VCG Holding Corp. (NASDAQ:VCGH)

VCG Holding Corporation (AMEX: PTT) was incorporated in 1998 (from SEC Form 10QSB (mrq)) and is headquartered in Lakewood, Colorado. (They are listed on the Russell 1000 Microcap Index, having been added to that list in June 2007.) However, VCG did not begin operations until April 2002, according to company press releases. VCG is a small cap company ($120.82 M as of July 12, 2007) and employs roughly 450 people according to Yahoo! Finance (though I suspect the actual number is higher due to recent acquisitions). (Adult club dancers are independent contractors, in general, not company employees.) Subsidiaries of VCG include (among others) International Entertainment Consultants, Inc. (IEC), founded in 1980 by Mr. Troy H. Lowrie (now CEO of VCG), as well as VCG Real Estate Holding Corporation. (Mr. Lowrie appears to be a very savvy and experienced marketer and manager – see below for more on this.) Given its small size, one might think that VCG is far from recession proof in this time of economic uncertainty. However, in view of the particular industry in which VCG operates -- adult entertainment -- there certainly seems to be a steady (and probably growing) demand for these products and services on a regular basis, through economic good times and bad. That may not make them recession proof, but then again it just might do the trick. So to speak.

Through most of the last five years, VCG has remained chiefly a regional business of limited scope and somewhat uninspiring profitability with a total of seven nightclubs in Arizona, Colorado, Indiana, and Illinois/Missouri (prior to October 2006). But that has been changing since 10/2006. The management of VCG Holdings is in the midst of a major expansion on a nationwide scale to become, as they put it in a press release dated 07/11/2007, "a leading consolidator and operator of adult nightclubs." And from their very professional-looking, classy, and informative website (though there are a couple of blank spots in the site that need developing), http://www.vcgh.com: "Management believes maximum profitability is obtained from owning and operating only first class adult entertainment nightclubs, which attract an affluent clientele." This particular niche of the adult entertainment industry (i.e. they're not into selling adult VHS, DVD's, VOD, or other high-volume, dime-a-dozen items at retail in a rapidly changing and highly competitive technological environment), operating high quality adult nightclubs, would seem to be an interesting one for them to play in.

If you're like me, this is an industry that I've never thought of investing in before, either in CAPS-land or IRL. Hence a bit more from their website on the quality of VCG's facilities and performers might be appropriate at this point as well: "The facilities are within ready access to the principal business, tourist, and/or commercial districts in the metropolitan areas in which they are located. Both the exterior of the buildings and the interior design and decor of the clubs provide the appearance and atmosphere of an upscale restaurant. The facilities have state of the art sound systems, theater-quality lighting and professional stage design. Some facilities have a VIP Room. This is a separate area of the club accessible only to those who purchase annual memberships. The VIP Room provides an elegant, quiet atmosphere with its own restaurant featuring a more upscale food menu. The VIP Room is particularly conducive to business entertaining...The facilities provide premium quality female performers. The highest standards are maintained for appearance, attitude, demeanor, dress and personality. The entertainment encourages repeat visits, increases the average length of a patron's stay and attracts customers to a late night destination, all of which creates increased revenue."

And here's some of VCG's marketing strategy as posted on their website: "During the past 20 years operating nightclubs, [our subsidiary] IEC has developed a results-proven, cost-efficient marketing program. The clubs are marketed as a safe and upscale environment for adult entertainment. The marketing strategy is to attract new customers, to increase the frequency of visits by existing customers and establish a higher level of name recognition. The marketing program includes advertising in travel and hospitality magazines, print advertising, billboards with distinctive graphics and taxi cab reader boards. The target market is the business-convention traveler local professionals and business people. In addition, IEC conducts various promotion activities throughout the year to keep the club's name before the public. In order to promote a good community reputation, the clubs actively sponsor and participate in local charitable events and make contributions to local charities."

