Corrections Corp Of America And The GEO Group Inc Crash On Announcement
Canaccord Genuity analysts Ryan Meliker and Michael Kodesch might have a message for the Gates Foundation: buy stock in for profit prisons on a drawdown. The Gates Foundation was the subject of 2014 protests for its involvement in investing in prison businesses whose ethical standards were coming under fire. Other large institutional investors have shed shares of the private prison providers. Today, after the US Department of Justice announced it was phasing out use of for profit prisons, the share prices fell dramatically — but they went too far say Meliker and Kodesch.
Political reformers cheer private prison news
When the Washington Post this morning reported plans by the US Justice Department to end contracts with private prison operators, the stock prices of such operators took a tumble. GEO Group REIT (GEO), for instance, was down nearly 40% on the day, closing trading at $19.51. Corrections Corp of America (CXW) was down even more, shedding 46% of its value. Concaccord | Genuity, for its part, had a buy rating on GEO as early as August 10, looking for a $38 price target.
“Today’s announcement is a welcome move that has shaken the perverse notion of profiteering from imprisonment,” said Daniel Carrillo, Executive Director of Enlace, convener of the National Prison Divestment Campaign. “The Prison Divestment movement has pushed investors to realize that profit extracted from suffering is morally and financially a dead-end strategy. Financial backers like Wells Fargo and Bank of America are increasingly being called out for their role in investing in and lending to private prisons. The 40% drop in stock price that Corrections Corporation of America and GEO Group have seen today is the beginning of the end of prison profiteering.”
It is the last part of that statement – that today is the beginning of the end of prison profiteering – that Concaccord |Genuity disputes.
The math doesn’t add up regarding stock price drop
When looking at the stock price fall – nearly cutting valuation in half over the course of one day – Meliker and Kodesch think the math doesn’t add up.
Perhaps most material, the DoJ revenue isn’t anywhere near 40% of the firm’s overall value profile. GEO has 11% exposure to revenue loss from the DoJ move, while CXW, the hardest hit today, has only 9% revenue exposure. The plan does not impact county, state, US Marshall or ICE contracts and, unlike prison reform advocates, Meliker and Dodesh don’t think the DoJ move necessarily puts these contracts at risk.
“The massive falloffs in the stocks imply that the risk will spread to other federal, state and local jurisdictions,” the report state. “While this is possible, we believe it is unlikely. As such, we think today’s stock action is more based on fear than actual cash flow risk.”
The plan will not impact revenue in the short term, the report noted, as contracts are to be phased out as they come up for renewal, which could take as long as five years.
There is also a feasibility issue that might extend the prison facilities revenue projections.
With 157,236 federal inmates in custody as of 8/18/16, according to Bureau of Prison statistics, the report estimated that there are only 131,531 beds available. “That means that excluding the remaining 21,460 private beds, capacity would move up to 143%, which is above the federal mandate for 137.5% by almost 9,000 prisoners.” Given federal mandates the report projected that “the ability to take away beds will be much more limited than the market currently is reacting to.”
When looking at projected bed cuts, Meliker and Kodesch think that the stock to own in the group is GEO, as CWX appers that over the long term could be the harder hit of the group. This reiterates similar recommendations made August 14 when the analysts noted headline risk but thought concern was unwarranted:
The prison sector has faced headwinds as of late, as BOP reductions, family detention dynamics, and general sentencing reform dialogue have weighed on the two prison REIT names. We continue to believe the sector offers a unique blend of stable fundamentals and the potential for accretive external growth, though we also acknowledge CXW’s current risk associated with the renegotiation of a material contract, which we believe to be one-off in nature. Additionally, it is our view that while headline risk is a concern from a stock performance perspective, these are unwarranted concerns from an operating perspective. We continue to prefer GEO shares to those of CXW, driven by GEO’s lower risk to family detention, higher and safer dividend yield (8.0% vs. CXW’s 7.9%) and diversified business model.
That headline risk occurred today. While Meliker and Kodesch didn’t predict the DoJ move, the did accurately model GEO shares being more resilient than CWS. The overall message, however, is clear. Buy on a drawdown. A primary key to this thesis is trend extension. Do other governmental organizations follow suit or is the DoJ move a trend outlier? Democratic Presidential candidate Hillary Clinton, if elected, might not have positive outlook on for profit prisons either if her 2015 tweet is any indication.