Motley Fool Hidden Gems Investing - The Business of Nightclubs

Episode Date: September 25, 2023

RCI Hospitality CEO Eric Langan on consumer spending, capital allocation, and getting into the casino business. (00:21) Jason Moser and Deidre Woollard discuss: - The wisdom Amazon’s bet on Anthropic. - Why Amazon is getting into charging for streaming. - If check-out-free technology is finally reaching its tipping point. (12:25) Ricky Mulvey interviews the CEO of RCI Hospitality, Eric Langan on his view on consumer spending, capital allocation, and his journey to the CEO seat. 5 Stocks Under $49 report here: http://www.fool.com/report. Companies discussed: AMZN, WMT, DIS, RICK Host: Deidre Woollard Guests: Ricky Mulvey, Eric Langan, Jason Moser Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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how are you doing today? Hey, doing great. How about you? Doing great. Good. The big news today was Amazon investing up to $4 billion in Anthropic. Anthropic, the OpenAI rival created by former OpenAI employees, this is a deal that includes Anthropic using the AWS cloud, of course, and Amazon's training chips, which are things like Trinium. What do you think Amazon is hoping for with this deal? Well, they're certainly looking to make inroads in the AI space and establish their own little corner of dominance, so to speak. I think you see them getting in there with

their own chip designs, like you noted. They're going in there and using their own chips in order to be a part of this. I think it's interesting to see OpenAI. All of these are connected. There are all these former executives from OpenAI, and they're all going their separate ways. You see Amazon making its own little bet here in Anthropic. I did a little digging. I was looking at Anthropic. Anthropic is not a publicly traded company, but it's interesting to see the other investors in Anthropic. It's not just Amazon in this case. Google is an investor in Anthropic. Salesforce.

And Zoom Video Communications as well, through their Ventures arm. So, again, you kind of go back to how these are all connected. I think it's very, very interesting. I do think that Amazon making this investment with the goal of using their chip designs, the Tranium chip, and I think there's another chip design in there as well. Inferentia. Yeah, Inferentia, that's it. I'll be interested to see how that plays out against Nvidia. That's their answer to all of this Nvidia hype. I think it's going to be interesting to see how that plays out. Just because you have all of the money in the world, companies

like Amazon and Apple, designing chips and then implementing those chips to do very specific things is very difficult. We're seeing Apple having a lot of difficulty in designing that modem chip that they want to be able to stick into their phones and ultimately displace their relationship with Qualcomm. I just think that's a little bit easier said than done. But generally speaking, I like the idea. It makes a lot of sense. Yeah, it's interesting, the interconnectedness that you mentioned. It reminds me a bit of what we saw before the dot-com bubble. It's all happening in San Francisco again. Anthropog is leasing Slack's former HQ. All of this seems very connected. I'm an old PR person.

I like to look at the bottom section of the press release, where you see about Amazon and about Anthropic. It tells me not what the company does, but what the company wants us to think they do. They call themselves Anthropic. They call themselves a safety and a research company. They say their big AI assistant is Claude, and Claude is focused on being helpful, harmless, and honest. If they say it enough, then maybe it'll be true, right? This feels like a Don't Fear Your Robot overlords line to me. Does AI need spin at this point? I think it does, to an extent. It's funny, what you said about the bottom of the release, it made me think of when you interview leadership of any company. Their one job is just to tell

you how awesome they are. At the bottom of this release, it seems like their one job is really, let's assuage any concerns that people may have regarding AI and the potential drawbacks, we're honest, we're safe, we're careful, and all that. I don't know that that necessarily is going to cut it. I think it's going to take a little bit more than just that. Time is something, I think, ultimately, that it's going to take. When you look at the general sentiment out there with consumers, it isn't all that great when it comes to AI right now. If you look at Pew Research, overall, right now, 52% of Americans say they feel more concerned than excited about the increased use of artificial intelligence. You have just 10% saying that they

