When putting aside the social graces and manners that were instilled in all of us as children for a moment, it becomes clearly visible that the vices are a huge business in America. And with regard to making money in the stock market, this phenomenon is no exception. For decades, investors have had little to no problem placing funds in alcohol and tobacco stocks. More recently, basically every casino chain or individual operator has gone public and often their IPOs were highly publicized events. In 1995, a new segment of the vice market crept on to Wall Street when Rick’s Cabaret (RICK) went public with a plan to show the world the huge profit potential that the live adult entertainment business could generate.

Initially, the market’s reaction was not as positive as many had expected. Gentlemen’s clubs often operate in an-all cash manner, and applying standard financial measures in order to track the company’s performance was just about impossible. Big wigs on the Street shunned the stock and there was no clamor for more coverage. But the owners of Rick’s had a different plan.

Having been an afterthought in the stock market world, management decided that it would apply strong financial controls and start generating the kinds of headlines that all big businesses do. A focus on good food and going the extra mile on the customer service front was hatched. Making the customers the top priority began to pay huge dividends in increasing the brand, and acquisitions soon followed.

Rick’s cleverly uses local adult nightclub regulations to its advantage by viewing them as creating high barriers to entry for its competitors.  Less competition in any given area is always a plus and keeping the local authorities on your good side is a necessity when operating gentlemen’s clubs. Anyway, a roll-up strategy began to spark growth and it is still very effective today (see below). The company purchases preexisting clubs that are or have been fully operational in desirable markets and rebrands them under the Rick’s Cabaret banner.

Purchasing entities in this manner has been very successful. Revenues for the most recent fiscal year (ended September 30, 2010) were just under $83 million, five times where they stood just five years earlier. Most recently, The Gold Club in the Indianapolis market was snatched up for $1.68 million. The recession has brought the price tags down on many struggling facilities. This deal was done at four times EBITDA and should be immediately accretive to earnings. But it is management’s moves in the South that have us particularly excited about 2011 results.
Via the buying of older clubs that were spruced up and the opening of brand new Rick’s, the company now has seven shops ready to go in the Dallas –Fort Worth area. To provide a little color, the National Football League’s Dallas Cowboys and its high-profile owner Jerry Jones built a groundbreaking stadium in that area that has helped bring local business and tourism to the region. Already, this Mecca of the sporting world has hosted huge basketball and football events at the professional and college level, as well as a Manny Pacquiao boxing match and concerts. On top of all this, Dallas-Fort Worth will be the host of the 2011 Super Bowl taking place in early February. This type of male-dominated influx of clientele cannot be duplicated in many markets. If all goes well, Rick’s may well be staring at a windfall of business stemming from this event alone.

Elsewhere, headcount figures at many of its clubs are on the rise. As anyone who has ever attended a live adult entertainment night club will vouch, once you are there it is difficult to curtail spending. That said, attracting a crowd is a top priority. Rick’s has had great success in this regard, particularly in its weaker markets, where it has rolled out $2 beer Tuesdays. Upon arrival, immediate upselling of VIP seating and bottle service is then emphasized.

Staying on the topic of liquor, the company is using a new inventory tracking system, which should help it flex some muscle as the largest purchaser of alcohol on the East Coast. The operating leverage generated from this should only serve to pad the bottom line. Earnings growth was flat last year, but the consensus calls are for a rise in the vicinity of 10% this year. Due to the inherent business, however, Earnings Predictability is not elevated.

In closing, Rick’s overall business looks to be headed for an upswing. After grinding out many years in the $1 and $2 range, this stock now may be poised for a bump. The economy is starting to show vague signs of improvement, and discretionary spending, possibly the most visible driver of the adult entertainment business, should be on the incline in the coming quarters. If so, the large and loyal customer base that the Rick’s brand has developed through the years will undoubtedly be back for more good times.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.