NEW YORK--(BUSINESS WIRE)--
Fitch Ratings assigns a 'BB+' rating to Correction Corporation of America's (CCA) proposed $675 million senior unsecured notes due 2020 and 2023, and a 'BBB-' to the amended revolving credit facility. CCA's Issuer Default Rating (IDR) is 'BB+' and the Rating Outlook is Stable.
The new bond issuance and upsized revolver are a result of the company's conversion (effective Jan. 1, 2013) from a C-Corp to a REIT with a Taxable REIT Subsidiary structure.
Proceeds from the issuance will be used to refinance $465 million of outstanding 7.75% senior notes due 2017, to pay the cash portion of an E&P (earnings & profits) dividend, and for roughly $70 million in other costs associated with the transaction and REIT conversion.
For lenders that agree to the amend & extend terms, the existing revolving credit facility is being extended to a December 2017 expiration from 2016 and upsized to as much as $900 million from $785 million, which will provide additional liquidity to offset the weaker free cash flow (FCF) profile. The amended credit facility will have a $100 million accordion feature.
KEY RATING DRIVERS
The REIT conversion does not place pressure on the ratings or Rating Outlook, as discussed in Fitch's rating comment on Jan. 31, 2013, available at www.fitchratings.com. However, Fitch does view CCA's REIT conversion as a slight negative from a credit perspective, driven primarily by the requirement to distribute at least 90% of taxable income to shareholders per regulations governing REITs. Fitch estimates the increased dividends will more than offset the potential tax savings and deteriorate the FCF profile by roughly $90 million as compared to the company pre-REIT conversion.
While this will restrain the company's ability to build more than one new correctional facility per year with FCF, management has increased its internal minimum liquidity threshold, which mitigates the increased reliance on consistent capital market access to grow and refinance indebtedness.
CCA will retain a strong financial profile in Fitch's view, as total leverage will increase to around 3x pro forma for the new issuance (from 2.5x), in line with prior expectations. Leverage through the secured credit facility at Dec. 31, 2012 will remain neutral at 1.5x, but it increases to roughly 2x on a fully drawn basis (from 1.8x) if the amend & extend is fully executed, given the upsized commitment.
At Dec. 31, 2012, Fitch calculated funds from operations (FFO) less maintenance capex of roughly $237 million for CCA and expects this to increase sizably for 2013 by roughly $50 million-$55 million, reflecting tax savings from the REIT conversion, partially offset by a slight decline in EBITDA. On a forward-run rate basis, this results in roughly $290 million-$300 million of annual FFO less maintenance capex.
This strong and stable stream of cash flow will be used to support the large recurring dividend commitments, which Fitch estimates to be roughly $215 million-$220 million on a run rate basis going forward (excluding the one-time E&P distribution). It should also be able to support fluctuations in accounts receivable, as well as other discretionary items including some prison construction, share repurchases, additional dividends, and/or paying down the balance on the revolver ($655 million at Dec. 31, 2012).
CCA's debt maturity profile is attractive. The only debt in the pro forma capital structure consists of $655 million on the revolver whose December 2016 maturity will be pushed out to December 2017 (if the amend & extend is fully executed), and the proposed $675 million of unsecured notes due 2020 and 2023.
The secured credit facility is rated 'BBB-', one notch above the IDR. CCA's accounts receivables are pledged as collateral, which totaled $252 million as of Dec. 31, 2012. Equity in the company's domestic operating subsidiaries and 65% of international subs is also pledged as collateral, but long-term fixed assets are not pledged.
The secured debt market for prisons remains undeveloped and is unlikely to become as deep as that for other commercial real estate asset classes, weakening the contingent liquidity provided by CCA's unencumbered asset pool. Fitch would view more positively an increase in institutional secured lender interest for prisons through business cycles, as this increase would mitigate the reduced financial flexibility stemming from the conversion. Fitch expects that the company will retain strong access to capital via the unsecured bank, bond and equity markets, given Fitch's expectation for strong credit metrics that are supported by the niche property type's stable cash flows derived from providing essential governmental services.
