Tuesday, August 19, 2008

Rick’s Cabaret – a Gentlemen’s Establishment with a private jet


This blog does not usually comment on small caps – but following Jeff Matthews I couldn’t resist. Ricks Cabaret is a listed consolidator of strip joints. Yeah – you read that right. The business consists of renting crappily constructed barns on the edge of towns (Houston, Vegas etc) and getting gals to jiggle their silicon around. They do own a fine-dining strip joint in NYC.

Despite having compiled an index of the price of hookers in various Eastern European locations I don’t usually hang around these businesses. I had never heard of Rick’s before Jeff’s post.

The stated premise for Rick’s Cabaret is that being a listed company gives Ricks (RICK:NASDAQ) access to capital and hence provides an exit for the thousands of strip club operators throughout the land. This of course ignores the other exits that Jeff Matthews points out (busted for prostitution, non payment of taxes etc).

But let’s take them at their word and look at the accounts as given. Here is the balance sheet:

CURRENT ASSETS:


Cash and cash equivalents

13,191,087

Accounts receivable


Trade

1,339,413

Other, net

722,868

Marketable securities

2,225

Inventories

1,706,544

Prepaid expenses and other current assets

975,067

Total current assets

17,937,204



PROPERTY AND EQUIPMENT:


Buildings, land and leasehold improvements

44,031,599

Furniture and equipment

11,463,950


55,495,549



Accumulated depreciation

-7,288,117



Total property and equipment, net

48,207,432





OTHER ASSETS:


Goodwill and indefinite lived intangibles

60,272,095

Definite lived intangibles, net

1,322,111

Other

761,753

Total other assets

62,355,959

Total assets

128,500,595





LIABILITIES AND STOCKHOLDERS' EQUITY




CURRENT LIABILITIES:


Accounts payable – trade

912,190

Accrued liabilities

4,390,849

Current portion of long-term debt

1,561,244

Total current liabilities

6,864,283



Deferred tax liability

16,278,165

Other long-term liabilities

508,579

Long-term debt, less current portion

28,877,816

Long-term debt-related parties

1,260,000

Total liabilities

53,788,843



COMMITMENTS AND CONTINGENCIES




MINORITY INTERESTS

3,359,595



TEMPORARY EQUITY – Common stock, subject to put rights (461,740 and 215,000 shares, respectively)

10,935,020



PERMANENT STOCKHOLDERS' EQUITY:


Preferred stock, $.10 par, 1,000,000 shares authorized; none issued and outstanding

--

Common stock, $.01 par, 15,000,000 shares authorized; 9,272,237 and 6,903,354 shares issued, respectively

92,722

Additional paid-in capital

52,807,479

Accumulated other comprehensive income (loss)

-11,123

Retained earnings

8,821,839

Less 908,530 shares of common stock held in treasury, at cost

-1,293,780

Total permanent stockholders’ equity

60,417,137



Total liabilities and stockholders’ equity

128,500,595



Now I am a dopey sort of guy – more used to bank balance sheets than strip joints. But there are a few things that are odd about this one.

The first is that there is over 60 million in goodwill on the balance sheet. That is 60 million paid to owners in excess of the value of couches and other fittings. That is a lot of goodwill for strip joints and leads you to the conclusion that if you want to be a multi-millionaire forget hedge funds – start a strip joint and sell it to RICK.

Indeed despite selling considerable common stock in unregistered sales to institutional investors the company manages to have almost no net tangible net worth. [The cash flow statement shows 27 million raised from sale of equity in the quarter – but I can find only one SEC 8K for about half that amount.]

The second thing that jumped out at me was the large deferred tax liability. The deferred tax liability of 16.2 million.

My first reaction was whoa – a deferred tax liability happens usually because profit for GAAP purposes is substantially higher than profit for tax purposes. This could be accelerated depreciation or some other tax incentive (though why the IRS/congress might give tax incentives for strip joints is beyond me) or it might just be that the company is declaring income for accounting purposes but not for tax purposes. There is of course a problem with faking your income up – which is that you tend to have to pay tax on the phoney income – unless you tell something different to the IRS.

In the quarter the prima facie tax was over a million but the payments were just over half a million. There is no large current tax liability to note – so there is prima-facie suggestion of overstating GAAP vis taxable income. Indeed the cash flow statement benefits from 632 thousand being added to the deferred taxes during the quarter… This does not surprise me – but it is not the main reason that that there is a large deferred tax liability. This company peculiarly tax effects the goodwill purchased – a treatment I have not seen elsewhere – but then I am used to looking at financials. [Anyone known why you would do this?] To quote:

Included in the Company’s deferred tax liabilities at June 30, 2008 is approximately $14,400,000 representing the tax effect of indefinite lived intangible assets from club acquisitions which are not deductible for tax purposes. These deferred tax liabilities will remain in the Company’s balance sheet until the related clubs are sold or impaired.

