Corrections Corporation: The End of the “Private, For-Profit Prison Racket”

Price Target $11.00

August 19, 2016 1:00 PM EDT

(SI Newswire) August 19, 2016

Senator Bernie Sanders, a long-time opponent of private prisons who referred to them as the “private, for-profit racket,” has to be smiling right about now. Yesterday, Deputy Attorney General Sally Q. Yates made clear the Department of Justice’s desire to end its relationship with private prisons. Private companies will immediately lose their contracts to operate 5 federal prisons in Texas under the DOJ’s plan to phase out the private management of federal prisoners nationwide. The Texas facilities house nearly half of the 22,000 inmates in 13 privately run prisons across the country. This has far and wide reaching implications for both Corrections Corporation of America (NYSE: CXW) and the GEO Group, Inc. (NYSE: GEO) who will each lose contracts to operate 2 of the 5 federal prisons in Texas.

The focus of this narrative is on Corrections Corp (CCA) because, based upon our research, we believe this company stands to lose the most in this political environment for the following 6 reasons:

Reason 1: Last year, Corrections Corp derived at least 51% of its income from federal sources according to the company’s 2015 annual report filed with the SEC. That percentage is expected to increase for the 2016 year. CCA stands to lose quite a bit of revenue as contract renewals cease. We discuss this and each of the remaining reasons in greater detail further below.

Reason 2: Corrections Corp has a short-term liquidity problem, and obtaining further loans in the near future may prove difficult. GEO seems to be one a more financially sound footing. Reason 3: Corrections Corp has been losing contracts with states over the last few years, and this trend will not only continue, but gain momentum.

Reason 4: The Department of Homeland Security Immigration and Customs Enforcement (ICE) is looking to re-negotiate the cushy $1 billion contract that Corrections Corp obtained in an unsavory “no-bid” process with the Obama Administration.

Reason 5: As a member agency of the Department of Justice, the US Marshals Service and other federal agencies will soon be on board the DOJ train to cease renewals with private prisons.

Reason 6: First Bernie Sanders and now Hilary Clinton have both expressed a severe distaste for private prisons and private immigration detention centers, and Mrs. Clinton specifically addresses this issue on her website.

Reason 7: Both CCA and GEO stand to lose hundreds of millions of dollars in tax savings resulting from converting their corporate structures to that of a Real Estate Investment Trust in 2013 for tax avoidance purposes.

Yesterday Deputy AG Yates posted on the Department of Justice’s website a blog article entitled, “Phasing Out Our Use of Private Prisons,” where she highlighted the results of the DOJ’s “Smart on Crime Initiative,” which began in 2013. The DOJ Initiative aimed to identify reforms that would ensure more proportional sentences and effective use of federal resources. According to Ms. Yates: “Today, in part as a result of that initiative, we are experiencing declining numbers in our prison population…[which] means that we can better allocate our resources to ensure that inmates are in the safest facilities and receiving the best rehabilitative services – services that increase their chances of becoming contributing members of their communities when they return from prison.”

Ms. Yates further states that she “sent a memo to the Acting Director of the Bureau of Prisons directing that, as each private prison contract reaches the end of its term, the bureau should either decline to renew that contract or substantially reduce its scope…This is the first step in the process of reducing – and ultimately ending – our use of privately operated prisons. The DOJ’s ultimate goal being to ensure that all federal inmates are ultimately housed at bureau facilities.” Acting Director Thomas R. Kane, who has a Ph.D. in Psychology from the State University of New York, has previously expressed similar views, and the Bureau under his guidance has already taken steps in that direction. According to the memo, the Bureau recently declined to renew a contract for 1,200 beds and reduced an upcoming contract from 10,800 beds to a maximum of 3,600. These and other steps taken together will reduce the total private prison population by over 50% by May 1, 2017 from its 2013 highs.

