Valuation: On Historic Multiples, Shares Are Worth $13-17

*Note: The Twitter account has been temporary suspended, apparently some people were not happy with the content the account was posting and reported it to Twitter.

While the many corporate governance issues I have discussed (and there are many more that have yet to be posted) were enough to dissuade me from ever trusting management and the board with my capital, the key thesis of the short position is that shares are significantly overvalued given the growth prospects (or lack thereof) of the underlying business. In a separate post, I will explain why I believe clubs are not indefinite life assets with perpetuity value(based on actual results of clubs closing and RCI impairment charges), but first I will discuss valuation:

RCI’s stock is up over 300% in the last 18 months. While there has been some fundamental improvements and earnings growth, the majority of the gains have come from multiple expansion as the company's new IR campaign and capital allocation strategy has attracted retail investors the believe Eric is the next Singleton or Buffett. New investors are drastically overestimating the prospects for RCI, having never seen the business through a whole economic cycle.

From 2008 to 2015 (before the capital allocation hype started in Oct 2016), the stock traded at an average Price/Sales ratio of 0.88x, a P/E ratio of 9.5x, and Price/Book ratio of 0.99. Based on these historic multiples and Q2 2018 TTM financials, RCI shares are worth between $14.32 and $17.41, or roughly 50% below the current level.

	RCI Current Multiple	2008 - 2015 Median	Stock Price If Trading at Historic Average Multiple	Downside from Current Price
P/S	1.96	0.88	$14.32	55%
P/E	17.39	9.46	$17.41	46%
P/B	2.06	0.99	$15.38	52%
Based on TTM Financials as of Q2 2018

On a justified P/E basis, shares deserve to trade at a 7.1x P/E ratio ($13.14 per share), which is even lower than historic multiples. This assumes a generous 0% growth rate (as stated, I believe it is clear RCI is a negative organic growth business) and a 14% cost of equity (the company recently issued unsecured debt at a 12% interest rate, so a fair cost of equity would be at least 14%, potentially even higher).

These valuations are using management’s overly optimistic “adjusted” earnings numbers, which ignore the costs of legal settlements. A combination of industry risk and management’s bad decisions have led to numerous legal cases that create a never ending legal liability for RCI that should be accounted for as ongoing expense, not a one-time charge. RCI’s settlement of lawsuits expense the last four years has been $300k, $1.8m, $11.7m, and $3.7m, for an average of more than $4 million per year. Investors should deduct this amount to get a true approximation of the earnings run rate of this business.