This led me to think that the company might be doing something very strange like buying the clubs and not the corporate structures that the clubs reside in. That indeed would be sensible because it would absolve the acquirer from unpaid taxes and penalties (criminal and otherwise) that might live with the old owners. That might give a peculiar GAAP treatment of goodwill. And indeed they are – as this 8K shows . If there is any accounting expert here – can you explain this.

But this still gives us a residual of 1.8 million of deferred tax liability that comes from another purpose. This implies GAAP income of about 5 million more than cumulative taxable income over the history of the firm. I will make the point that this is roughly the half cumulative profit of RICKS. When in doubt (and where I can’t see a good explanation for deferred tax liabilities) I tend to prefer the income people report to the IRS than their stated income. (Maybe that is something I just learnt in the mortgage market!)

Now the premise for listing this thing is – I presume – access to capital. But you got to wonder the extent to which a bank or for that matter typical financial market type might lend money to a strip joint whose tax accounts don’t match their GAAP accounts. Well for the most part they don’t lend that way. Indeed almost every strip club they consolidate they do with high interest vendor finance. This is typical:

On November 30, 2007, in connection with the acquisition of Miami Gardens Square One, Inc., (see Note 9), the Company entered into two secured promissory notes in the amount of $5,000,000 each to the sellers (the "Notes"). The Notes bear interest at the rate of 14% per annum with the principal payable in one lump sum payment on November 30, 2010. Interest on the Notes is payable monthly, in arrears, with the first payment due thirty (30) days after the closing of the transaction, which occurred on November 30, 2007. The Company cannot pre-pay the Notes during the first twelve (12) months; thereafter, the Company may prepay the Notes, in whole or in part, provided that (i) any prepayment by the Company from December 1, 2008 through November 30, 2009, shall be paid at a rate of 110% of the original principal amount and (ii) any prepayment by the Company after November 30, 2009, may be prepaid without penalty at a rate of 100% of the original principal amount.

Most the long term debt is pretty short term – 30 November 2010 won’t get them to a time when bank lending standards drop enough. So they better have the cash when they get there. And that is not the only "long term debt" on the books.

Indeed access to capital looks questionable when the CEO has to personally guarantee corporate debt:

In connection with the acquisition of the real estate in Dallas related to the acquisition of Hotel Development Ltd., on April 11, 2008 (Note 9), the Company issued a $3,640,000 five-year promissory note (the "Promissory Note"). The Promissory Note bears interest at a varying rate at the greater of (i) two percent (2%) above the Prime Rate or (ii) seven and one-half percent (7.5%), and is guaranteed by the Company and Eric Langan, the Company’s Chief Executive Officer, individually.


Come to think of it – this company also purchased its private jet on hock:

In February 2008, the Company borrowed $1,561,500 from a lender. The funds were used to purchase an aircraft. The debt bears interest at 6.15% with monthly principal and interest payments of $11,323 beginning March 12, 2008. The note matures on February 12, 2028.

Hey – the interest rate on a private jet (presumably secured by the jet) is almost 8 percentage points better than the interest rate on a strip joint secured by the strip joint. Impressive.

Summary

So what have we got?

  • A company in a seedy business usually infiltrated with the sort of people who you would not want to have marry your daughter.
  • A company whose tax returns do not match their GAAP accounts
  • A company with no obvious access to capital and with a lot of debts that mature quite shortly and pay high interest rates,
  • A company who has no reason to be listed but manages to buy a private jet

People own this stock? Search me as to why…

That this is listed and retains a market cap over $100 million tells me that this market has a long way to fall. I shorted a token number last night.

A positive: the company has a code of ethics

I can’t be all negative.

Rick’s must be the only strip joint with a public stated code of ethics. You can find it here. However at Rick’s ethics tend only to apply to financial matters. The code is also only applicable to the following persons:


1. The Company's principal executive officers; 2. The Company's principal financial officers; 3. The Company's principal accounting officer or controller; and 4. Persons performing similar functions.

I will leave it to your imagination what other unethical behaviours might happen at a strip joint and who might perform them.

I wonder if you can think of any ethical violations that might involve the private jet.

I thought you could.

John

16 comments:

John Hempton said...

There is so much more I could add.

For instance the assets include over a million in trade.

Who precisely does a strip club sell services to that are not paid immediately in cash? Why does it need to collect money?

In a past quarter they wrote off some bad debt.

Can anyone with more experience than me tell me if a strip club will sell you things on credit?

J

John Hempton said...

And why could you possibly have 11 million net - maybe 15 gross in furniture and equipment.

That is a lot of couches...

J

Huntington Hartford said...

