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Published: June 9, 2010
There are some companies that work in
distasteful industries. Companies like payday lenders,
mortuaries and waste management services just aren't the sexy
companies people get excited about. Some even get on a soapbox
and proclaim these businesses to be unethical and immoral. But
the simple fact is that investors can earn outsized returns by
investing in these businesses.
And who wouldn't want that? I know I would, and I know Peter
Lynch hit several home runs doing the same thing, like with
death service provider Service Corp International (NYSE: SCI)
and garbage collector Waste Management Inc. (NYSE: WM).
A trend began many years ago when state governments began to
outsource a part of their judicial system in order to save
money, time and hassle. Several companies stepped in to fill the
gap. These companies knew there were good profits to be made if
they could provide their services more affordably than the
government could. They also knew that crime never goes away.
What could be better than a business that's guaranteed to have
customers (willing or otherwise)?
I'm talking about jail -- specifically, the building and
management of prisons.
One of these companies is Corrections Corporation of America
(NYSE: CXW) and, as an investment, I think it's the best of
the bunch.
The reason the company came on my radar was Bill Ackman, the
hedge fund manager, who is pretty sharp at finding distressed
assets and overlooked growth plays. He now owns 10% of the
company.
Ackman likes Corrections Corp. for many reasons. For starters,
Corrections Corp. is the largest private prison company in the
nation, owning 48% of the market, and is the fifth largest
prison manager. The company owns the land and buildings at 90%
of its facilities, making it a real estate play as well.
The company has huge opportunities for growth. The nation needs
prisons. According to Ackman, only 8% of prisons are privatized
and the average capacity rate for state prisons is 96%, meaning
many state prisons are overcrowded. Meanwhile, federal prisons
are at 137% of capacity.
Corrections Corp. can deliver on this need.
It takes the company an average of 18 months to build a jail,
compared to five to eight years for a state. Prison populations
have been growing at a +5% compound annual growth rate, and have
historically increased after recessions.
Corrections Corp. operates in a sector with strong secular
growth. And what's more, the company is financially positioned
to take advantage of it.
The company carries $1.15 billion in debt, of which 80% is fixed
at an interest rate of about 6%. Earnings have always vastly
exceeded debt service, so there's no concern about default. Even
better, the company's
free cash flow in 2009 was $270 million. The company will be
able to fund new prisons out of that
cash flow.
Considering that Corrections Corp.'s tenants are credit-worthy,
has low capital expenditures for maintenance, enjoys local
monopolies when constructing prisons and is part of an
oligopoly in the sector in general, it all adds up to a
compelling story.
Are there risks? Yes. Just about every state is going through
budget nightmares right now. It's possible that building new
prisons is something a state just can't afford. But nobody wants
to be perceived as being soft on crime, so most legislatures
probably won't cut private prison construction.
Nevertheless, anything that results in decreased prisoner
populations is bad for Corrections Corp. In addition, if
something really bad happens between now and when the company's
debt matures in 2012, it may not be granted a repayment
extension. There's also the bad press and backlash that occurs
when local communities attempt to stop new prisons being built
in their area.
Still, the risks are minor compared to the fact that this is a
solid, profitable company operating in a sector with strong
secular headwinds, with the support of a smart
hedge fund manager.
Action to Take --> I see
Corrections Corp as a buy and long-term hold. The company is
extremely well-positioned to take advantage of the private
prison trend. Between the company's operations and real estate
value, the stock is worth between $40 and $54 a share -- at
least double its current share price -- based on 2012 earnings
and cash flow estimates.
-- Frederick M. Steier
Contributor
StreetAuthority |
