Feature

 | SATURDAY, JUNE 23, 2012

Ready to Bust Out

By JONATHAN R. LAING | MORE ARTICLES BY AUTHOR

Investors haven’t warmed up to Corrections Corp. of America. But they should, especially if it becomes a real-estate investment trust.

Corrections Corp. of America isn’t exactly in a warm and fuzzy business.

In fact, it’s a private company that, in return for a fee, houses federal, state, and local criminals—some 80,000 in all of its facilities in 20 states and the District of Columbia. The company’s self-described “correctional system” is bigger than that of 47 states and all 24 Immigration and Customs Enforcement facilities combined.

The Nashville-based outfit is no favorite of civil libertarians. Many find incarceration for profit, rather than rehabilitation, repugnant. But the company, founded just 30 years ago in the Reagan administration heyday of privatization of government functions, is winning favor with investors. That’s because of its growth potential and likely plan to convert itself into a real-estate investment trust with the ability to save on taxes at the corporate level and shower rich dividends on income- hungry shareholders.

CURRENTLY TRADING BELOW $27, its stock (ticker: CXW) could hit $49 to $54 a share if the company were to convert to REIT status, according to a base-case scenario sketched out in a report filed on a value-investor Website (www.valueinvestorsclub.com).Even without such a conversion, the report estimates that the stock’s fair value ranges from $32 to $42.

The report characterizes the private corrections industry as a business with substantial barriers to entry, recession resistance, and good customer credit quality. On the last score, 45% of CCA’s revenue comes from the federal government, which, after all, can print its own money.

The company would seem to have substantial growth possibilities, even if the scandalously high U.S. prison population of 1.6 billion inmates were to decline somewhat in the years ahead because of, say, immigration reform and decriminalization of marijuana possession. For one thing, spending by the so-called private corrections industry, in which CCA is the largest player, accounts for only 10% of the estimated $74 billion spent annually on all prisons, yet private corrections boast significant cost advantages over the public-prison sector.

According to Corrections Corp., its average per diem prisoner cost of $67.08 in its owned facilities is 21.1% below the $85 for the Federal Bureau of Prisons and 52% less than California’s $140 a day. The difference arises from such factors as the company’s ability to build its facilities in areas with lower labor costs and more modest retiree benefits than those for which California’s prison guards have become notorious. In addition, CCA’s newest facilities employ designs that reduce their staffing needs.

THE COMPANY SEES RICH POTENTIALin exploiting its advantages by purchasing existing public facilities to help cash-strapped government units with both upfront cash infusions and savings on operating expenses. Late last year, CCA did its first such deal, buying the Lake Erie Corrections facility from the State of Ohio for $73 million. Corrections Corp. has contacted 48 states, earmarking about $250 million in additional funds to buy and operate other facilities. The facilities each must have at least 1,000 beds and can’t be more than 25 years old, and the contract must guarantee a 90% occupancy rate.

CCA’s stock seems expensive, based on earnings share calculated on generally accepted accounting principles. At its current price, it trades at more than 17 times the average analyst forecast of $1.56 a share for 2012.

But a fairer measure of its value, perhaps, is something of CCA’s preferred metric, called adjusted funds from operations. AFFO adds back to GAAP earnings noncash charges for facility depreciation and amortization. (Together, these added $109 million to net income of $162.5 million last year.) Then, capital expenditures to keep up the facilities are deducted. Because the prisons are made of concrete and steel, capital spending for maintenance costs are invariably far lower than the depreciation and amortization charges required under GAAP. Last year, the company’s AFFO after various tax adjustments came to $235 million, or $2.23 a share, fully diluted, resulting in a more modest price/earnings ratio of 12.1.

Over all, U.S. prisoner population growth typically flags in recessions, in part because of more early releases to hold down operating expenses. During the Great Recession of 2007 to 2009, the inmate population flat-lined at about 1.6 million; it’s dropped very slightly since.

Earlier this year, Corrections Corp.’s stock came under some pressure when California announced plans to return some 9,600 prisoners ensconced in the company’s facilities to public prisons inside the Golden State.

Barclays analyst Manav Patnaik points out, however, that this effort, if it comes to pass, would be phased in over several years and depends on several less-than-assured factors. Among them, Californians will have to approve a ballot initiative to raise taxes, and the state’s plans to transfer much of its prison population to county facilities will have to pass muster by the federal court panel that has ordered California to substantially alleviate overcrowding in the state system.

CCA has plenty of excess inventory—some 12,000 empty prison beds, plus any losses from the California transfer—to offer to various state and federal prison systems. So its capital spending figures to be negligible over the near term. The company is counting on better economic times, population growth of 19 million over the next five years, and the old standby of recidivism to keep prison head counts growing, filling its empty beds.

MEANWHILE, THERE ARE increasing signs that Corrections Corp. plans to convert into a REIT. Earlier this year, two activist hedge funds, Corvex Management and Marcato Capital Management, filed a 13-D with the Securities and Exchange commission, disclosing their 7.6% ownership of the stock and recommending such a shift in the company’s corporate structure.

REIT stocks with characteristics similar to Corrections Corp.’s generally trade for a price/AFFO ratio of nearly 22, compared with the company’s current ratio of 12.1.

In short, as a REIT, Corrections Corp. would disprove an old adage. Crime can pay…at least for investors. 

Comments: 

09:58 am ET June 23, 2012

Nancy wrote:

Please read the brilliant investigative series in the NYT this week on Community Education Centers, Orwell-speak for privatized prison in NJ. Let’s also recall the judge in PA who took over $1 million in bribes to pu children in a for-profit juvenile detention center.

The very notion of privatizing the an element of the delivery of justice in America is repugnant.

10:05 am ET June 23, 2012

Jim wrote:

I don’t have a “hippie” portfolio — I will take whatever makes me money. But even I will draw a line: CXW is a disgustingly immoral company that lobbies for tougher prison sentences for non-violent crimes as a way of increasing its customer base. Yes, tobacco companies advertise for the same reason, and lobby against taxes. But there’s something so squalid about putting people in jail for victimless crimes…for money. I won’t touch it.

Stephen  wrote:

In the continuous myth that the private sector does everything so much better than the government, privately run prisons are the more egregious exploiters of the general public’s naivete. When the private prisons can cherry pick the nations’ throwaways (the lowest level offenders with no history of physical or mental illness) and run institutions with low paid staff with virtually no training in corrections, it’s small wonder the privately run outfits like CCA and Wackenhut earn a profit. No, I am no bleeding heart liberal – I worked for the CA Dept of Corrections as an educator for the better part of 7 years. Those who did the crime must do the time. (I won’t digress into what, if any, benefits are derived by incarcerating users of drugs). There are incorrigibles who should be and should stay in prison, but the privately run institutions that supposedly do things better and less expensively than those run by the states and feds, have neither the desire nor the wherewithal to cope with the nation’s predators. The New York Times recent expose about the Bo Robinson halfway house is just yet another example of exploitation of the American taxpayer. And,of course the so called “security” industry can flagrantly get away with this because for the majority of the American public, inmates once out of sight are out of mind. I wholeheartedly agree with Mr. Chubb that profiting from the incarceration of others is reprehensible and morally repugnant.

10:25 pm ET June 24, 2012

William replied:

If a state government builds a new prison, and floats a state muni bond to pay for the construction, are the purchasers of those muni bonds reprehensible and morally repugnant for profiting from the incarceration of others when they collect their interest payments? I agree with everything else that Stephen Thomas says, but I don’t understand why he feels so strongly about private sector funding and employment versus government funding and employment in the case of the lowest level offenders.