| 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.
While the nation’s prison population may stagnate or decline, a greater percentage of inmates is likely to do time in a facility run by a for-profit company.
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.
The Bottom Line
Corrections Corp. shares, now below $27, could hit at least $32 in a year, given the company’s business outlook. They could be worth $49 or more if CCA becomes a REIT.
Corrections Corp. wouldn’t discuss its possible conversion with Barron’s, and declined to make its CEO, former Kansas prison guard Damon Hininger, available for an interview. But transforming itself into a REIT should appeal to a management team that has shown itself to be shareholder-friendly, with well-timed stock buybacks and the recent institution of an 80-cents-a-share annual dividend. As a REIT—something that makes sense, given its extensive property holdings—CCA would save about $75 million a year in taxes and be able to triple its dividend payout to shareholders to more than $2.55 a share, according to one estimate. (By law, REITs must pass at least 90% of their otherwise taxable income to shareholders.)
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.
09:58 am ET June 23, 2012
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
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.
There are multiple flaws in the analysis of making CXW into a REIT. The first is it once was a REIT and nearly went bankrupt within 6-9 months as a result. Its contracts renew every 1-3 years and states and cities did not like signing deals with a company that was paying out over 90% of its earnings – creating fears of cutting corners and having a lack of capital to sustain itself. In fact, within 6 months of becoming a REIT, CXW could not get a bond offering completed.
Second, the cost comparison is flawed. It compares the cost of essentially watching a death row inmate with someone who failed to pay traffic fines and is serving 6-months or was caught with 3 joints as their 3rd strike. Apples to apples, many states have found that CXW does not save them any money. On top of that, because states have unions involved, they are paying unions whether they watch prisoners or watch TV. So, CXW is the overflow prison guard. If a state has facilities and union guards to watch 80,000 prisoners, they fill those first. If they have 95,000 prisoners, CXW gets 15,000 but a drop back to 90,000 means CXW loses one-third of its population.
The number of people in prison has been dropping for years. The aging population works against crime rates, which also have been falling for years. 70-year olds do not steal cars. States have also learned that it is much cheaper to not put someone in prison than outsource. Fines, probation, house arrest are being used.
12:26 pm ET June 23, 2012
States have been cutting prisoners for some time and have cut payments to CXW for items like job training, haircuts, and drug treatment for prisoners. Federal prisoners from illegal immigrants filled the gap for a short time. However many illegals left during the recession and illegals are not held for long periods of time. These numbers are starting to drop too.
That means CXW will be a REIT with rising vacancy and a lower cash flow per prisoner. They are already seeing enough empty beds to close facilities. The bad part of a prison is what can be done with the empty space? It cannot become a Burger King or Nordstrom. CXW has to just run the fixed costs over fewer customers and see cash flow fall. Then, what is the real estate worth? It is in the middle of nowhere (150-200 miles from a reasonably large town) and is a steel and concrete building. Few people live nearby, they are seldom even near interstates – there is no terminal value for this stuff. Just like there are closed schools, post offices, and gas stations no one wanted in the rest belt and thus were not sold – who would ever buy one of these prisons? The real estate value is falling with lower cash flows and has no terminal value.
Contracts up for renewal are coming in at lower prices as CXW competes against GEO and state prison systems who will take in outsourced prisoners. Renewals happen all the time to speed the cash flow drop. This is a business in long-term decay.
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.