Following the conversion to REIT status with a TRS structure, Fitch continues to expect the company will manage leverage to around 3x when allocating capital toward additional share repurchases and/ or dividends.
The 'BB+' IDR incorporates CCA's financial policies, including the willingness to increase leverage to a cap of around 4x that would only be reached via opportunistic growth investments such as facility acquisitions and/or construction of multiple facilities in a relatively short period of time. The timing of such growth opportunities is difficult to predict, returns on capital have been attractive, and its main competitor (GEO) is more highly leveraged, all of which support the potential for leverage to increase.
In the event leverage were to increase to the 4x range due to growth opportunities, Fitch expects that discretionary capital allocation policies would shift toward reducing leverage to around 3x within a relatively short period. However, the reduced FCF profile from the REIT conversion will limit the company's ability to deleverage quickly, so the timing of any deleveraging could be influenced by its willingness to issue equity to partially fund any growth opportunities.
Additionally, CCA has increased its internal minimum liquidity threshold as noted above. Fitch expects the company to manage liquidity to this higher level, which gives it ample flexibility to potentially build multiple facilities simultaneously, offsetting its weaker pro forma FCF profile.
Solid Secular Credit Factors and Competitive Position
The 'BB+' IDR considers the industry structure and other credit characteristics of private correctional facilities, which Fitch believes will remain attractive for the long term, as described more fully in the January comment.
A lingering concern has been the concentration of the company's customers, which is exemplified by ongoing uncertainty regarding contracts with the California Department of Corrections and Rehabilitation (CDCR). CDCR made up 12% of total revenue for 2012, and revenue will be under pressure in the coming years, depending on the pace of successful implementation of changes proposed in California's corrections realignment program and whether or not federal judges uphold their prior rulings centered on CDCR prison population reduction. Fitch's base case assumes material declines in business from California, but there is ample cushion for operating declines within the context of the 'BB+' IDR.
Limited Real Estate Value
Based on a cost of $60,000 per bed, the replacement cost of the company's 47 facilities is around $4 billion, which compares to roughly $1.1 billion of debt and a current enterprise value of $4.9 billion.
The company's real estate holdings provide only modest credit support in Fitch's view. There are limited alternative uses of prisons, the properties are often in rural areas, and there is no established mortgage market as a contingent liquidity source. However, the facilities do provide essential governmental services, so there is inherent value in the properties. Also, prisons have a long depreciable life (50 years) with a practical useful life greater than that (equivalent to 75 years), and CCA has a young owned portfolio (median age of 16 years).
Considerations for an investment grade IDR include the following:
--Further penetration and public acceptance of private correctional facilities;
--An acceleration of market share gains and/or contract wins;
--Adherence to more conservative financial policies (2.0x leverage target; 4.0x minimum fixed charge coverage);
--Increased mortgage lending activity in the private prisons sector.
Considerations for downward pressure on the 'BB+' IDR and/or Stable Outlook include:
--Increased pressure on per diem rates from customers;
--Decreasing market share gains and/or notable contract losses;
--Material political decisions related to long-term dynamics of the private correctional facilities industry;
--Leverage sustaining above 4.0x and FFO fixed charge coverage sustaining below 4.0x.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--Corporate Rating Methodology
--Criteria for Rating U.S. Equity REITs and REOCs
--Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Applicable Criteria and Related Research
Recovery Ratings and Notching Criteria for Equity REITs
Criteria for Rating U.S. Equity REITs and REOCs
Corporate Rating Methodology
- Security Upgrades & Downgrades
- Fitch Ratings
Michael Paladino, CFA, +1-212-908-9113
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
Steven Marks, +1-212-908-9161
Jamie Rizzo, CFA, +1-212-908-0548
Brian Bertsch, New York, +1 212-908-0549