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Corrections Corporation of America Message Board

  • pdi7 pdi7 Jun 6, 1999 12:17 PM Flag

    PZN Shareholders

    May 04, 1999
    PRISONS: WHY THEY'RE SECURE
    INVESTMENTS
    Bob Hirschfeld

    Earlier this spring, the
    Department of Justice released a sobering statistic: 1.8
    million Americans were behind bars at the end of 1998.
    That translates to one in every 150 citizens being
    behind bars, a rate only exceeded by Russia and South
    Africa.

    The decade-long surge in the prison
    population is the result of stricter sentencing guidelines.
    At the end of 1997, federal prisons were at 119% of
    capacity and state-run prisons at 115% of capacity,
    according to J.C. Bradford's Michael Hughes.


    Overcrowding, though, has been a boon to private operators of
    prisons, which now house 4% of the entire inmate
    population. 119,000 private beds are currently outsourced
    from the Government through 145 privately managed
    secure correctional facilities in the U.S.

    Cost
    Savings

    The basic appeal is cost savings. Private
    systems, according to the Center for Policy Analysis, save
    20% on construction and 5%-15% on operations, matters
    of no small appeal to budget-conscious states.
    Public and private advocates debate the cost benefits:
    the State of Texas figures that it saves $9.50 a day
    per inmate when it turns prisoners over to private
    operators. (The comparison, though, is not apples to apples,
    as the state has the costly task of housing all
    maximum-security prisoners).

    In all, 33 states use private
    adult corrections facilities. Texas leads the way with
    43 different sites. California, with 24 facilities,
    has also moved aggressively to outsource its prison
    business. The trend has not caught on as quickly east of
    the Mississippi, thanks to stiff opposition from
    labor unions and law-enforcement officials in those
    areas, says Bradford's Hughes.

    In 1996,
    sociologist Charles Logan compared the quality of confinement
    in public and private prisons, and found that
    inmates prefer state prisons, while staff prefer private
    facilities. The tighter security of private facilities
    strongly appeals to staff.

    Background

    Over
    60% of inmates in the Federal system are doing time
    for drug violations, triple the rate of 15 years ago,
    according to the New York Times (in state and local, the
    number is 22%). During the 1980s, Congress and state
    houses passed laws requiring judges to issue mandatory
    minimum sentences that would put drug offenders, even
    first-timers, behind bars.

    Crime has dropped
    precipitously in recent years, yet the inmate population
    continues to swell. 'We've got crime going in one direction
    and social policy going in the other,' says Dr. Allen
    Beck, a statistician with the Department of Justice.


    Private prisons are not a new concept. In the mid-1800s,
    states awarded contracts to private entrepreneurs to
    operate several facilities including New York's Auburn
    and Sing Sing penitentiaries. But allegations of
    prisoner abuse, and the inappropriate use of convict labor
    put an end to that era of private prisons.


    Corrections Corporation of America, which entered the market
    in 1984, was heavily criticized for allegedly
    understaffing its Youngstown, Ohio, facility. Though initially
    licensed as a medium-security prison, the company later
    transported in hardened, out-of-state criminals, including an
    estimated 600 murderers. Numerous stabbings and a pair of
    murders resulted. The furor prompted new legislation
    specifically requiring the Youngstown prison to limit its
    population to medium security inmates.

    Adding
    concern: Ohio, Tennessee, and Texas have enacted or are
    considering enacting legislation to control private prisons.
    One possible regulation: prohibiting out-of-state
    inmates above the level of medium security. Another
    concern: Prohibiting private prison operators from
    speculative prison building, in which the private concerns
    builds a prison, then fills it with (often times out of
    state) inmates.

    At the Federal level, a bill was
    introduced in March to prohibit Federal inmates

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    • Trends

      As a backdrop to all of the
      regulatory turmoil, several industry trends have quietly
      taken hold. For starters, REITs, or Real Estate
      Investment Trusts, are taking a greater role. Government(s)
      are choosing to offload the capital investment for
      new prison construction onto the private sector,
      notes Bradford's Hughes.

      In addition, the
      market for facilities that house juveniles is swelling
      rapidly, and has historically been a greater focus of
      private operators. About 40% of juveniles in custody are
      held in privately run facilities (though these are
      often not-for-profits), versus abut 5% of adults in
      custody.

      The Private Players

      Prison Realty
      Trust (NYSE:PZN - news) is the largest private prison
      company, with 56% of the market. Prison Realty merged with
      the management arm of Corrections Corporation of
      America this past January 1999, in a $2.88 billion stock
      swap. Wackenhut Corrections (NYSE:WHC - news) is the
      second largest player with about a 21% share, followed
      by privately-held Ogden. Correctional Services
      (NASDAQ:CSCQ - news) , which controls 5.8% of the market,
      merged with Youth Services International (NASDAQ:YSII -
      news) in March. Cornell Corrections (NYSE:CRN - news)
      holds a 5.6% share.

      Given its cost advantages,
      private sector prison growth is all but assured. Hughes
      projects growth of 20,000 to 24,000 beds per year going
      forward, adding that 'this type of bed growth should help
      most of the publicly traded companies sustain 20%-plus
      earnings growth over the next four to five years.'


      Recent Performance

      Bradford's Hughes has
      developed a private corrections index based on the
      performance of six publicly traded companies. Since the
      beginning of 1998 through the end of March, the JCB index
      fell by about 15%, underperforming both the S&P 400
      and the Russell 2000. Prior to that time frame,
      corrections stocks had appreciated smartly.

      But the
      lackluster performance of these stocks masks continued
      strong growth of the sector. According to Brian
      Ruttenbur, of Sun Trust Equitable Securities, the adult
      segment of private corrections is expanding at 20% per
      year, and the youth segment at 30%. Overall prison bed
      growth is only about 4%-5%, indicating that the move to
      privatize will continue.

      Given the efficiencies of
      the companies, bottom-line growth should expand more
      quickly. In a nutshell, huge top-line growth and highly
      efficient operations make the business model of the entire
      industry highly attractive.

      What's more, current
      valuations are attractive, given that most corrections
      stocks have 'corrected' and now trade at serious
      discounts to the market multiple. PEG ratios (a ratio that
      measures PE ratios in relation to the company's core
      earnings growth rate), for instance, are low both on an
      absolute and historical basis. Given the
      recession-resistant nature of the business and above-average earnings
      growth, many analysts argue that such severe discounts
      are unwarranted.

      Last fall, shares for the
      industry players started to come back. In the fourth
      quarter, the average correctional services stock gained
      over 30%. But shares gave back many of those gains in
      the first quarter of 1999. Correctional Services sold
      off over 30% on news of its merger with Youth
      Services International. Wackenhut Corrections declined
      over 30% on disappointing fourth quarter top line
      results. Shares of prison REITs also fared poorly: Prison
      Realty was down 12.5% and Correctional Properties Trust
      was off 17%.

      Bottom Line:

      Private
      corrections is an undervalued industry with virtually assured
      growth that plays to the theme of privatization and to
      the nations' appalling increases in prisoner
      population.

      Oh what a difference a month makes

 
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