are more excited than concerned. But what's interesting here, the share of Americans who are mostly concerned about AI in daily life, it's up 14% since December 2022, when just 38% expressed that view. The trend is going in the wrong way. Americans are becoming more and more concerned about the drawbacks and risks of AI as opposed to the opportunities. That's going to be something that's going to be very difficult to balance. As the social media information moves just at the speed of light, not everybody's fully honest out there. You get all sorts of funny stories and disinformation and misinformation and things that can lead you down rabbit holes and conspiracy theories and whatnot. I think this is going to be a long-term trend that is going to

be full of challenges. It's going to take a lot more than just language at the bottom of release to make people feel better about the potential positive impacts that AI can have on our future. Yeah. To throw it back to the early aughts, again, we felt the same way about the internet. There was a lot of concern at the start of the internet. This is going to be a bad thing. This this is going to put people out of jobs, this is going to end the world. We're seeing that with AI. Certainly, I was reading Wired's All AI issue this weekend, and it was very, everything from the world is going to end in eight years

to this is going to make a sort of new utopia. So, opinions are all across the board. The disparity of the outcomes is impressive. I mean, going from panacea to full-on world destruction, you can't get much more polarizing than that. Yeah, absolutely. I want to pivot a little bit to talk about another part of Amazon. We may have an end to the writer's strike, hopefully, fingers crossed. But meanwhile, let's talk about Amazon Prime.

Amazon announced on Friday, they snuck this out, they're adding ads to Prime. They say not a lot of ads, not just a few, nothing to worry about here. You can opt out of the ads for about $2.99, about $3 a month. It's small, but 200 million Prime users, that does add up. What do you think? Are you paying for the Amazon ad-free tier, or are you going to wait? I probably won't. I don't know that I use Amazon streaming enough to really justify that.

But honestly, I don't know that they want us to pay to opt out. We've seen from companies like Netflix and Walt Disney here over the last several quarters, they've been talking more and more about these ad-supported options that they've introduced into their models. Ultimately, those ad-supported models can be more profitable for the businesses. They actually like being able to incorporate ads as long as consumers will tolerate them, because they can be very profitable. Consumers will tolerate them, particularly on a global basis. When you look at the advertising-supported video on demand, that is a really fast-growing market on a global scale there in connected TV. I'm a little bit surprised we didn't hear

this announcement from Amazon sooner. I like it. It gives consumers a choice. If you're someone that uses the Amazon Prime streaming service a lot, then maybe this is something you'll consider. I'll say, a lot in our house, we use the Hulu Live offering, and we pay for the ad-free version of that so that anything that we're streaming on Hulu, any of the on-demand stuff. We can just get all that stuff with minimal to zero ads. I think it really just boils down to what platforms you use the most, where is the value proposition going to be there. But I think, generally speaking, most of these companies, they don't want you to opt out because those ad-supported models can be quite profitable.

Well, with Amazon especially, advertising is a bigger and bigger and more profitable part of that business already. It is. They distribute content in so many different ways, right? They've already got a little bit of this going with that freebie offering, right? I mean, that is essentially TV with ads right there. I mean, that's an Amazon property. And so, this is just taking it one step further. So, with Amazon, they distribute content so many different ways that this is just a natural fit. Maybe the $3 is just to bring awareness to the idea that there's going to be ads. Who knows? That's a very good point. One last Amazon question. I noticed on the

bottom of the press release. I love to do that. The Just Walk Out technology was on their list of the things that they are talking about. This is the technology where you can basically go into the store, pick stuff up, and just leave. We surveyed our listeners last week on X. About 78% said they're willing to do it. Amazon has struggled with integrating this tech for a while. They had those Go stores. They tried this out with Amazon Fresh. That hasn't been going so well for them. Do you think the tipping point on this is coming soon? It could be. I liken this to self-driving cars in that, to me, it feels like the technology is on a much faster pace here than actually figuring out how to handle the tech as a society.

