Strip Club Depression

by Doug French by Doug French

Strip clubs are the ultimate boom time creation. After all, the business model rests on masses of men overpaying for cocktails while overpaying lithesome young women to bump and grind on their laps — all of this after paying an exorbitant charge just to enter the building.

Prior to the great boom of the past decade the jiggle business was localized. Politically unpopular, zoning for such establishments is confined to industrial areas, tucked away from mom and the kids. Financing to build such businesses was hard to come by as many bank boards frowned upon the morals of the operation, turning a blind eye to the abundant cash flows. Publically traded strip club operators were unheard of.

Of course given their unpopularity with local do-gooders, entrepreneurs who are able to open an adult business become ongoing targets for extortion by local politicians. Since the government tightly controls how many can open and the rules when they do, adult business owners are often forced to bribe city officials first to gain approvals to open their businesses, and then to remain open.

Such was the case in one of the most fertile fields for the stripping business, Las Vegas. As home equity rich Americans were flooding Sin City after the shock of 9/11 wore off and Federal Reserve liquidity was making testosterone-filled young men feel like the good times would never end and money was for wasting, strip club owner Mike Galardi operated a small hole-in-the-wall money machine called Cheetahs. But with the town booming, he wanted to expand his feline-themed empire. But he wasn’t the only one. Everyone wanted to build a big club in Las Vegas. Convention traffic was soaring, gaming win was growing by leaps and bounds and more casino properties were planned for the Strip. Las Vegas was just getting started and the big-box strip club race was on. The 70,000 square foot Sapphire Gentlemen’s Club was underway right behind Circus Circus, as was the large, ornate Treasures located across I-15 from Palace Station. So many others were trying to open clubs that a moratorium was placed on new applications.

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With approvals for his 25,000 square foot Jaguars club hard to obtain, Galardi made a few hundred thousand dollars in gifts and cash payments to county commissioners to get Jaguars started and keep county inspectors off his back. Ultimately three Clark County commissioners, as well as Galardi, would go to prison in a political corruption case known as G-Sting.

Of course Galardi was only doing what he had to do. In his book, The Ethics of Liberty, Murray Rothbard explained that there “is nothing illegitimate about the briber, but there is much that is illegitimate about the bribee, the taker of the bribe. Legally, there should be a property right to pay a bribe, but not to take one.”

Former Galardi employee and friend Rich Buonantony told the San Diego Union-Tribune newspaper. “[Galardi] was giving hundreds of thousands of dollars, and do you think it was easy to remember giving five grand here and 10 grand there? It was nothing for him to give money. People looked at Mike Galardi like he was an ATM machine.” Those "people" Bounantony referred to were politicians.

But now that the boom has turned bust, business has flattened for strip clubs. The 25,000 square foot club that forever changed the lives of Galardi and three commissioners is now owned by the publically traded Rick’s Cabaret International Inc. Eric Langan, the man who took over Rick’s in 1998, ramped up the company’s growth in 2005 and now it owns 19 clubs around the country. Quite a story for a guy who sold his baseball card collection to finance his first club, "I just jumped in," says Langan. "With cold beer and some naked girls, it’s pretty easy to make money."

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With that initial $24,000 investment, Langan’s first club measured 1,600 square feet. Now, as he told BBook.com, some of his clubs have dressing room areas measuring more than three times that space. Back in 1999 Rick’s was trading for less than a buck a share on NASDAQ but by December of 2007, with his shares trading for $27 — more than the price of a lap dance — Langan’s goal became to own 50 clubs in three to five years. He bought a 47,000 square foot club in Miami for $25 million, a 25,000 square foot Dallas club for $9.5 million and he paid $18.7 million for the former Jaguars in Las Vegas. Rick’s balance sheet is now showing the strain. At September 30, 2006, liabilities totaled less than $17 million. Now with business sagging along with the asset values of the clubs, the company’s debts have soared to almost $72 million.

And the company has encountered expenses that Langan likely didn’t include in his pro forma when analyzing his company’s Las Vegas purchase. Cab drivers in Sin City have always collected bounties for delivering passengers to various businesses — especially strip clubs. But the price has soared in recent months as business has soured.

When a lot of loose cash is floating around, lawyers start taking interest. Attorney Al Marquis has filed a lawsuit to stop cabbies from being paid for delivering customers, thinking that it’s bad for Vegas. "The problem with paying for the delivery of customers is that it’s been escalating in recent years. It has begun to substantially alter the conduct of lots of different parties from hosts and doormen at casinos; to individual cab and limo drivers; to tourists getting diverted over their objection."

To regain market share Rick’s Las Vegas hiked cabbie payouts to $100 per head which led to an increase in monthly sales to $1.9 million in April, according to the Wall Street Journal. However, $1 million of that went to cabbies and the club lost money for the month. "You gotta remember, in our industry it’s all about the girls. So he who has the girls has the customers, and he who has the customers has the girls," Lagan philosophized during a recent investor conference call. "So it’s really a chicken and egg and which came first. The trick is keeping the girls and the customers on a platform…. The guys will always go where the girls are."

What Lagan didn’t say is that the girls are important because they pay to work. So, beyond the drinks and the cover charges and in some cases expensive meals, strip club cash flow depends first and foremost on entertainers paying to entertain. Back in the Las Vegas boom days it was $50 per shift (depending upon the time of day) and $75 or $100 during convention weeks. On top of that, dancers are expected to tip the disc jockeys, floormen and house mothers.

But the current bust means too many dances are chasing too few laps in too much square footage. "For an industry often thought to be recession proof," the WSJ’s Kris Hudson writes, "the transition has been sobering." Rick’s stock is trading below $7 and publiclytraded rival VCG Holding Corp. is trading at $2.40, a decline of 83% from its peak. And investors are not the only ones getting hammered by the softness in the bump and grind industry. The entertainers themselves are shaking their moneymakers for much less these days. Buffy, who plies her trade at Rick’s in Las Vegas told the WSJ that she is making only a quarter of what she did during the boom. However, that beats the mortgage business for Sara, who gave up making loans in the bay area, for stimulating conventioneers in her g-string at the Sapphire Gentlemen’s Club. Reportedly, "a laid-off paralegal, a laid-off fashion designer, a Bank of America banker, a former paralegal and two Los Angles real estate agents" have changed careers despite the lower returns to be had working in 8-inch heels. However, anyone who has spent time in strip clubs will tell you that obtaining reliable personal information from entertainers is problematic.

The overexpansion of the strip club business is yet another malinvestment created by the Federal Reserve’s monetary creation. As F.A. Hayek has explained, profits made through stock market or real estate appreciation in terms of money, "which do not correspond to any proportional increase of capital beyond the amount which is required to reproduce the equivalent of current income, are not income, and their use for consumption purposes must lead to a destruction of capital."

The wealth that strip club patrons and strip club moguls thought they had to throw around was but an illusion and the reality is sobering for the entertainers, cabbies, politicians and others that have been riding the strip club boom.

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