(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)
Firm: Undisclosed. Hedge Fund.
Location: New York, NY.
Recommendation: Long Shares of Rick's Cabaret (Nasdaq: RICK).
Timeframe: 6 Months to 1 Year
Recent Price: $8.65
Target Price: $15.00
Disclosure: The author of this report had an active position in this security at the time of its posting. The report was originally published on June 2, 2012.
RICK is a cheap stock relative to fundamentals (8x run-rate EPS), which continue to be strong organically. FY’12 revenue should be up 10% YoY. Moreover, the business should see a positive acceleration over the next few quarters as RICK exits Las Vegas, which has been a money losing venture (~$0.13 in EPS), and uses strong FCF generation to increase acquisitions and share buy-backs.
On conservative assumptions ($1.20 in EPS and a 13x multiple), the stock is a double.
Why is it cheap? In short, I think the stock is mispriced because there is little institutional ownership and no coverage (only 1 sell-side analyst). A clear catalyst would be management re-issuing guidance, which seems likely to happen over the next 1-3 quarters once Vegas is fully flushed out of the numbers.
1. Business performing well and should improve as RICK exits the Las Vegas market. 2011 revenues rose 12.7% (FY end in Sept) and this is largely organic as comps are trending positive as patrons are coming back to RICK’s clubs. EBITDA grew 32% YoY as management has re-focused on the bottom-line, trimming unnecessary marketing dollars and strengthening FCF generation. More importantly, RICK just exited Las Vegas (Q3’11), which had been a disastrous acquisition and a drag on numbers since ’08. RICK was losing ~$2 million per year in Las Vegas, which equates to an incremental $0.13 in EPS. By exiting Las Vegas, RICK will also realize $4.9 million in tax benefits (according to the Q3’11 conference call), which represents ~$0.50 in value per share.
It is also important to note that EBITDA and EPS have been optically distorted by the Texas “pole tax” – a $5 fee that RICK has to pay for every club visitor, instituted in January 2008. RICK, along with the Texas Entertainment Association (TEA), filed a lawsuit claiming that the tax was unconstitutional. They won in the State District Court and the Court of Appeals. In August 2011, the Texas Supreme Court reversed the ruling and now RICK and TEA are considering appealing to the U.S. Supreme Court. This is interesting because RICK continues to expense the tax (in protest) though it has stopped making the cash payments. To date, RICK has paid ~$2 million in cash and accrued a liability of ~$6 million. In sum, it expenses ~$2 million per year (non-cash), which is another $0.13 in EPS.
2. RICK is generating an increasing amount of FCF. According to the company presentation from late September 2011, RICK is generating ~$1.5 million in cash per month. This is in-line with the $18 million in operating cash flow RICK should generate this year and the $17 million it generated last year in FY’10. At $6-$8 million, CapEx seems to be running a bit high at 7-8% of revenue (I’m still trying to understand this). Still, RICK is generating over $11 million in FCF (12-15% margin) and that should trend higher as EBITDA improves, especially as Vegas moves out of the picture. This is relevant because RICK has good uses for the cash. It can re-accelerate its acquisition strategy to grow revenue (beyond Vegas, the company has historically been a good acquirer). More likely, it can buy back stock and reduce debt.
3. Based on where VGCH was taken out, RICK has 130% upside. The stock is clearly very cheap. Assuming no incremental EPS from share buy-backs, organic growth or acquisitions, run-rate EPS is ~$1. Adding back Vegas losses of $0.13, and backing out the $0.50 tax benefit, puts the stock at 6.4x EPS and adding back the “pole tax” puts the stock at 5.7x. The other way to look at it is on EV/EBITDA. Current TEV is $109m and RICK should generate $20-$25m in FCF over the next 2 years plus $5m from the tax benefit. Adjusted TEV, therefore, is ~$80 million and I think that run-rate EBITDA of $24m will benefit by $2 million from the Vegas exit and another $2 million if the “pole tax” is repealed. That math puts the stock at an “adjusted” EV/EBITDA of 2.8x and 3.0x when you exclude CapEx.
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