There's infrastructure investments that need to be made. They're educating the consumer. Once you get stuck in your old ways or your habits, those can be difficult to break. I think it's interesting technology. I would certainly try it. It's not like it's something that scares me, but kind of like that old trust but verify saw. I think I'd be going through my receipt to make sure I was getting charged the right stuff. Furthermore, the store owner, in this case, whether it's an Amazon Fresh, whatever, but let's assume this technology gets rolled out to stores and shops everywhere. As a store owner, I have to imagine, you're just going to take this on blind faith that everything

is getting charged, that can be a little bit of a leap of faith right there. And so that'll take a little bit of time, ultimately, to play out there. So I don't know. I mean, I see it playing a role. I'm just not sure how quickly we're going to get there. I think it's going to take probably a little bit longer than maybe people think. Yeah, yeah. The checking out thing is interesting because, I mean, now, you know, if you leave like the

Walmart, they at least look at your receipt. Not sure if that would happen if you're using the checkout-free technology. Well, and that would be the idea. The whole point is convenience and zero friction. Well, if you're going to introduce some friction and say there, well, checkout-free, but we're still going to check your receipt, well, that's not really checkout-free then, so it's kind of false advertising. As a consumer, hey, you know, you're checking out, and you probably don't really have much

to worry about, and maybe you're not getting charged for everything. Maybe you are. Maybe you care. Maybe you don't. But if you're the shop owner, you care. You want to make sure you're getting charged for every single thing that that consumer is walking out with. Whether this technology can really do that consistently, I guess, remains to be seen.

Yeah, I think that's true. Thanks for your time today, Jason. Thank you. We just talked about Amazon. We think there are a lot of great companies out there that are back at levels not seen in years. And that's why our analysts have rounded up five companies that have dipped below 49 bucks a share. And we're giving away that list for free. You can grab your copy of this report,

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don't just file a ticket and wait weeks for an outdated report. Describe what you need and have Rippling AI build it instantly from your live people and business data. Whether it's a dashboard with detailed charts or automated workflows with the right triggers, conditions, and approvals. Ready to rule your business? Head to rippling.ai slash fool to get the only AI built to give you full visibility and take complex actions across your entire organization. That's r-i-p-p-l-i-n-g dot a-i slash f-o-o-l. Sign up for exclusive access today. rippling.ai slash fool. Last week, the CEO of RCI Hospitality, Eric Langen, tweeted he was grabbing dinner at the Grange Food Hall in Denver and was happy to meet up.

The company operates restaurants, nightclubs, and soon casinos. RCI shareholder Ricky Mulvey took him up on it and brought his recording equipment. Mulvey talked to Langen about consumer spending, capital allocation, and his journey to the CEO seat. I know you've told this story on X or Twitter, whatever you want to call it. It's, it's gotta be an interesting journey to, um, I think you, you had maybe one club and then to be the CEO of a, of a publicly traded nightclub restaurant, gentlemen's club cabaret business.

Yeah. I mean, I started out, I was dating an entertainer. I was 19 years old. Uh, I got married and divorced at 19. Friends started taking me to a club to hang out, to try to, you know, keep my mind on my ex-wife had ran off with my daughter. So I didn't really know where my daughter was. So it was kind of, you know, I was young and crazy and, but they started taking me to clubs.

So I started dating one of the entertainers at the club and then didn't really like the way things were going there for her. So I decided to open up, we were going to open our own club up and sold my baseball card collection. Opened up my first club was about 1600 square foot, little tiny place, just sold beer and wine, no hard liquor. But then parlayed that into another club and another club. And now we have, you know, almost 70 went public in 97 merged with Rick's who did an

IPO in 95, uh, then bought out the founder in 99 and basically been CEO chairman of the board since 1999. That's incredible. Yeah. We had, uh, seven locations, I think, or six locations in 1999. So we have 70 locations right now. We have 14 different projects in various phases of construction. Our next one that will open, it'll be in Stafford, Texas, which is a South, uh, Southwest Houston suburb area. Uh, that one should open in the next two or three weeks. We're We're building a flagship location in Rowlett, Texas, which is between Mesquite and Rockwall, right on the lake. I have a 3,800-square-foot outdoor patio, really fantastic location, part of a huge 108-acre or 180-acre, I can't remember how big it is, development with all types of business there.

