I've Seen This Move Before

 | May 12, 2012 | 3:00 PM EDT  | Comments
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cxw

Corrections Corporation of America (CXW) has had a very nice run over the past year -- since I last wrote about the name this past June, shares have risen 32%. That includes the 12% haircut the stock took in late April after California announced spending cuts that will cut billions from the prison budget, potentially bringing home inmates housed in other states. Part of the fear here is that those inmates will be brought back from Corrections Corp. facilities.

There's always been controversy with this name, at least since I've started covering it, and to this day there are those who believe prisons should never be in the hands of for-profit entities. Yet, Corrections Corp. has been around for nearly 30 years, having opened its first facility, Houston Processing Center, in 1984. The company now operates 67 facilities, 47 which it owns, in 20 states and in Washington, with total capacity of 92,000 beds.

There's really nothing new here. The company is seemingly always at risk due to state budget concerns or some other overhang -- one controversy or another. Much of this is short-term noise and, frankly, what's been appealing about this name is that it is an austerity play. Many state budgets are already stretched, and outsourcing corrections can be a way to cut spending. The company has proven time and time again that it can build and operate correctional facilities less expensively than governments can do. For 2011, this equated to $1.74 billion in revenue and $162.5 million in net income, for a solid 9.4% net profit margin.

But now I'm getting a sense of déjà vu, as the company is considering converting into a real estate investment trust structure. Haven't we been here before? The answer is, "yes we have," in a sense. Back in 1997 the company separated into two publicly traded entities, CCA Prison Realty (a REIT), and Corrections Corp., which served as the operating company. In 1999, those firms combined to form New Prison Realty, which also operated as a REIT. The whole episode was a disaster: The company took on loads of debt and operating performance declined, putting the firm on the verge of bankruptcy. It was a long climb back.

This time around, Corrections Corp. is evidently doing a great deal of due diligence on the notion of converting into a taxable REIT subsidiary, or TRS. That would allow it to remain as a single entity, and not be divided into a REIT and an operating company. There's some interest and pressure here from investors, too. Last month, Corvex Management announced that it had taken a 7% stake in the company, and that it was holding talks with management about REIT conversion.

I just hope Corrections Corp. takes a long, hard look at what happened in the late 1990s before going any further.

I'm sure it will be different this time.

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