Prison Demographics Bode Well for Money Stock
by Dan Burrows
http://www.smartmoney.com/undertheradar/index.cfm?story=20070226
Here's prison-capitalization stocks that are making big moves on Wall Street.
Like license plates, shivs and pruno, there's money to be made in prison. Just ask
investors in Geo Group (GEO: 46.21, -0.69, -1.5%), who've seen their stakes in the
private jailer more than triple in value in the past year. A breakout as brazen as
that might have some investors thinking about locking in profits, but the prison
business, sad to say, is booming, and Geo Group looks to have secured its place in
the yard.
Geo Group, of Boca Raton, Fla., operates in the shadow of Corrections Corp. of
America (CXW: 52.20, -0.23, -0.4%), the nation's largest publicly traded prison
company, but its share performance for the trailing 12 months has been second to
none, jumping to $48.35 as of Friday's close from $15, including a 3-for-2 split on
Oct. 2. That outshines Correction Corp.'s 85% gain for the same period and clobbers
the small-cap benchmark Russell 2000 index's 13% rise.
The proximate cause for Geo Group's pumped up stock price is that the company keeps
raising guidance, pummeling Wall Street's estimates and moving past analysts' price
targets. Geo Group has beaten the Street for six consecutive quarters. Last week, it
said fourth-quarter earnings, to be reported Tuesday, will also come in better than
expected. Geo Group now sees its most recent quarter producing pro-forma earnings of
51 to 53 cents a share, 10 cents higher than its previous forecast. Analysts, on
average, were looking for 43 cents, but have since lifted their own view to 51 cents,
according to Thomson Financial. Geo Group said revenue should come in at $242 million
to $247 million, up from its prior view of $237 million to $242 million.
There are a couple of factors behind those results, and observers say neither should
abate anytime soon. Sure, Geo Group benefited handsomely from the November 2005
acquisition of Correctional Services Corp., but the company is also enjoying sky-high
average occupancy rates (standing at 98% by third-quarter's end), new contract wins
and better contract terms. Perhaps more important, there's a severe shortage of
prison space in the country, leaving states and the federal government with no choice
but to outsource incarceration to nimbler, and cheaper, private concerns.
As for Geo Group specifically, the company has a number of advantages, including
experience and management talent. "To some extent building prisons is like real
estate development," says Robert Wasserman, an analyst with New York investment bank
Jesup & Lamont. "You have to know how to get all the permits and you have to know how
to build everything and do it correctly. Sometimes you have NIMBY [not in my
backyard] situations that have to be dealt with. Geo Group has been doing this a long
time and they have the relationships."
Robert Sullivan, manager of Satuit Capital Micro Cap fund (SATMX:
26.12, -0.99, -3.7%), was forced to sell the fund's position when Geo Group's market
cap exceeded the fund's $500 million threshold, but says he still thinks it's a great
company, partly because of how well it's run. Geo Group's current market cap is $934
million.
"After you talk to management a couple of times you find out that these guys are
really solid operators," Sullivan says. "To be able to bid successfully on a contract
and then to be able to manage the facility, and then to be able to drive the margins
to make it more profitable to actually generate cash flow, that's a pretty big
undertaking for this kind of an industry."
But it's the severe shortage of prison space and the climbing prison population that
make the best case for Geo Group going forward. There are currently 2.2 million
people behind bars in the U.S. More than 7% of them are held in the type of privately
run facilities built and operated by Geo Group, which has about 30% of the market,
according to Patrick Swindle, an analyst with Avondale Partners, the Nashville,
Tenn., investment bank. "It's difficult for me to see an environment where we don't
grow the aggregate inmate population between 1.5% and 2% each year," Swindle says.
That jibes with a new report from the Pew Charitable Trusts that the prison
population will grow 13% by 2011, and that construction of new prison beds will cost
as much as $12.5 billion. That kind of burden will likely force states and the
federal government to outsource even more. It's simple mathematics, Swindle says:
"With construction costs having doubled over the last four-and-a-half years, the
private sector today can build for typically $60,000 per bed. States would build at
some price north of $75,000 to $80,000 per bed. The federal government builds at
north of $100,000 per bed."
Consistent public policy with tougher, mandatory sentences was already straining the
country's jail cells. Now the Department of Homeland Security's Border Initiative and
its detention of undocumented immigrants has further burdened the system. "The story
is very simple: There are too few prison beds," says Swindle, who has a Market
Outperform rating and $55 price target on Geo Group's stock.
One caveat: The prison industry has gone through a period of boom and bust before. In
the 1990s the private sector was building beds very quickly, inmate population growth
slowed, and by the end of the decade there was too much supply. By 2001 the beds that
were started in the late '90s were finished and filled. So, as in any industry, there
are certainly cycles of which to be mindful.
But Jamie Cuellar, co-manager of the Brazos Micro Cap fund (BJMIX:
21.55, -0.96, -4.2%), which first took a position in Geo Group in September, said the
prospects look good in the near- and medium-term, at least. "These are typically long
cycles," Cuellar says. "And the amount of debt the prison companies are carrying on
their balance sheets right now is sort of regulating a little bit how much capacity
they can add." At the end of the third quarter Geo Group was carrying about $267
million in debt, down from about $350 million at the beginning of 2006.
While Geo Group's stock has enjoyed a steep run-up over the past year, and it looks
expensive by some measures, the tremendous industry fundamentals are tough to ignore.
So too is Geo Group's auxiliary business of running residential treatment facilities.
A five-year deal signed last week with the state of Florida to operate a 175-bed
mental-health center is expected to add $14.5 million to the top line this year and
$21 million in 2008. For the third quarter, Geo Care's total revenue more than
doubled to $19.8 million from $8.3 million.
That revenue stream could prop up Geo Group when the prison-building cycle turns
south. Avondale's Swindle thinks the company's Geo Care business, where states
outsource their mental health, substance abuse and health-care services to the firm,
could reasonably double over the next three years. "These are predominantly very old
state facilities, many of which need to be replaced," says Swindle. "Geo Care is a
first mover in a space that was not previously privatized. That business is really
beginning to get its legs."
There's another bright side to the somewhat dark prospect of owning shares in a
company that's bread and water, er, butter, is prisons: They have a defensive aspect.
As Cuellar points out, they're almost counter-cyclical to the broader economy. "When
times are bad, more people tend to go to jail," says Cuellar. "It's awful, but it's
true."
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I intend to last long enough to put out of business all *****-suckers
and other beneficiaries of the institutionalized slavery and genocide.
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"The army that will defeat terrorism doesn't wear uniforms, or drive
Humvees, or calls in air-strikes. It doesn't have a high command, or
high security, or a high budget. The army that can defeat terrorism
does battle quietly, clearing minefields and vaccinating children. It
undermines military dictatorships and military lobbyists. It subverts
sweatshops and special interests.Where people feel powerless, it
helps them organize for change, and where people are powerful, it
reminds them of their responsibility." ~~~~ Author Unknown ~~~~
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