New Exposure for Hedge Funds: Strip Joints

Hedge funds have stepped in to a onetime Mob province: financing strip joints.
Publish date:

It's the return of Wall Street's go-go years.

Slowly but surely, hedge funds with cash to burn are breaking with Wall Street's longstanding reluctance to finance the adult entertainment industry and becoming bankers to upscale strip joints.

Rick's Cabaret International

(RICK) - Get Report

, the operator of strip clubs in a half-dozen cities, including a soon-to-be completed club in midtown Manhattan, is talking to a number of hedge funds about raising additional financing. Last year,

VCG Holding


, another national strip club company, turned to Iroquois Capital, Omicron Capital and a subsidiary of Downsview Capital, three midsized hedge funds, to help finance the purchase of a $6 million club in Denver.

There are even rumblings that a multibillion dollar hedge fund in New York is lender to several Hustler Clubs, the chain of strip joints opened by Larry Flynt, one of the nation's best-known porn promulgators.

James Chamberlin, chief financial officer for

LFP Inc.

, the corporate name for Flynt's company, says he couldn't comment on any financing deals involving the Hustler Clubs, because each strip joint is an independently owned franchise that merely licenses the Hustler name. But Chamberlin say he has been talking to several hedge funds about raising $25 million to finance the national expansion of retail stores owned and operated by Flynt's company.

"I'm actively looking to put a deal together," says Chamberlin. "We are the Nieman Marcus of adult stores."

Eric Langan, chief executive of Houston-based Rick's, says the company is in active discussions with Iroquois Capital, a small fund run by Joshua Silverman, about a financing deal. Langan says he's also had past discussions with Laurus Funds, a $1 billion New York hedge fund run by Eugene and David Grin.

All the hedge funds either declined to comment or didn't return telephone calls.

The move by hedge funds into the world of adult entertainment comes at a time that these investment vehicles for the rich are increasingly supplanting Wall Street banks in providing financing and capital to start-ups and midsized businesses.

Nowadays, hedge funds are providing financing to everyone from struggling retail chains to aggregators of surplus life insurance policies.

Of course, Wall Street historically has kept its distance from the skin business, at least as a financier.

Even though the securities industry has been tarnished by a number of high-profile sexual harassment lawsuits over the past decade, stories of brokers and raucous parities with strippers still abound. Raunchy jokes haven't quite been banished from the trading desks of Wall Street firms.

In one of the most notorious incidents involving Wall Street and the porn industry, James McDermott, the former chief executive officer of investment banking firm

Keefe Bruyette & Woods

, pleaded guilty in 2001 of passing along stock tips his porn-star mistress.

Still, Wall Street has been chary of investing big bucks in adult entertainment, even though it's estimated that Americans spend about $10 billion a year on porn-related businesses.

For instance, the largest institutional investor in Rick's, as of March 31, was Calpers. The big California public pension fund owned a whopping 4,000 shares.

The stocks of most publicly traded sex businesses have been failures. Shares of Rick's, VCG and Scores, another upscale strip club with two locations in New York, all trade for under $3. The parent company of


magazine filed for bankruptcy in 2004. Shares of

Playboy Enterprises


, which once traded around $70, now cost $13.

The major exception to Wall Street's hands-off policy regardingsex-related business is

New Frontier Media


, a Colorado-based satellite and cable broadcaster of erotic movies. About two-thirds of the company's stock is held by institutional investors, including



Morgan Stanley

and Steel Partners, a $3 billion hedge fund.

As of June 6 filing, Steel Partner, managed by Warren Lichtenstein, owns12.7% of New Frontier's outstanding shares. Over the past month, SteelPartners has been aggressively adding to its position in the company.

In the vast majority of cases, however, Wall Street's reluctance to invest in adult businesses has meant strip clubs have had to turn to wealthy individuals, community banks, private finance firms and even mobsters to raise cash. But with so many hedge funds looking for places to put their money, the adult entertainment industry is beginning to find new investors.

"At one time, people didn't want to invest in cigarettes, but you can make a lot of money in cigarettes. The perception is changing," says Jon Dangar, the investment banker with

Westminster Securities

, the small securities firm that arranged the VCG financing.

But the change is coming in small steps. The VCG deal, for instance, raised just $1.25 million. The small size of the deals indicates hedge funds aren't yet willing to put too much at risk.

VCG's money came via a PIPE, which is short for private investment in public equity. PIPE deals are popular with hedge funds because the investors often buy notes that are convertible into stock at discounted prices. In the VCG transaction, the hedge funds bought notes with a 12% coupon that were convertible into stock at a price of $2 a share. At the time, that represented a 43% discount to the company's stock price.

Some hedge funds are demanding even better terms. Langan, the CEO of Rick's, says he decided against doing a deal with Laurus because the terms the hedge fund demanded were "too onerous" and the company isn't desperate for money.

Omnicron, Laurus and Downsview are three of the biggest investors in the $14 billion a year PIPEs market, according to PlacementTracker, an investment research firm.

Laurus, which has become a leading financier to cash-strapped publicly traded companies, last year helped Bob Guccione, the founder and former editor of


, stave off eviction from his 30-room Manhattan townhouse. Laurus provided Guccione with $24 million to pay off the creditors, which included affiliates of

Merrill Lynch


Deutsche Bank

, according to public filings.

The terms on the Laurus loan are steep. The minimum interest rate on the three-year convertible note ranges from a minimum of 7.5% to a maximum of 13.5%. Monthly payments began at $200,000 but quickly escalated to $400,000.

To some degree, the adult entertainment businesses see the burden as the cost of doing business and gaining a degree of acceptance from Wall Street.

"I'm going to find the right kind of partner with a hedge fund," says Hustler's Chamberlin. "The traditional banks aren't the right place to go."