..::The Official Website of Rick's Cabaret::..

Strip-club stocks rise on Wall Street

Industry's in steady growth, consolidation mode

By William Spain, MarketWatch

Last Update: 8:04 PM ET Feb 26, 2007

NEW YORK (MarketWatch) -- It's Wednesday night at Rick's Cabaret on West 33rd Street, and business is clearly picking up as the walkie-talkie for the strip-club hostess squawks, "We need more girls down here."

Out on the floor, groups of men sit in plush chairs downing expensive cocktails while watching the dancers. A guy in a Red Sox hat orders a lap dance; one in a suit heads off to a private VIP room.

At $11 million for the site and subsequent renovations, the club is not the largest, but is by far the most high-end in the 13-property portfolio of Houston-based Rick's Cabaret International Inc. (RICK). It is also a symbol that the "gentleman's club" business is moving fast from the back alleys to the main drags of America, steadily growing more mainstream as chain operators begin to roll up mom-and-pop operators from the Carolinas to Colorado.

Revenues at the two major listed companies in this category have doubled over the last two years, as the companies expand via acquisitions while drawing in more customers at existing locations. But pushing the story to investors can be a challenge because of the industry's sordid reputation for exploitation, prostitution and other law-breaking activity.

"We have always been in expansion mode, but rather than buy a bunch of other locations we focused our efforts on New York," said Eric Langan, chief executive of Rick's Cabaret. "The New York club has really helped build our brand name." Watch the interview.

So far, all those $20 cover charges and $7 beers -- not to mention the $10 businessman's lunch where diners can choose to watch dancers or CNBC on plasma-screen TVs -- have paid off handsomely.

'Under-followed, undervalued'

Coupled with some other acquisitions and steady growth at its operations in Texas, North Carolina and Minnesota, Rick's has been putting up the numbers. In its last fiscal year, which ended Sept. 30, the company turned to a modest profit while revenue grew to $24.5 million from $14.8 million.

Also, 2007 is off to a good start: Revenue at the New York club alone was up 63% in the first quarter, while "same-store sales" gained about 10%. Further, Rick's is looking for revenue to jump into the $50 million range this year and it expects to earn about $6 million, more than three times last year's profit.

The reaction of the stock has been to rise sharply with each bit of good news. Rick's cracked a 52-week high last week, cresting at $11.10 -- its highest level in more than 10 years. A year ago, it was trading at $4 and change.

"We view [the company] as an under-followed, undervalued growth play on the gentleman's club industry," said Steven Gart, an analyst with Nickel Investment Capital. "With the impressive 2006 performance of Rick's in New York, the company has made a strong, 'can deliver growth' statement to the investment community."

He added that Rick's "deep acquisition pipeline combined with the company's ability to deliver respectable organic growth at existing clubs should yield continued strong results in the future."

Gart likens the company to a "well-run restaurant chain with slightly different entertainment. If you get the customer in there with a few hundred dollars, he is going to spend it."

Low overhead and costs

Rick's and its competitors benefit as well from what may well be a unique aspect of their business model. The entertainment that brings folks in the door is actually a money-maker: Dancers pay to work there as independent contractors (how much depends on location and shifts, with some shifts costing several hundred dollars) and get paid from tips. That keeps overhead and salary and benefit expenses low.

There are basically three revenue streams, in addition to the fees from dancers: cover charges, which can top $20; food and drinks; and services, which include the renting of private rooms. A customer may pay the club $400 to $500 for a spell in one of those rooms.

Like so many other "sin" categories, the business seems to be somewhat resistant to economic downturns, especially as the customer base keeps expanding.

"It continues to keep going even when the economy isn't on fire for most people," said Michael Ocello, president of VCG Holdings Corp. (PTT), another club operator and head of the Association of Club Executives, the industry's trade group.

At the same time, "clubs have become more mainstream," he added. Ocello credits that to several factors, including a kind of "best practices" approach of "keeping the clubs clean and making people feel safe" while they are there.

VCG owns eight clubs and manages another five. Its revenue last year was $17 million, and it has stated it expects that number to grow to $40.8 million this year, to $66.3 million next and to $92 million in 2009. Meanwhile, profit should jump from $8.6 million this year to $18.2 in 2009 as it continues to roll up smaller operations and buy some clubs that it manages but are owned by Chief Executive Troy Lowrie.