I don't know this to be the case but they likely have "licenses" to operate these strip clubs. These licenses are probably hard to come by. They may be counted as intangibles for accounting purposes but they might have an incredible amount of intrinsic value. I bet it's hard to get a strip club open these days ... the religious neighbors will eat you alive. But if you've been in business for a while they have a hard time throwing you out. Lastly, many normal, hardworking religious folk will visit a strip club for a bachelor party... so they are relevant businesses with lasting appeal (i.e. prostitution is the oldest biz, etc.).

Analysts are putting out $1.20 and $1.91 eps for 2008 and 2009. There are plenty of companies that trade only on earnings (and earnings potential) as the balance sheet is ignored.

I'm not long, just taking a 2 minute stab at a bull case.

John Hempton said...

Huntington Hartford is probably right to some extent. The company has some licenses - and in some instances they have actually broken the intangibles into a value for the license and a value for the rest.

But this would suggest Vegas and Houston (where there are not large license requirements) would be worth less. The company is dominated by Vegas and Houston...

Huntington Hartford said...

I wouldn't mind doing some channel checks... to check product quality, customer satisfaction, etc.

Mikey said...

"Indeed despite selling considerable common stock in unregistered sales to institutional investors..."

Wouldn't this be naked shorting the traditional way?

John Hempton said...

Apologies. I accidentally deleted a comment from someone who lives down the road and promised to do some due diligence for me.

I won't pay you for it - and don't spend too much because I am short a token number of shares!

----

As for the person who thinks this might be naked shorting - I know little here.

The sale of unregistered letter stock was common enough amongst scam companies in the go-go era. The stock was sold at a discount to face - with a "letter" promising best efforts to get the stock registered.

The unscrupulous fund manager would mark the stock they purchased at a discount to market up to market - and book a performance fee.

Sometimes they would short the common to lock in the profit - which could only be locked in finally if the company could actually register the shares... but it worked enough...

J

Peter Phan said...

I can probably accept 11 m in furniture and equipment. The fitout will cost quite a bit, plus the music system, the lights, the signs, etc etc. It depends on how many venues they have on their books. What I cannot understand are firstly, the receivables as pointed out by John, and the inventory. One can speculate that the inventory is just booze, but well, again depends on how many venues there are.

Anonymous said...

You certianly have a bias. They aren't any seedier than the BANKS that you clowns have reccomended to your clients.

what do we ahve herer. An analyst tht didn't get his kick?

Anonymous said...

Taxable income is lower that GAAP because you can amortize and deduct acquisition intangibles for tax purposes.

Anonymous said...

John, I'm not going to explain my position, but good luck with your short. The fact that you haven't done channel checks and don't understand the value of exclusive licenses is laughable, but go ahead, short some stock! I'll take all your shares.

By the way, you ask who does a strip club sell services to that is not immediately paid in cash? Have you heard of credit cards? You think people pay at the bar using just cash?

Let me shed a little light on what's happening with this company: return on invested capital has increased from 5% in 2000 to 11% in 2007. Operating margin has increased from 1% in 2000 to 13% in 2007. Free cash flow has increased from $220K in 2000 to $3.2M in 2007.

I do understand that most people buying and selling this stock don't understand how to read a balance sheet, but I don't understand why you haven't bothered to do a single channel check!! Take a look my friend! Do some homework!

Bdog

John Hempton said...

Some replies to anonymous:

First Anon said "Taxable income is lower that GAAP because you can amortize and deduct acquisition intangibles for tax purposes."

That is specifically disavowed in the accounts. So dismiss. But I would like to know.

Second anon asked me why I hadn't done channel checks. (Well I would - but I need to explain it to my wife...) But seriously then went and quoted some numbers. The accounts make no sense... but of course you can use the ROIC figures straight anyway...

The thing started with some clubs it owned. It then purchased clubs at a premium - presumably because licenses/sites are valuable. Those should have lower ROIC because they needed to purchase the goodwill. But the ROIC goes up? I do not get it - there is no explanation I can see.

The private jet to me is the gimme. Companies with 3 million in cash flow don't justify full ownership of a jet.

When a long can explain the jet I will get more interested.

As for the short - it is "token". I used that word advisedly. It gives me an incentive to check the stock and an excuse to go on the site and read the press releases!

j

a yo said...

Response to: 60 million in goodwill on the balance sheet. In the q, it says goodwill and intangibles. Assuming purchase accounting rules, the difference between the market value and book value is added as goodwill. Goodwill if you look at the Q that parses out each deal is not a large part. The larger part are these "SOB licenses" - basically licenses to operate sexually oriented businesses. In addition to that you have property, trademark, liquor licenses. In a highly regulated business, I would assume that the greater part of the value of the deals are intangible related b/c you already have all the stuff to be up and running.

