Naeem — Making Money on Detention

Topic(s): Prisons | Comments Off on Naeem — Making Money on Detention

Corrections Corp. Breaks Out
Shares in the private-sector detention company have surged, thanks to a growing inmate population
Crime may not pay, but punishment has been doing pretty well lately. Shares in Corrections Corp. of America (CXW) recently touched a 52-week high of $52.45, and the stock was up 13.6% for the year at the close on June 1. A growing U.S. prison population suggests the Nashville-based company can continue to deliver solid profits.
Corrections Corp. is the biggest domestic player in the burgeoning private-sector detention business. The company runs 63 prison facilities in 19 states and Washington, D.C., with bed capacity for 71,000 inmates. In 2005, the company brought in a profit of $70.9 million, a 22.9% increase from 2004, on revenues of $1.19 billion. “We’ve never seen the wind at our back like it is today,” Chief Executive John Ferguson said in a May 3 conference call.
LOTS OF COTS. Certainly, the forces of supply and demand are working in the company’s favor. State and federal authorities are projected to seek 21,600 beds in the private corrections sector in the next two years, but only 13,450 beds are currently available, according to Bank of America analyst T.C. Robillard, who has a buy rating on the stock. Corrections Corp. “is the best-positioned company to benefit from the supply imbalance within the correction industry,” Robillard wrote in a May 3 report. (Bank of America has led or co-led an offering of securities for Corrections Corp. and has received compensation from the company for investment banking services.)
On May 3, Corrections Corp. posted a $21.3 million first-quarter profit, after a loss of $8.9 million for the same period a year earlier. Management also raised its full-year profit outlook 2006 by 10 cents, to a range of $2.20 to $2.27 per share. Shares surged to a 52-week high of $49.38. They went on to hit their most recent one-year peak on May 23.
Share prices have since eased, to $51.08, down 2.6% from their zenith. On May 30, shares dropped as low as $50.19 on the news that the Federal Bureau of Prisons awarded a contract for the housing of 1,200 low-security inmates to a competing bidder. Despite the setback, Corrections Corp. reaffirmed its outlook for 2006. “Although psychologically disappointing on the margin, there is no change to our estimates,” wrote Avondale Partners senior analyst Patrick Swindle in a May 30 report, reiterating an outperform rating. (Avondale has received compensation for investment banking services from Corrections Corp.)
FOREIGN INFLUX. Political trends suggest the jailhouse stock’s blues might not last long. White House and congressional immigration reform efforts call for more prison space to accommodate illegal aliens from countries other than Mexico. Currently, these immigrants are subject to a “catch-and-release” program. “Part of our strategy is to end catch-and-release by expanding the number of beds in detention facilities along the border,” President George W. Bush said June 1 before the U.S. Chamber of Commerce (see BW Online, 05/16/06, “Huddled Masses, Tricky Politics”).
Faced with budget crunches, authorities will probably get those extra prison beds from privately run corrections outfits. State and federal governments currently outsource 6.7% of prisoners to the private sector, a figure expected to reach 7% by the end of 2008, according a Mar. 30 report by Bank of America, which estimates the private corrections market at $3.6 billion of the $53.1 billion total domestic corrections market. “The private sector is in a position to provide beds at an incrementally lower cost than either the state or the federal government can provide those same beds,” Avondale’s Swindle says.
Corrections Corp. isn’t the prison industry’s only breakout stock. On June 1, Houston-based Cornell (CRN) reached a 52-week high of $16.36, up 18.4% on the year. Boca Raton (Fla.)-based Geo Group (GGI) finished the day at $38.32, up 67.1% on the year but down from a 52-week high of $41.40 reached on May 23.
PLANNING AHEAD. Nevertheless, Corrections Corp.’s size and cash flow give it an advantage over rivals, analysts say. “What they do that’s different from the other companies out there is effectively use their balance sheet and build ahead of demand,” says Jim Macdonald, a managing director at First Analysis. “Other companies tend to operate at 100% occupancy, and they would tend to build a facility after they have a contract.” (First Analysis has managed or co-managed a public offering of securities for Corrections Corp., and Macdonald has a long position in the company’s stock).
Building prisons before knowing for sure that there will be inmates isn’t as risky as it may sound, others say. “It’s not a purely speculative build,” Swindle says. “They have a pretty clear expectation of who the customer will likely be for that facility.”
As a prison operator, however, Corrections Corp. faces other risks to its share price. One is the chance that abuse or other events at its facilities will make the news. In 2000, Amnesty International cited “reports of torture and ill-treatment” at Corrections Corp. facilities. The company has disputed those allegations. Corrections Corp. “has never in its history lost a federal state or local contract due to performance issues,” says Louise Gilchrist, vice-president of marketing and communications at the company. “They would not rely on a contracted vendor if there was any issue about the quality of our performance.”
“SOCIAL INJURY.” Earlier this year, Yale University’s Graduate & Employees Student Organization, a labor union, pushed for Yale to divest its interest in the company, held in a hedge fund. Correction Corp.’s “pursuit of profit through incarceration inherently leads to social injury.” Hedge fund Farallon Capital Management sold its stake in Corrections Corp. during the quarter ended Mar. 31, according to filings with the Securities & Exchange Commission. Yale spokesperson Tom Conroy says that unlike the university’s recent move to divest from Sudan, Yale “did not make any decision” itself to sell out of Corrections Corp.
Another hurdle for Corrections Corp. is the uncertain timing of contract awards. Government time frames can be difficult to pin down, analysts say. “Predicting the timing of contract awards is next to impossible, but it is also highly improbable, in our opinion, that [Corrections Corp.] will not benefit in a big way over the next three to five years,” writes BB&T Capital Markets analyst Barry Stouffer, who has a buy rating on the stock. (BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Corrections Corp.)
HOW MUCH UPSIDE? It also remains to be seen whether the stock can continue its climb. At least one analyst points out that the stock already reflects the positive trends. “Typically, this industry has not traded much above 15 times earnings,” says First Analysis’s Macdonald. “The stock price is probably justified, but I’m not sure the upside is there.”
Other analysts maintain that Corrections Corp. is poised for further gains. “We continue to view the shares as attractively priced,” wrote Jefferies & Co. analyst Anton Hie in a May 3 report. Hie has a buy on the stock and a target price of $55. (Jefferies acted as a co-manager on a high-yield offering for Corrections Corp. in January, 2006.) Analyst projections range as high as a $65 target price at Bank of America. If the stock continues its run, investors might just be tempted to lock up profits.