Wall Street has thrown the book at companies who manage federal, state and county prisons. The past year saw many of these stocks relegated to the slammer, losing 40 to 80 percent of their value.
But some analysts say investors in the companies that house jailbirds may be in for some good news for a change. In fact, some Wall Street experts judge prison stocks as undervalued and attractive for their growth potential. If investors are patient, they may be rewarded.
Why the downturn? Several negative factors have punished these stocks. The slowdown of state procurements, delays in federal commitments, because of contracting issues, damaging media and lack of financing have all driven stock prices down. The strong economy has also helped push the crime rate to all-time lows, even though prison populations are at all-time highs.
It’s no secret that the major companies served some hard time last year. The stock prices of both Wackenhut Corrections Corp. (New York Stock Exchange: WHC) and Cornell Companies (NYSE: CRN) lost about 60 percent of their value within the past year. Prison Realty Trust (NYSE: PZN) received the stiffest penalty: Its stock is more than 80 percent off its 52-week high.
But these companies may soon be heading up. The industry is counter-cyclical: In poor economic times, offender management companies thrive as the crime rate goes up. Analyst Howard Halpern of Taglich Brothers, Inc. in New York City believes the industry’s recent financial downturn represents an opportunity for investors to buy while prices are low.
“I’m not really sure why investors haven’t recognized the importance of what [these companies] do,” Halpern said. “The rate of growth is swelling because people are staying in jail for longer periods due to truth in sentencing and mandatory sentences.”
That translates into more profits for the companies who incarcerate criminals. Total public expenditures for incarceration currently exceed $40 billion annually, and analysts expect that prisons will be home to over 2 million inmates by 2001. These factors combined with the trend toward longer sentences and the cost savings associated with privatization spell out increased growth.
Privatized adult offender management is a $2 billion industry driven by government contracts — and competition is slim.
The industry as a whole has three segments: adult secure corrections, juvenile corrections and community corrections.
Companies do more than just manage prisons, though. Prison companies also offer construction, inmate health care, food service, education and training, and security monitoring. In the United States, only six major companies compete for the largest contracts.
In 1999, new construction and contracting guidelines conspired to create a major slowdown in the number of contracts awarded. Industry experts expect the trend to reverse this year and predict a major procurement from the Federal Bureau of Prisons as prisoner populations increase.
Recently, Wackenhut and Cornell were awarded contracts to manage prisons in Texas and in Arizona, and more are pending.
One of the industry’s biggest hurdles has been its need for capital. Offender management companies historically need $2 in capital for each $1 in revenue for privately owned prisons, and capital has been very hard to find lately, says analyst James Macdonald of Chicago-based First Analysis Securities.
That’s compounded by the fact that while 80 percent of new prison projects require private money, only 20 percent succeeded in finding that funding. Prison Realty Trust, along with its parent company, Corrections Corp. of America (CCA), controls 50 percent of the market share, but the company is troubled.
The fiasco began in 1997,when CCA got rid of its real estate assets through an initial public offering of a real estate investment trust (REIT), naming the new company CCA Prison Realty Trust. Investors loved the business structure of REITs, and the stock did very well. But CCA stock plummeted, and management decided to buy back the new company. Activist investor groups cried conflict of interest, turning the situation into the corporate equivalent of a prison riot.
Restructuring is ongoing at Prison Realty. In June, the company announced it plans to merge CCA into a wholly owned subsidiary of Prison Realty Trust and drop its REIT status. Macdonald rates the stock as a “hold,” noting that lingering questions have cast a shadow over Prison Realty Trust’s future.
The outlook for Wackenhut is better, according to Macdonald, but the company’s long-standing clean record was recently marred due to bad press over several inmate killings and other problems in New Mexico. To neutralize these problems, Wackenhut has been spending to improve operations. This, combined with higher insurance costs, has reduced earnings, which are expected to be flat in 2000. Still, Macdonald rates it as a “strong buy.”
“Wackenhut has very good management and the most financial flexibility,” Macdonald said. “It’s a very conservatively run facility, and I expect very good growth.”
Cornell Companies, which seemed to have weathered 1999 better than the rest of the companies, still faces problems. The company is fully leveraged with debt, and the shortage of capital has slowed its acquisition strategy.
However, Macdonald noted Cornell holds a $200 million portfolio of real estate that may support a sale-leaseback transaction, where it could raise capital by selling its owned property to other buyers who would then lease the property back to Cornell. Cornell also recently signed a three-year management contract in New Mexico.
Macdonald says that Cornell has good management and is smaller, so it can grow faster. He likes the fact that the company operates in several different sectors — adult, juvenile and halfway houses — so it can grow without heavy capital investment. He currently rates the company as a “strong buy.”
“On the downside, it is very highly leveraged,” he said. “On the good side, Cornell owns its own real estate and is selling at less than the value of its properties.”
Other companies involved in the corrections industry include Correctional Properties Trust (NYSE: CPV), Res-Care, Inc. (Nasdaq: RSCR) and Children’s Comprehensive Services, Inc. (Nasdaq: KIDS). Correctional Properties Trust acquires correctional and detention facilities from both private prisons and governmental organizations, forming a REIT.
Res-Care, Inc. has two divisions: one that serves the disabled and one that works with at-risk and troubled youths. Children’s Comprehensive Services and its subsidiaries work with government organizations to provide a variety of services to troubled youth.
Of the three, Macdonald believes the outlook for Correctional Properties Trust is the most favorable.
