Prisons for Profit: Don't Hope for a Breakout

NEW YORK (TheStreet) -- There are a lot of publicly traded companies in seemingly strange businesses, but Corrections Corporation of America (CXW) takes the cake, building and operating prisons.

This is nothing new, either; the company has been in business for almost 30 years, having opened its first facility in 1984.

Of course, the notion of a for-profit company running correctional facilities, which has historically been a function of state, local or the federal government, is not without its share of controversy. Yet the company has continued growing through the years, and now operates 67 facilities in 20 states and the District of Columbia, with a total capacity of 92,000 beds. The company owns 47 of those facilities; which makes for an interesting albeit somewhat strange real estate portfolio.

I became acquainted with this company in 1990, and will never forget the first CXW annual report that I saw; it featured reproductions of handwritten letters from Corrections Corp. inmates heaping praise on the company for the skills and training provided within the facilities.

The cover was even more interesting; displaying a letter from the mother of an inmate, praising the company for the kindness shown to her by the prison guards. It was addressed to "Warden." You can't make this stuff up.

While Corrections Corp has built a thriving business, it has had its share of stumbles along the way. In 1997, at a time when I had a position, the company separated into two publicly traded entities CCA Prison Realty (a real estate investment trust or REIT) and Corrections Corp. which served as the operating company. Just two years later, those companies combined to form New Prison Realty, also organized as a REIT.

This episode resulted in the company taking on loads of debt. Operating performance declined, and the company nearly went under. The company survived, but it was a long, slow climb back and begged the question, should for-profit companies be involved in prisons.

Certainly one of the drivers to the company's success has been the cost advantages it can offer over government-run facilities; which may spur further growth as states grapple with budgetary constraints. In 2007, Pew Charitable Trusts estimated that the average annual operating costs per inmate were $24,000 per year for government run prisons, and $16,000 for privately run prisons. Building costs of privately run facilities have also historically been lower, as have the lead times for construction.

The path to growth in this business, however is not always straight. While the company signed new agreements last month with Idaho, and renewed an agreement with Oklahoma, California is reducing its use of private facilities, and intends to end its agreement with the company by 2016.

The bigger news, however, was the May announcement that the company is exploring conversion to the REIT structure again. This time around, Corrections Corp. is doing its homework on the notion of converting into a taxable REIT subsidiary, which would allow the company to remain as a single entity and not be divided into a REIT and an operating company. While no final decision has been made, management has stated that a conversion could happen as quickly as January of next year. If that's the way they end up going, I hope the result is better than the late 1990's debacle.

In June, Corrections Corp. initiated a 20-cent quarterly dividend, which puts the indicated yield at a healthy 2.6%. That is a positive in my view, and signals some confidence in the business by management. The assumption would be a higher dividend in the event the company actually coverts to a REIT, but that remains to be seen.

Just how profitable is the corrections business? The company has averaged a 9.5% net profit margin over the past five years. Some may find profit margins generated through incarceration distasteful. But in an era of budget austerity, states with fiscal woes may have no choice but to look to the private sector.

In the world of publicly traded equities, it does not get much stranger than for-profit prisons. But did I tell you the one about the publicly traded funeral home chain, or the little company that converts fish into vitamin supplements? I'll save those for another day.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

At the time of publication, Heller was long XXXX.

Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.

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