Monday, August 18, 2008

What Would Warren Do? Not This.

One of the most striking things at the Berkshire annual meeting is how few questions are actually asked about the business itself. Mostly, shareholders seem to ask the kind of questions they’d ask Dr. Phil, not the world’s richest human being.

You’ll read a few of the more extreme cases in Pilgrimage to Warren Buffett’s Omaha (release date October 4) but in the meantime we’ll take a look at something Warren Buffett would most certainly never do, which is to invest in Rick’s Cabaret.

Take the most degrading publicly-traded business in the world, add a faulty analytical premise, and you have an investment idea that ranks right up there with Berkshire’s investment in US Air.

What makes us bring this up is the headline that appeared on our indispensible late last week, under the ticker RICK:

3Q08 EPS weak on start-up costs; believe impact is temporary and co's acquisition outlook remains solid.

Now, Rick’s happens to be a strip club operator.

We know next-to-nothing about the company, except that the shares were once recommended in Barron’s by an old acquaintance from this business—the investment business, not the strip club business. We don’t recall the details, but the core of the investment idea seemed to be that it was a defensive play in an uncertain world.

Firm expects mgmt to take advantage of its access to capital to fuel the expansion of its three distinct strip club brands to take additional share within the industry.

Now, the idea of a “brand” in an “industry” not too many steps removed from the flesh-trade business would be laugh-out-loud funny, except of course that the subject itself is pathetic. Almost as pathetic is the analytic reasoning behind the next gem in the report:

Merriman believes RICK is in the enviable position of representing just about the only exit strategy for the 3,800 strip clubs in the United States.

Without much effort we can think of a few other “exit strategies” for any one of those 3,800 strip clubs not already owned by legitimate enterprises such as Rick’s—like being shut down for anything from money laundering to unpaid taxes to prostitution.

Charlie Munger explained the reason Berkshire had never invested in the gaming industry this way: “It is a dirty business.” And while we here at NotMakingThisUp don’t claim to be the world’s leading experts on Berkshire Hathaway, we’re pretty certain an investment in RICK is something Warren Buffett would not do.

Jeff Matthews
I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.


John Fischer said...

Wouldn't a roll up of these establishments into a public company tend to tamp down on illegal practices by subjecting them to greater transparency and legal liability? And wasn't Goldman doing a roll up of love hotels in Japan (perfect place to take a high-school "date") a few years ago? What about cheese-ball places like Hooters (never been, don't know who owns them)? Are these businesses dirtier than subprime credit? From my experiences with the latter, I'd say probably not. Now Amex, Wells, and USB (Warren's big holdings) aren't the most abusive of lenders, but I think you'd find a lot of gray areas in his portfolio over time.

Mark B. Spiegel said...

Jeff, I think you assume too much here...

Just because Warren refuses to invest in high-tech, it doesn't mean he can't appreciate the earnings power of alternative uses for silicon!

Jeff Matthews said...

There's a better story here than we suspected. Go to:


James Reilly said...

One small point, totally off the nature of Rick's core business, but related to conflicts. The glowing research note comes from Rick's main investment bank, Merriman. Clearly not a signatory to the global research settlement from the Merrill days...

Anonymous said...

Maybe The Oracle of Omaha would not invest in RICK because it's a "dirty" business, but if one were to use some of Buffett's tenets when investing in a stock like RICK, this could, IMHO, be worth a second look.

RICK is an understandable business by Buffett's standards: as tasteless as strip clubs may be to some people, they're not that hard to understand as a business (think restaurants with semi-nude models serving drinks for your pleasure).

Second, I think the mangagement is conservatively growing its business by using debt and stock issuances/option exercises to grow its working capital and purchase new clubs which hopefully continue to generate revenue for the company. They're not, from my perspective, wrecking the balance sheet to increase their operating income (although their goodwill to total assets kind of scares me, but that's another matter).

Third, if you think about it, strip clubs are pretty much a cash business. There's very little overhead and RICK has recently been operating cash flow positive over the last four years. The business is also what I would call "high barrier to entry", meaning with state and local regulatory issues such as zoning, taxes, and other matters inherent in a "seedy" industry such as adult entertainment, I think it's probably much more difficult now than say, ten years ago, to open such a venue.

Fourth, look at the company's ROE and retained earnings since 2006. You can't say with a straight face that over 12% ROE and a steadlily increasing retained earnings base isn't respectable.

Basically, I think others shouldn't be too quick to judge/value a business solely on it's morality. If one removed the nature of this business from its financials, one could argue that its numbers look respectable.

I could be wrong in my opinion, though.

TT said...

Have to disagree with your premise; just because it's a strip club roll up doesn't mean Warren wouldn't invest in it. It's a simple business. Warren understands simple businesses. My guess is that he wouldn't invest in it because he couldn't make a serious amount of money. The net margins fluctuate between 11%-18%. He's used to the usurious returns of cat-re and car insurance. Plus, the RICK market cap is less than $200M. Buffet needs $2B at minimum. I wouldn't poo-poo RICK too much. They have excellent operating protocols for their clubs. The idea of centralizing financial and strategic ops makes sense in a business like this. It doesn't scale like other businesses but their is no doubt you enjoy efficiencies with a larger footprint. Forget about the branding--this is about accounting and control. If you're a small cap investor, this is a stock that has a viable long-term growth strategy and you ought to be looking at it. What they need to work on is their forecasting skills. I told them to look you up, Jeff.