Also, what VCG has written about the industry in which they operate is relevant here and is well presented: "For years, sexual content has been continually increasing in the media, including [in] movies, television, magazines, newspapers, and the internet. Capitalizing on this opportunity, businesses that were not previously involved in the industry have now become major providers of adult entertainment. These include hotel chains, cable and satellite television companies, national video store companies and long distance telephone carriers. Public acceptance and demand for the premium quality adult entertainment nightclubs have become common in both cities and suburbs throughout the United States as there is an increasingly open and healthy attitude toward sexuality. There is a strong existing and developing market among businessmen, professionals and other affluent persons for first-class adult entertainment nightclubs. According to Forbes magazine (May 23, 2001), as the adult entertainment industry has become more socially acceptable, it has grown to an $11 billion market and 'Adult entertainment businesses can expect to see their market capitalizations at least triple over the next five to seven years.' The social acceptance and accelerating growth in adult entertainment includes adult entertainment nightclubs, particularly first class adult entertainment nightclubs, which are popular among affluent customers for social and business entertainment."

I would say that this philosophy dovetails with what some call being "sex positive." For example, the tastefully run (and female founded, owned, and operated) California company Good Vibrations operates on a “sex positive” approach. That is not to say that the industry in which both VCG and GV operate is devoid of ethical challenges and highly dubious businesses, to be sure -- but I would argue that is true in one form or another of many industries and sectors of American business today. I give VCG credit for trying to upgrade their slice of an industry that has been sorely in need of professionalization for a long time.

Evidently no one in this line of business now controls more than 1% of all such clubs in the U.S.A. In fact, most adult nightclub owners own only one club. VCG management's opportunities for consolidation include: (1) the potential for building their existing brands (e.g. they have licensed the well-known Penthouse Club brand for use in two existing VCG clubs and in new clubs in up to seven states); (2) re-branding recent acquisitions (e.g. renaming Thee Dollhouse in Raleigh, NC, to The Men's Club, an existing brand name being leased by VCG from another company operating in different states from VCG); (3) utilizing economies of scale; (4) professionalizing business models of newly acquired clubs; (5) bringing in more big name adult stars to perform at special events; and (6) definitely taking advantage of well-positioned real estate in growing areas of the country (such as the ever expanding suburbs of the Southeast) with desirable demographics. For example, compared to a generation ago, the adult video industry now has something it never used to have: high visibility, high quality, high profitability brands, such as Vivid Entertainment (which is not currently open to the investing public, alas). That's a big change from the 1970's, to be sure, and the opportunities to develop something analogous in the adult nightclub business today are self-evident in my view.

Since October 2006, VCG has acquired an additional nine adult nightclubs (bringing their total to 15, I believe, as they have sold the Phoenix, AZ, nightclub), including ones located in Louisville, KY; Minneapolis, MN; and Raleigh, NC. The bulk of their clubs remain in Colorado and Illinois, but the CEO of VCG has clearly signaled that the company is looking to expand further nationwide, such as into the suburban Midwest, Southeast, and Northeast. The company has recently (announced 07/11/2007) obtained additional financing ($10 million in several lines of credit at 8.75% interest) to support current and future acquisitions. A June 11, 2007, press release announced that VCG has signed letters of intent to purchase two more nightclubs (which would bring their total to 17), including one in a Southeastern city (deal set to close in September) and the other in a Northeastern city (deal set to close this month, in July). Additionally, a June 19, 2007, press release announced VCG's plans to acquire three more adult nightclubs (which would bring their total to 20) in the Southeastern and Southwestern U.S. As with previous acquisitions, these five clubs are expected to be accretive (already!) to EPS for 2007. So far, this sounds like shrewd expansion strategy.

VCG's Total Debt to Equity ratio should remain good, as the mrq shows it at 0.694. The Current Ratio (mrq) is an impressive 4.888. Cash flow and profitability have shown significant increases in recent quarters. Other Key Statistics from Yahoo! Finance, Capital IQ, and Google Finance include:

Profit Margin (ttm) = 9.34%
Profit Margin (mrq) = 16.59%
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