Our neighbor's going to be Margaritaville, to give you an idea. Jimmy Buffett's Margaritaville, so hotel and resort. One thing I've heard you talk about on earnings calls is you talk about capital allocation more than a lot of publicly traded CEOs. And you've drawn inspiration from a book called The Outsiders. Just maybe broadly, how that book has affected you as a CEO, and also how you just maybe generally think about capital allocation at RCI. Well, in 2014, we were supposed to do this big acquisition. And I found some accounting irregularities I didn't like. The more I dug in, the more i realized there was some type of fraud going i didn't know what it was at the time

i found out about 18 months later when the owners were arrested for uh money laundering basically they were their sales didn't make any sense versus the inventories i was watching the inventory so basically on the one club i finally when i when i finally said okay no we're not doing this deal they would have had to been selling beer for about uh 120 bucks a piece wow you know and beers were like four, four 50 back then. Right. So I was like, how can you have this much beer sales, but you only bought this much, right? You can't have, you know, you can't have a hundred thousand dollars in sales and you only bought enough beer at your four 50 to make, you know, $20,000 in sales. So where's this other $80,000 in beer sales? Yeah. You're paying the tax. Yeah. You've,

you know, everything looks normal, right on the surface. But when you, when I dug into their inventory, uh, purchases, the actual purchases of the product, they didn't buy enough product to have that much in retail sales so and i i've been to the club multiple nights and it was always slow you know and then you know compared to the what what the revenue numbers they said they were making so it kind of threw me off uh so we walked that deal when i did my bankers who were getting ready to do a about 14 million dollar raise for us didn't get their six percent and so they started pressuring me hardcore no just buy it you can fix it you know what you're doing i'm like no there's i'm not paying for something that just doesn't make sense this is not right something you know

something's wrong here. I can't do it. And so we backed out of the deal. And so that we got into a big argument with them. I ended up firing all my financial advisor, fired people that were raising money for us about mid 2014. And then about a month later, a group from California came out to me and said, you know, Hey, we've got a proposal for you. And they hand me this book and it's called the do nothing proposal. I'm like, I'm good at doing nothing. I like this. I, and I, I open it up and it says, you should do nothing other than buy back your stock as long as your free cash flow yield is over 10%. And your free cash flow deal today is 32.6% or something like that at the time. Because I didn't do the deal, the stock had gotten beat up.

And so I was like, hmm, okay. And so I started looking. And I was like, you know, and then they explained to me how the deals we had done in the past with equity had been the most expensive capital that we could use. and so because because of the free cash flow yield and so we started looking and really got me into it so that's right now it started i was like okay so basically within i don't know probably a month i had we had kind of settled everything down we weren't we stopped looking for acquisitions we kind of closed down anything we were doing and we literally took all of our free cash flow every week and started buying back stock so if i had five hundred thousand dollars in

extra cash that week i would call the broker on monday say buy me five hundred thousand dollars the stock this week. I'll talk to you next Monday. And that was my job for the week. So like I said, I was really good at that, doing nothing. As we did that, you know, we started buying back lots of stock. If you look originally, we were fully diluted basis. We had 10.8 million shares outstanding. And today we have 9.4. We've used half a million on one acquisition, 200,000 on another acquisition. But the 200,000 that we used at $80 a share on this acquisition in March, we bought back at an average price of $65 a share over the period of time after we did the first acquisition. So we've been very lucky in timing and following the strategy, it really works.

So if we set a hurdle rate for ourselves, if we're going to invest money, if our free cash flow yields at 10%, then anything money we invest that's not buying back our own company, we want a 25% to 33% return on, cash on cash. And I don't worry about levered returns. We have bank financing now. Until 2017, we didn't have bank financing. Everything was cash or seller financing or super high interest, 12%, 14% money from hard money lenders. So that's really changed the ball game for us between 2017 and now. And if you look at our stock today, we closed at a 52-week low today, which, you know, I'm, I'm just in shock over because, I mean, I guess not really because we've been, we've been weakening and people have misunderstood or misunderstanding where we're

going because they're looking at our post COVID numbers. And I say, I tell everybody, we got through the last three years away. There was no normality to anything. There was no seasonality where in the summertime, when numbers were supposed to get down, we start running record numbers. When the numbers were supposed to go up, our numbers were off. It's like, there's no normality to anything because, you know, you get open and then we get closed, COVID closed down. Then there'd be another scare. Oh, we got to put your mask back on. Oh, you got to do this. You got to. And so there was no real normality. And, and especially like the restaurant side, you know, you look at the restaurant association, what they say, like 40% of mom and pop restaurants