In making this decision, Yates cites findings by the Justice Department’s inspector general who recently found that a group of 14 privately contracted prisons reported more incidents of inmate contraband, higher rates of rapes and assaults, and more uses of force than facilities run by to BOP. Additionally, they do not save substantially on costs. Federal officials hope their decision will be a model across the correctional field.

David Fathi, Director of the National Prison Project for the American Civil Liberties Union (ACLU) believes the decision will have a “trickle-down” effect on state and local prisons where more than 90% of US prisoners are held. “We hope that ICE and the states will follow the lead of the Justice Department.”

How does all of this impact Corrections Corp and the GEO Group? Both companies will see marked declines in income within the next two years, but Corrections Corp, which owns approximately 59% of all privately owned prison beds in the United States, stands to lose the most because of its higher dependence on federal sources of income and its weaker balance sheet.

We will discuss these and other reasons for Corrections Corp eventual demise below: Reason 1: 51% of Income From Federal Sources

Corrections Corp derived 51% of its revenues from its 3 largest federal sources in 2015, 42% from state prisons, and the remaining 7% from smaller federal institutions and local municipalities. In contrast to CCA, federal institutions account for only 43% of GEO group revenues.

The following is an excerpt from Corrections Corp’s 2015 Annual Report filed with the SEC earlier this year:

“Our customers consist of federal, state, and local correctional and detention authorities. Federal correctional and detention authorities primarily consist of the Federal Bureau of Prisons, or the BOP, the United States Marshals Service, or the USMS, and ICE. Payments by federal correctional and detention authorities represented 51%, 44%, and 44% of our total revenue for the years ended December 31, 2015, 2014, and 2013, respectively.”

“Our customer contracts typically have terms of three to five years and contain multiple renewal options. Most of our facility contracts also contain clauses that allow the government agency to terminate the contract at any time without cause, and our contracts are generally subject to annual or bi-annual legislative appropriations of funds.”

In 2015, the USMS contributed 16% of CCA’s income, the BOP contributed 11%, and ICE (Immigration and Customs Enforcement) contributed 24%. In total, just these 3 federal sources contributed a whopping 51% of total revenue. The USMS and BOP, which are both agencies of the Department of Justice, together contributed 27% of CCA’s income last year. CCA’s recent claim that BOP contracts only account for 7% of its revenues may be technically close to the truth, but actually closer to being very misleading.

In 2014, The Obama Administration awarded Corrections Corp a cushy 4-year $1 billion no-bid contract to detain asylum seekers from Central America. This one particular federal contract alone contributed 14% of the company’s revenues in 2015. Reason 2: Financial (Un)Soundness

Corrections Corp had a current ratio of 1.05 at the end of 2015, meaning it had more current assets than current liabilities at the end of last year. By the end of the first and second quarters of this year, the current ratio had fallen to 0.92 and 0.95 respectively. In stark contrast, the GEO Group has a stronger balance sheet with a current ratio of 1.52 as of the end of the most recent quarter filed with the SEC. Additionally, in 2015 when Corrections Corp first realized a substantial amount of income from the $1 billion ICE contract, the company achieved an EPS of only $1.90 versus an EPS of $2.74 in 2013. With the tax savings realized from its conversion to a REIT in 2013 and the big ICE contract, CCA should be “rolling in dough,” yet they’re not.

It is very likely that Moody’s will put the company’s outlook on watch for a ratings revision downgrade from “stable” in the very near future. Fitch Ratings currently assigns a "BBB-" to the company’s revolving credit facility and "BB+" ratings to its unsecured debt and corporate credit. We expect those ratings will also be on watch for downgrades. Reason 3: Loss of State Contracts

In reply to Deputy AG Yates’ memo yesterday and in a feeble effort to minimize the impact of her actions, Corrections Corp issued a statement that “Today’s announcement relates only to BOP correctional facilities, which make up seven percent of our business.” In fact, BOP generated 11% of the company’s revenues in 2015, and the US Marshals generated another 16%. Taken together, the Department of Justice generated 27% of the company’s revenues last year, with ICE generating another 24%. Federal revenues totaled at least 51% of total revenues last year. Impending losses of federal contracts will significantly affect both CCA’s top and bottom lines. Just as important, Corrections Corp is feeling the bite of the loss of state contracts:

California: In 2015, California gradually declined the state’s use of CCA beds outside the of state. At the beginning of 2015, CCA housed nearly 8,900 inmates on behalf of the state of California in 4 facilities outside of the state. By the end of 2015, the number had fallen by over 40% to 5,300.

