One of the more controversial elements of value investing is the purchase of distressed, or simply overstressed, names -- those that seemingly have been over-punished by the market. This is fraught with risk, and not for those with a weak stomach.
Earlier this week, I took a position in such a name, but this one brings with it even more controversy due to the nature of its business. Corrections Corp. of America (CXW) is one of the nation's largest owners of private correctional facilities. Now, "prisons for profit" have been extremely controversial, and this company in particular has a long but complicated history. As I wrote in June, it nearly imploded in the 2000-2001 era after converting to a REIT structure. In 2012, the company gave it another go as a REIT.
CXW shares plunged 35% on Aug. 17, when the Department of Justice announced that the Bureau of Prisons would phase out the use of privately run correctional facilities. This announcement did not affect other federal-related private prison contracts. However, it fits the political narrative espoused by the current administration and presidential candidate Hillary Clinton, who vehemently opposes for-profit prisons -- a stance that may be putting more pressure on the stock as Election Day approaches.
Interestingly, just weeks after the Aug. 17 announcement, the Bureau of Prisons extended a contract with operator The GEO Group (GEO) to run a 1,900-bed correctional facility for an additional two years. Extricating itself from the reliance on the private sector may be easier said than done, especially with a $20 trillion national debt and still-wide budget deficits.
Bureau of Prisons contracts represent just 7% of CWX's revenue, and while it appears the market overreacted to the news, the controversy is unlikely to end soon. At the state level, given still-strapped budgets, it is difficult to fathom an end to privately run prisons. States likely will continue to sign on with private operators as a cost-cutting move.
CXW does have considerable debt, at $1.45 billion. However it also has considerable real estate assets, owning or controlling 66 facilities. Granted, that's not prime real estate, but there is value there nonetheless.
While the stock currently yields around 16%, I fully expect that a cut is coming, and took a position with that opinion. CWX is already in cost-cutting mode, reducing headcount, and CEO Damon Hininger has forfeited $2 million in restricted stock units awarded in 2016.
It does not get any messier than a controversial company in a controversial industry. This is not the type of company to go all-in on; if you have the stomach for it, staggering into a position may be warranted. In addition, the next several weeks could be extremely volatile given the coming election, the results of which could provide even more headline risk.
