Does the move toward legalization of marijuana pose a threat to the for-profit prison industry?
On November 6th, voters in Colorado and Washington passed referenda legalizing the recreational use of marijuana. It is not clear yet how federal enforcement officials will respond to the new laws in practice, or whether the move toward legalization is the start of a larger trend. But if we see similar reforms gain traction in future elections in other states, it could affect the fortunes of several public companies. And not just Yum! Brands (YUM) and Pepsi (PEP).
For companies like Corrections Corporation of America (CXW) and GEO Group (GEO), the downside risk to marijuana legalization could be substantial. Recent reports from the analyst community make general mentions of policy changes as an ongoing risk factor, but make no specific mention of changes to drug laws. SunTrust cited the risk of "change[s] in state or federal policies and funding that reduce inmate populations," and a post-election report from Macquarie included similar language. Otherwise, analysts are very positive on the stock, and are focused mostly on the company's short-term plans to convert to a real estate investment trust. During the Q3 earnings call on November 8, an analyst asked about a referendum in California to reclassify some "three strikes" inmates, but no other policy changes were mentioned.
While changes in drug policy have not been a focus of industry analysts, CXW itself is more straightforward; each year's 10-K filing with the SEC includes the following in the "Risk Factors" section:
"The demand for our facilities and services could be adversely affected by the relaxation of enforcement efforts, leniency in conviction or parole standards and sentencing practices or through the decriminalization of certain activities that are currently proscribed by criminal laws. For instance, any changes with respect to drugs and controlled substances or illegal immigration could affect the number of persons arrested, convicted, and sentenced, thereby potentially reducing demand for correctional facilities to house them." **
That is, fewer people in prison because of drug charges would mean lower profits for companies in the prison business. As the largest private owner of prisons in the U.S., CCA operates 66 facilities housing 91,000 beds. The company manages 45% of the for-profit prison space under contract with state and federal governments. And while the company has some revenue from prison transport operations and from income related to its real estate holdings, the vast majority of revenues come from housing inmates.
Drug policy may actually be the key driver of profits for the prison industry. A study released in September from the U.S. Government Accountability Office found that growth in the federal prison population was outpacing prison capacity, and that the main drivers of overcrowding were the drug war and especially harsh federal drug sentencing. And marijuana-related charges are a big part of that picture: 2007 data from the Department of Justice showed that marijuana possession charges comprised more than 42% of federal drug charges (another 5% were for sale and manufacture), and that marijuana arrests were rapidly outpacing all other drugs.
fig. 1. Number of arrests by drug type, 1982-2007. Source: U.S. Department of Justice
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