If Rick's stock-price jump over the last year has been impressive, VCG's has been nothing less than meteoric. Traded on the Amex, shares climbed as high as $10.84 on Tuesday from 90 cents in June.

Ocello estimates that there are about 3,000 strip clubs in the United States -- from bars that might have a small stage with an "amateur night," to huge pleasure domes like the famed Spearmint Rhino in Las Vegas.

"There is absolutely plenty of room to grow," he said. "We think there are great opportunities for consolidation."

Helping companies do it at a good price is the fact that "there just aren't a lot of buyers," according to Dennis McAlpine, managing director of McAlpine Associates, a research firm focused on stocks in media and entertainment. "So Rick's has been buying [clubs] at three to four times earnings," a bargain by most standards.

McAlpine commented that he is "a little surprised that [consolidation] is as slow as it is." He also sees the industry steadily moving into the mainstream, or perhaps the mainstream coming over to it.

"Most strip clubs are not the bad places they used to be. They are cleaner, safer and in nicer locations," he said. "You are going to see more women get into this whole thing, and as [they do] it is going to become even more acceptable."

That should come as no shock: "If you go back and look at what was considered adult entertainment 10 years ago on cable TV, it is very mild compared with what it is today."

Stigma remains

While there almost always are fights with neighborhood groups and officials when a club is set to open or expands, both Langan and Ocello said that the stigma regarding their business is beginning to fade -- because they are getting more attention and regulation.

Still, it is an industry with a seamy reputation, often linked with exploitation of women, drugs and prostitution in the public mind, and sometimes deservedly so. There are periodic police stings at strip clubs across the country, nabbing dancers and employees for everything from selling narcotics to offering sex for money.

Just last month in New York, law-enforcement officers raided a Scores (SCRH) club (made famous by shock jock Howard Stern) and arrested seven people on prostitution-related charges, costing the club its liquor license, at least temporarily.

Robert Smith, a security consultant to the hospitality industry and also a detective with the San Diego Police Department, said that illicit goings-on are now "extremely rare," but for venue operators "it is a hard, uphill fight to change the perception. And it is a lot harder than it appears to be for them to turn that around."

He added that "99% of these clubs don't want [illegal activity] going on, but they almost invite it by not having standard policies and practices."

When a dancer does get caught, that can affect the bottom line: "Remember, 50% of the guys go to see naked women, and the other 50% come to see [a specific dancer] because they think she really likes them," according to Smith.

"You fire her and she just goes to work for the competition."

As far as drug use goes, Smith noted that while it is far more prevalent among the dancers, "for the employees of these clubs, it is no different than it is at any mainstream club you would go to."

While police can use drug and prostitution laws to crack down on individual clubs, authorities are limited in the tools they can use against the industry as a whole.

State or local attempts to bar nude or topless dancing can run afoul of constitutional protections of free expression. Instead, they use liquor laws -- over which states have far wider latitude -- to restrict how much, if anything, a dancer can take off. Many prohibit the sale of booze at all-nude establishments, keeping most major clubs only topless. Because alcohol sales make up such a large percentage of revenue, few clubs can get by without them.

Still, some outlets get around that by going BYOB and selling pricey "set-ups" (glasses, ice, etc.) so patrons can drink up while watching nude entertainers.

"You always have the political problem that someone is going to try and change the rules after you go in," said McAlpine, "But the nice part of it for the established strip clubs is that because of the resistance, there is barrier to entry for competitors."

Over at Rick's, Langan periodically visits New York to drum up investors, and he recently held a "due diligence ball" at the local club following the company's quarterly conference call.

The company is also experimenting with other formats, including a club concept geared toward African-American customers called Onyx.

"We really noticed that there is an underserved market for middle- and upper-class African-Americans," according to Langan. "There are few clubs in our industry that cater to that market."

He acknowledges that the stock can be a hard sell to some institutional investors, but said that is more a function of its small size than any qualms about its business: "Wall Street understands profits and losses; they don't get into the morality of it of that much."

William Spain is a MarketWatch staff writer in Chicago.