There was recently a major change in my portfolio that was left unexplained until today. I quietly sold off my entire RCI-Hospitality-Holdings (RICK) holdings after having beat the drum for the company for quite some time. Therefore, I feel that I owe an explanation of why I have done so.
As you might have noticed I was quite fond of RICK´s insanely cheap valuation. The position was bought at levels of USD 8 and USD 10 per share respectively. In my Seeking-Alpha analysis of RICK I determined the company to be worth anywhere between USD 12.50 on the low- and USD 16 per share on the high side. The lower of the two price target centred around an assessment by the company itself that all R/E holdings are worth USD 50 mn in excess of book value. The company claimed that a conservative valuation has been conducted by an independent third party.
Through a discussion with a Seeking-Alpha Member, which you can find here and here, I began to fear that the numbers don´t add up and R/E might after all be worth much less. Arguments herefor are:
- Purchase price of some past owners is much lower than RICK values the properties on their books indicating for a not very straight-forward purchase price allocation. Goodwill might be avoided and allocated to depreciateable R/E values. This would go in line with the emphasising of management to focus on FCF instead of earnings and communicating maintenance CAPEX that run on a much lower level than depreciation.
- Scrapping the plan to spin-off R/E into a REIT. The company has had plans to sell all of their R/E into a REIT to lift hidden reserves. This plan was abolished some time ago because management argued that it now has access to competitive bank financing which would diminish the advantages of forming a REIT. Another reason could be that funding fell short of the number they targeted and a dropdown would have ended in painful impairments.
- Tax base and book value of some properties doesn’t add up and rise additional concerns on the recoverability of book R/E.
While I cannot be sure that the above is correct, if proven true, these red flags shatter my asset based valuation that provides a safety net if cash-flows falters. In order to adhere to the probably all important rule in investing “Don´t lose money” I decided to sell. Don´t get me wrong. RICK still is a Cash-Flow monster and will earn you around 17% FCFY, but this new information changed the risk-reward pattern on this investment by a lot.
Further, lawsuits fears and risks of rising maintenance CAPEX are ever-present. I could live with these if it weren’t for the doubts on Property Value that insured on the downside. Without said secure floor these concerns hover like Damocles´ Sword above RICK´s investors.
Bearing in mind all this I am very happy to have realised a nice 36% return from my investment in RICK and will book this investment as a wild success. In case the company will reach my initial USD 16 target after all, I hope this blogpost helps and reassures myself that back then it was the right decision to sell out and feeling regret about having missed a rally is not warranted.