Kentucky: Kentucky had housed prisoners for approximately 30 years in private prisons, including 3 CCA-run facilities, but decided not to renew its last contract with Corrections Corp in 2013.

Idaho: After lawsuits, violence, and falsifying records, Idaho ended its contract with CCA for the operation of the Idaho Correctional Center in 2014, a move applauded by the ACLU.

Texas: In 2013, the Texas Department of Criminal Justice announced that 2 CCA-operated facilities would close: Dawson State Jail and Mineral Wells Pre-Parole Transfer Facility. Grassroots Leadership and its ally organizations had advocated for the closure of Dawson after the deaths of 3 incarcerated women and the death of a baby who was born to a woman at the jail with no medical personnel on site.

Colorado: Colorado closed the CCA-owned Huerfano County Correctional Center in 2010 after Arizona said it was withdrawing all of its 700 inmates from the facility. CCA-owned Kit Carson Correctional Center recently closed, which is the fourth private prison to close in the state since Huerfano. The Colorado Criminal Justice Reform Coalition (CCJRC) has been working for over 15 years to reduce the prison population enough to make the prison unprofitable for CCA.

Mississippi: Two months ago, Mississippi announced that the notorious, privately operated GEO’s Walnut Grove Correctional Facility will soon be closed. The closing is the culmination of years of work by the ACLU, which in 2010, argued that the conditions in the prison were unconstitutional.

In May of 2013, CCA lost its contract to operate the 1000-bed Wilkinson County Correctional Facility. A month earlier, a riot at the facility resulted in the death of a 21-year old prisoner and the injury of several others. It was the second riot within a year at that facility. A year earlier at a different CCA-owned federal prison in Mississippi, a riot took the life of a 24-year old guard.

Minnesota: Although the state’s prisons are overcrowded, the outlook remains bleak for opening the CCA-owned private prison in Appleton. The facility has been vacant for 6 years. Ohio: Governor John Kasich initially wanted to sell 5 prisons to private companies, but eventually settled for 1. In 2012, state employees assigned to monitor CCA’s contract compliance documented inmates not having immediate access to running water or toilets, using plastic bags for defecation and cups for urination, clogged water fountains, moldy showers, padlocked fire exits, no guards monitoring “pill call,” and much more. The state fined CCA over $573,000, after which the company did make an effort to address those issues.

Oklahoma: The Diamondback Correctional Facility in Watonga, Oklahoma suffered rioting in May of 2004, and CCA was forced to close it in 2010. The North Fork Correctional Facility in Sayre, Oklahoma suffered rioting in April and June of 2000, and CCA closed it in November of last year.

Hawaii: While Hawaii still utilizes CCA facilities, the state is actively looking for alternatives after 2 lawsuits for inmate death and allegations of prisoner abuse. In 2009, Hawaii decided to bring female prisoners back from a CCA prison in Kentucky over sexual abuse charges. Reason 4: ICE Looking to Renegotiate Contracts

The Department of Homeland Security Immigration and Customs Enforcement (ICE) houses up to 62% of its prisoners and detainees in private facilities, and accounted for 24% of CCA’s revenues last year. Presidential frontrunner Hillary Clinton has specifically stated that as president she will end the era of mass incarcerations, including private immigration detention centers. According to Mrs. Clinton, “immigrant detention shouldn’t be based on profit concerns. People just go out and round up people in order to get paid on a per-bed basis. That just makes no sense at all to me. That’s not the way we should be running any detention facility.”