and went out of business during that, that two year, three year period of COVID. Right. And what we've had in the last 12 months is new operators leasing all those buildings or renting all those buildings, opening new stores. So we had the big bump because everybody was closed. Then we get this dip because now everybody's reopening different stuff, but it's new. And when anything's new, it has a honeymoon period. That's why if you look at most restaurants, including bombshells, we don't include them in same source sales for 18 months because the first six months are abnormal numbers, you know, cause you're, you're boosting because you're in your honeymoon period. And so we were going against outrageous comps from a year ago and getting hit

by all these new places opening up. They're in their honeymoon periods that didn't take just their business back, but took a little bit of our business as well. And we probably could have been a little quicker on raising some prices and doing a few other things. At the same time, we had labor squeezes. So we had lots of overtime. So our labor costs got out of whack. Food costs were fluctuating. So we played these games. So right now, Bombshells is running. I think we had a 15% margin. We had 12.9% in the last quarter. I'm not sure what this quarter is going to be. We did raise some prices at the end of June, so this should help and stabilize. But we should be back to our 18-20% margins.

But what people were looking at before was 28% margins, 32% margins. And you can go back and listen to earnings conference calls. I talked to one of our largest shareholders, and he'd say, oh, we could extrapolate this out. And over the next three years, you're going to say, no, those margins are not doable on a long-term basis. Yeah. I think one of the things that often affects stocks is when a Wall Street analyst has to change his or her model. And you must be in a tough environment where the denominator isn't going back to 2020 or 2021 levels. Now it's at 2022, the post-pandemic reopening boom. And I would say a lot of not long-term investors, but traders are just looking

at that one year, same store sales number. Well, if you look, it's computers that are selling our stock. Yeah. Right. I can't remember if it's dimensional or Renaissance, but they're both computer ran funds, right? Computers do all the buying, all the selling. Uh, and they, you know, they're net, they were net seller in the last quarter based on their 13 F filing of 300,000 shares, uh, which is a huge part of the volume for that quarter. And so, you know, I look at the, I look at our shareholders lists and I look at the 30, you know, our, our, the humans that own our stock are holding it. The computers are doing a lot of the selling right now. And so when the computers run out of stock and they will, I mean, their, their, their counts are all time lows. I

mean, at one point dimensional on 985,000 shares of the company, which because of our buyback at that time, you know, that same quarter, we bought back a bunch of stock. And so they ended up being on, you know, a little over 10% of the company. So they, I'm sure they sold immediately after we filed sold down under 10%, but they also kept right on selling and they've continued to sell. So you can look at their 13 F's, like I said, and see that they're very, very small portions of our, of our holdings now and as those computers run out of stock eventually we will turn uh i think in as early as first quarter 24 which is our october we were fiscal year so maybe october november december so by february the computers you know could flip because we started down about mid

october last year the blue collar customer started getting hit in mid-october uh we stabilized that customer by April. And then in May, our high-end customer started planning European vacations, Mediterranean vacations. And this summer, our super high-end customer, in the casino terms, they call them whales, but our big spenders were all gone. They're all out of the country. And so we saw our big tickets just shrank. I went to, you know, went from 25 plus a week to, you know, at, you know, 5,000 plus to one a week at one of our top locations in the country. And so we started looking, it's like, wow, we're really being affected, you know, to tune of a couple million dollars this quarter of top-end customers.

And that top-end customer is, you know, VIP room, you know, high-dollar champagnes, bottle services that are super high margin for us. So not only did we lose the total revenue, but we lost a much larger share of our bottom line margins through that. But they're coming back. They're back from vacation. Kids are back in school. Weather's changing. It's getting dark earlier, and we'll start seeing that customer.

