man with cash © Corbis

Extra3/6/2007 2:00 PM ET

Strip clubs go mainstream

Vice has its virtue for the operators of two publicly traded 'gentleman's club' chains. Revenue is soaring and the stocks are on fire.

By MarketWatch

It's a Wednesday night at Rick's Cabaret in midtown Manhattan, and business is quickly 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 and down expensive cocktails while watching the dancers. A guy in a Red Sox hat orders a lap dance; a man 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 Rick's Cabaret International (RICK, news, msgs), based in Houston.

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 past 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, the chief executive of Rick's Cabaret. "The New York club has really helped build our brand name."

Watch dancers or CNBC

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.

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.

Stock Charts (Year)

Rick's Cabaret International
Graphical chart for RICK
Rick's is looking for revenue to jump into the $50 million range this year, and the company 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 on Feb. 26, cresting at $11.10 -- its highest level in more than 10 years. A year earlier, it was trading at $4 and change.

"We view (the company) as an underfollowed, 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."

Dancers pay to work there

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 moneymaker: 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 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, the president of VCG Holding (PTT, news, msgs), another club operator and head of the Association of Club Executives, the industry's trade group.

Stock Charts (Year)

VCG Holding
Graphical chart for PTT
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 five others. It had revenue of $17 million last year and said it expects to generate $40.8 million this year, $66.3 million next year and $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 past year has been impressive, VCG's has been nothing less than meteoric: Over the past 12 months, shares have soared 750%.

This article was reported and written by William Spain for MarketWatch.

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