“You’re about to discover the details on my favorite stock.

“Not because it’s cool (it is), not because the company makes a ton of money (they do), but because their growth model has almost no end in sight.

“They’re growing so fast because they’re filling an age old need and charging a premium for it. They’re catering to a clientele more than willing to shell out its hard earned money. And they’re growing by gobbling up all of the little guys.”

That’s a quote from an ad signed by Bret Jensen, who’s trying to get folks to sign up for his new Small Cap Gems newsletter at Investors Alley. And it looks like it’s the first teaser pick he has pitched for potential subscribers, so shall we see what it is?

We shall indeed. As befits a new letter (and a Monday morning), it’s not the absolutely most difficult teaser pitch to solve — other than the fact that many folks will be surprised that there’s a public company in this sector. But let’s walk through the garden of clues he provides…

“Another investing strategy I took from the book [Peter Lynch’s Beating the Street] was how powerful a market leader growing market share by acquiring less efficient firms in a very fragmented industry could be….

“Another company I have recently taking a stake in has an opportunity to consolidate and prosper within a more exotic space.

“And that’s the company I want to share with you today.

“It’s in a space that some investors may not even think to explore while others may be put off by the nature of its business. One should never be put off by potentially raking in double, even triple digit gains assuming the company is engaged in legal and ethical activities. And this one is.

“An Old Type of Entertainment with an Expanding Base

“This company is the nation’s leading hospitality company in adult clubs and the only play in the space that is a publicly traded company. It owns and operates just over 40 clubs in 10 states with half the company’s overall revenues come from fast growing Texas.

“And the stock is selling for just under over $11 a share.

“Breathtaking Growth through Consolidating a Fragmented Industry = Profitable Endeavor”

So yes, this is that stock that occasionally comes up when pundits write their semiannual articles about “sin stocks” and investing in tobacco, alcohol and gambling… the strip club stock.

Know it offhand? Don’t worry, we’ll get to it in a moment.

(We’re not keeping any secrets, we’re just building the anticipation. Taking it off one piece at a time, as it were).

Jensen tells us that the “adult club” is fragmented, and that there are substantial economies of scale to be had in “rolling up” the industry — consolidating to cut overhead costs, get better deals from distributors, etc. And they also, by rolling up the industry, get “grandfathered in” on locations — “adult entertainment” is not always a desired local business, so starting up a new club is apparently difficult. I guess that’s why Porky’s was out in the middle of the woods.

And then a bit on the numbers — about why this is such a good business:

“This company’s clubs are not for everyone but the business model is very attractive on an economic basis compared to other plays in the hospitality space such as restaurants and bars.

“Gross margins in those areas average a bit more than 35% on average on a historical average. This company’s gross margin company wide at its clubs is north of 85%.

“Operating margins are over 20% which is mostly unheard of in the restaurant sector. As can be seen below, the company gets high margin revenues from a variety of sources.”

And some new stuff that they’ve been doing to bolster the bottom line and grow:

“They recently cut their lease expenses by over 40% annually at one of their two clubs in New York City by selling the “air rights” of that space for some $8 million over five years….

“They also partnered with a leading video company to come up with and launch a new upscale club model co-branding both of them. The first club with that concept just opened this year and is exceeding expectations by a wide margin….

“… the company is planning to open a new club in Odessa, Texas, which is the second fastest growing metropolitan area in the country. The city’s population has been bolstered by exploding oil and gas production.”

So who is this operator of “Gentlemen’s Clubs”? This is RCI Hospitality Holdings, formerly known as Rick’s Cabaret (ticker RICK).

And they are expanding in several ways, as teased, including some large scale bar/restaurants under the “Bombshells” name that they may be building near military bases (family dining during the day with “attractive” waitresses, gets racier at night — much like every other Hooter’s-inspired sports bar, though perhaps some of them also have a strip club connected). This is a huge business sector, with at least several thousand “gentlemen’s clubs” around the country, but I don’t know how big the “upscale” part of it is that they’re aiming to roll up in acquiring new clubs — not sure there’s been a census done of the number of huge, urban bachelor-party clubs versus the number of seedy truck stop one-pole operations. I can thankfully say I don’t know much about this business.

But yes, they do seem to roll through a helluva lot of money — at least, the big clubs do. They’ve been cutting costs somehow over the last decade, perhaps by changing the way they operate, so that more of the cash hits the bottom line these days than it used to — but they haven’t necessarily been a consistent grower quarter to quarter or year to year. I assume it’s acquisitions or buildouts that are causing the substantial variation in profitability from one quarter to the next, but haven’t looked close enough to know for sure — they have boosted revenues by about 50% since 2011, but profits have been fairly flat over those past few years of rapid revenue growth.

That indicates to me that either there are big start-up costs in their newer operations that will be worked out over a longer period of time, or the model doesn’t benefit much from “scale.” The gross margin is consistently very high, in the 75-80% range, but the selling, general and “other” operating expenses have risen in a straight line along with the revenue — makes sense, there may be room for some slivers of cost savings if you consolidate a chain of clubs, but you still have employees and real estate costs at each club. Part of the weakness may be lawsuit settlements, I’m not sure — you can get some sense of how the company thinks it’s doing in their latest quarterly release here, they do think that they’re in a “turnaround.”

Oh, and yes, they have opened a couple co-branded “video themed” clubs with Vivid, the pornographic filmmaker, including one in New York. I assume they’re popular, but don’t really know — the only time I’ve heard anything about that one was when the club got a lot of publicity (intentionally, I’m sure) for refusing to play the New York Giants games early last year when the team wasn’t doing well because it was bumming everyone out and “making the girls work harder.”

So… will RICK make you rich? Can the big national chain run a better strip club for the roughnecks in West Texas than a local entrepreneur would? Will the big, glitzier (and very expensive to operate) urban clubs rise or fall in popularity? I have absolutely no idea. The company looks decently priced at about 11X trailing earnings, but it’s also very, very small with a market cap of just over $100 million and about $70 million in debt. The stock has been wildly volatile, as you’d expect from a penny stock, with a huge run-up in the mid-2000s followed by several years of weakness — over the last five years or so it has been gradually ticking upward from $7-8 to about $11, with plenty of ups and downs along the way.

Have an opinion on the potential of the “gentleman’s club” business (sorry, “gentleman” really has to be in quotes)? Let us know with a comment below.