And I really think the turning point is this next quarter and for sure January, February, March. So sometime between February and May, all those computers are going to switch their models. the quants, as they call them. And the quants are going to go, oh, we better start buying the stock again. And I think the stock will rebound pretty nicely, especially as we continue to get out on X and get out and put humans in the stock. We hired Equity Animal out of New York to bring us in. And we went from a little over 6,000 shareholders to a little over 9,000 shareholders now. Sure. Smaller shareholders, but you know, I always say it's real simple. I need, you know, 900,000 people to buy 10 shares, or I need 90,000 people that can buy a hundred shares,

right. Or 9,000 people that can buy a thousand shares. And so I just started playing as the numbers came. I used to be in door to door sales as a kid. And I started, let's say, we just got to knock the door. So let's just keep knocking doors, knocking doors. Uh, and, and it's working. We're seeing those shareholders come and you know, they're, they're holding, they're, they're buying, they're holding. Yes, the stock was 90-something in January. It's back down to 60. The market's up 15 points. We're down 30%. But we were also at an all-time high in January. I mean, not just a 52-week high. I mean, all-time. We'd never traded at that valuation before. And so, I always thought it would return to the mean. I thought the stock was, say, between 70 and 80. When it

dipped below 70. I was kind of surprised we held 68 for a long, long time. Uh, we finally broke through that 68 support recently, which according to charts, so quant charts puts us at 64. We've now broke through that. So the next support level I think is 58. So we'll see if we can hold 58 here. Uh, I mean, I, like I said, the humans that I talked to are, and the people that I've known me for a long time, they're all calling me and saying, Hey, is your stock a buy? I said, you You know, look, based on our cap allocation strategy, you can do the math and, you know, we're buying and I've put it out there, you know, pretty publicly that basically we buy about $100,000 worth of stock a day as part of our deal.

We don't buy every day and sometimes we do. It really depends on our total cash and where we, if we have places to put that cash, you know, if it's a 10 or 12% yield, but we have a place to put it that we think we can earn 30% plus, it makes more sense to invest it at a 30% plus ratio, but we get a certain amount of cash on our books. Typically, right now, that number is about $25 million. If we're over $25 million in cash on the books, we will buy every day. If we get between $20 million and $25 million, we may skip a day here or there trying to let it catch back up. For the humans invested in RCI Hospitality, how do you want them to judge the health and

growth of your company? I think you have to look at 2023 as a growth year for us. We did acquisitions, but we didn't do any new builds. We didn't build more bombshells. We've found these casino properties. We're building three nightclubs right now, Fort Worth and Lubbock, Texas. So we have some clubs under construction as well. So with all these projects, there's a lot of, I call them anchors or some drag, right? There's drag on stuff. So our margins, we shoot for 30% EBITDA margins, 20% free cashflow margin on total gross revenues. And we were at 19 and change and we hit 29 and change in this past quarter. But there's a lot of drag on with all these projects that we're doing, you know, architects being paid

and attorneys and, you know, carrying costs for whether it's property taxes or utilities. And so there's a lot of little things out there that we're spending money on, travel to go to these sites and meet with people and get construction started and get the GCs working. All that's going now. And it was really because of COVID we stopped, right? We got closed down. We didn't really know what was going to go on. We finally got some stuff open in May. We struggled for that six to eight months you know uh then we finally got open we and we started doing so good we were so busy that we didn't really have the time to go hunt new projects uh but then you know last year we started hunting the projects uh from the time we start to the time he opens typically 12 to 14

months uh so the first one will open you know in october that's of this of these 14 that are in line right now we'll probably open six or seven of them this year and six or seven of them in fiscal 25 and i don't have to look for anything right now until the end of calendar 24 so after december 2024 early early 25 i'll start looking for stuff that's going to open in 26 you know we're in pretty good shape there and i think there's these things come online the drag goes away and they start income producing uh we're going to be back in if you look at our five-year kgar rate through june 30th we're at 20 free cash flow per share growth uh in the previous five years. That's through COVID. I think overall, you know, our growth has been solid from when we

started the capital case strategy eight years ago, we were doing $15 million in free cash flow. I project that 2024, we're going to come in over $70 million in free cash flow. So, you know, that's not bad growth for an eight-year period, in my opinion. I'll take it. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Woollard. Thanks for listening. We'll see you tomorrow.