In 2014, the Obama Administration skirted around the traditional public bidding process and agreed to a deal that many lawmakers view as “unsavory” that offered generous terms to CCA to build a massive detention facility for women and children from Central America seeking asylum. The contract has been a boon for CCA, which gets the money regardless of how many people are “detained” at the facility. Critics say the policy twisted and distorted the procurement process beyond recognition and has been both expensive and ineffective as arrivals of Central American families at the border have continued unabated and recent court rulings have forced the Obama administration to step back from its original approach to the border surge. “For the most part, what I see is a very expensive incarceration scheme” said Rep. Zoe Lofgren (Calif), the top Democrat on the House’s Immigration and Border Security subcommittee. “It’s costly to the taxpayers and achieves almost nothing.” Further similar “cushy” contracts are highly unlikely as a federal judge recently ruled that the government must make contracts with private prison companies available to the public.

While dropping its contracts with private prisons may take more time for ICE, re-negotiating its contracts is in the immediate cards. CCA’s CEO Damon Hininger told investors in its most recent earnings conference call this month that ICE has recently begun pushing for a more “cost-effective solution.” Advocates are going even further, calling directly on ICE to end its multimillion-dollar relationship with the private corrections industry. ICE has not yet specifically commented on the impact that the Justice Department’s announcement will have on its own relationship with private companies but says the agency “remains committed to providing a safe and humane environment for all those in its custody” and “provides several levels of oversight in order to ensure that detainees in ICE custody reside in safe, secure, and humane environments and under appropriate conditions of confinement.” Reason 5: US Marshals Will Soon Be on Board

As a part of the Department of Justice, the US Marshals Service (USMS) is responsible for the custody of federal prisoners beginning at the time of remand and ending when prisoners are either acquitted, arrive at a designated Federal Bureau of Prisons facility to serve their sentence, or are otherwise ordered released from Marshals custody. Marshals are entrusted with the safe and humane care of prisoners in their custody. The Marshals partner with the Federal Bureau of prisons to house 20% of their prisoners, partners with private facilities for another 20%, and partners with state and local governments for the remaining 60%. It is just a matter of time before the Justice Department requests of the Marshals Service the non-renewal of contracts with private prisons as it has just done with the BOP. Reason 6: Shifting Political Winds

Democratic presidential candidate Hillary Clinton has publicly stated that the country should move away from using private facilities to house inmates, and her campaign says it no longer accepts contributions from private prison organizations. Mrs. Clinton’s website states that she will “end the era of mass incarceration, reform the mandatory minimum sentences, and end private prisons and private immigration detention centers.”

During the Democratic presidential primary race, Mrs. Clinton’s main rival Senator Bernie Sanders made a campaign promise to end private prisons and became a staunch advocate for criminal justice reform. According to Senator Sanders, “We cannot fix our criminal justice system if corporations are allowed to profit from mass incarceration…it is an international embarrassment that we put more people behind bars than any other country on Earth…due in large part to private prisons.” Marc Mauer, ececutive director of The Sentencing Project said the DOJ’s announcement represents a “major milestone in the movement away from mass incarceration.” Reason 7: Impending Loss of Tax Breaks

Finally, US Senator Ron Wyden (D-Oregon) has recently introduced legislation that would make it harder for private prison companies to take advantage of federal rules that provide massive tax breaks. After converting themselves to REITs, both CCA and GEO have avoided hundreds of millions of dollars in federal income taxes since 2013 – they avoided a combined $113 million in 2015 alone.

Author Donald Cohan says it best: “Every taxpayer dollar we take back from the private prison industry is a dollar that can be spent on cultivating a more humane criminal justice system and a safe and just society.”

About us: Street Watchdog Research comprises a small group of investors, analysts, & short sellers based in Scottsdale, AZ. Our team includes Maxwell Athanis, Timothy Diggs, Cynthia Wayne, Angelene Dunlap, and Marissa Cabrera.

Disclosure: We are short CXW. We do not have a financial relationship with the company.

Website: www.streetwatchdog.com

Email address: research@streetwatchdog.com



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