No tangible net worth- when the stock was higher, they used their equity as currency to conduct some of these deals. If you read the Q, shares are issued in conjection with quite a few of these deals.

Deferred tax issues – Here’s what gaap says about DTLs and acquisitive deals.
For a taxable asset transaction, under Section 197 of the Internal Revenue Code, goodwill and
intangibles are generally deductible on a straight-line basis over a period of 15 years.
This is important since a taxable acquisition will lower a company’s cash taxes, and
increase operating cash flow. However, a higher acquisition price may have been
paid for the assets due to the tax shield.

From the Q you can see DTLs were created with the deal which seems ok
From 10Q tootsie proforma valuation
Net current assets $ 390,000
Property and equipment and other assets 4,919,000
Non-compete agreement 200,000
Goodwill 7,546,240
SOB licenses 20,152,000
Deferred tax liability (7,546,240)
Net assets acquired $ 25,661,000
Philly
Property and equipment and other assets $ 3,882,885
Non-compete agreement 100,000
Goodwill 1,480,783
SOB licenses 4,002,115
Deferred tax liability (1,480,783)
Net assets acquired $ 7,985,000

I haven’t pulled all the detail on the DTLs but from quick glace there seems to be a difference but it’s closer to 1-3m which I don’t have a good answer for but isn’t that abnormal.

Interest – the terms on financing a jet would have less risk than using the funds to acquire a strip club. There’s no regulatory risk associated with buying a jet. Not sure if this makes sense but that’s the thought. As far as high rates, I would assume if they went to a normal bank the rate would be much higher. But maybe that is na├»ve.

As far as management, I think we have to draw a distinction between mgmt credibility and a seedy business. There can be seedy management in credible businesses (I can certainly name a few) and there can be strong management in seedy businesses. I’m here to make money not to worry about whether the operations are morally right or not. But I agree there are many people with your view that fail to consider the potential valuation expansion b/c of its operating business.

a yo said...

Receivables – it’s a new day – people use credit cards at strip clubs. I went to their quarterly due diligence ball and can confirm this is TRUE. The drinks in NYC are $18 so after a couple rounds you’d better save your cash for the girls who do not take credit cards…so that makes perfect sense to me.



FROM THE K
Trade accounts receivable is primarily comprised of credit card charges, which are generally converted to cash in two to five days after a purchase is made. The Company’s accounts receivable, other is comprised of employee advances and other miscellaneous receivables.

So the other 700k I admit their explanation is vague but 1.3m trade receivables is def credit.

Inventory
FROM THE K
Inventories include alcoholic beverages, food, and Company merchandise. Inventories are carried at the lower of cost, average cost, which approximates actual cost determined on a first-in, first-out (“FIFO”) basis, or market.

In the 10k, here’s the ppe net info. Broken out as 21m for building,land and leashold improvments (things done to leased assets to make them nicer). 5.7m is due to furniture and equipment. Accumulated depr (the contra acct) is 5.6m so that is the 21m.

In the new 10q, the net ppe is 48m. apples to apples now that is 44m for building, land, and lease hold improvements. 11m for furniture and equipment. Accumulated depr is 7.2m

So we can roughly say that’s about double the buildings and double the furniture. Since Sept 07 10k release, 4 major purchases have been made net when was valued at 21m. If you check the Q, they give initial valuations on net ppe for each deal: Miami 4.9m, Philly 3.82m, Dallas Hotel Develop 6.2, Texas Wireway 6m = 20.9m plus the 21 (even though this is now worth a little less) =40 or so….

They don’t breakout the furniture stuff but double the number would make sense to me if the buildings/land/etc looks about

paolo said...

Several comments have already pointed out the extensive use of credit cards by customers in this business. What I want to know is how the orginal assessment of this company did not take into account this obvious explanation for the size of accounts receivable. Was it because the analysis was created to fit the original thesis to short the stock?

Anonymous said...

I am familiar with many of the Rcks properties in Texas as well as the management. I have never owned any Rick's stock but have been a competitor for 20 years.
The 60 million in goodwill is easily explained when you realize that for a relatively small investment in a strip club an operator gets a substantial net cashflow. Before the recession, you could lease a building, spend 500 K on buildout and have net cashflow of 500 K every year. The problem is obtaining a permit from the city. Very few locations qualify and are commercialy viable.

So when a strip club owner wants to sell he can now sell to Ricks for a combination of debt and stock at 5 to 7 times net cashflow before you were lucky to get 3 X from the big operators.

Eric Langan is brilliant. He took a sleazy business added a fresh coat of paint and now he is riding around in a jet. All the big operators before him have done prison time for skimming money but Eric pays all his taxes. He is cleanning up the industry. My hats off to him.

B

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