Private Prisons Overview

(This article originally appeared in the The Motley Fool's Evening News on Friday, February 21, 1997)

An Investment Opinion by TMF Templr
FOOL ON THE HILL: Private Prisons Overview

Privately managed correctional facilities are relatively new in the scheme of things, with the first few appearing in the early 1980s. Increased fiscal constraints and an inherent inability to manage large institutions have driven local, state and federal governments to begin to allow private companies to build and manage prisons. Unlike similar attempts to privatize public education systems, the creation and maintenance of prison facilities met with little societal resistance. While entrenched organizations like the National Education Association (NEA) and various teacher's unions could protest against privately-run education and claim that maintaining the current system was to the benefit of children, opponents of privately run prisons lacked the same level of persistence.

Beds under management by private companies has grown from a mere 350 in 1983 to around 87,072 as of 1996, compound annual growth of 48%. With many analysts looking for approximately 350,000 to 400,000 beds by 2006, the industry is looking at overall annual growth of 15% to 16% over the next decade, with the lion's share going to today's dominant players. The rapid growth of the state and federal prison populations due to mandatory sentencing has driven a secular increase in the number of prisons per 100,000 citizens. In 1983 when there were only 350 privately run beds, there were 212 prisoners per 100,000 citizens. In 1995 this number had climbed to 600 prisoners per 100,000 citizens, meaning that one out of every 167 people is behind bars. Society is also clamoring for even tougher sentencing and longer prison stays via truth-in-sentencing legislation, something that will cause the inmate population to continue to grow by increasing the length of sentences.

With such a rapid growth in the prison inmate population, it is difficult for government institutions to keep pace with the growth. The first and most significant problem is a simple cost disadvantage. Government employees get generous pay and benefits packages relative to their non-government peers. Just by being able to replace full-time employees earning overtime pay with part-time employees alone generates cost savings. Add in profit-sharing instead of long-term benefits, a reduced number of paid days off, and a lower number of managers and you can cut somewhere between 10% to 15% right off the top of what it costs the government to do the same thing. Consider as well that privately designed prisons have the architecture optimized for the highest level of efficiency and you can add up to 5% more in savings.

The best known privately run prison company is CORRECTIONS CORP. OF AMERICA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CXC)") else Response.Write("(NYSE: CXC)") end if %>, which trades well below the momentum-driven 52-week high of $45 it hit last Spring. Despite the fact that the stock has dropped nearly 40%, the valuation remains somewhat extreme. With $0.33 per share in trailing earnings and $261.1 million in trailing revenues, the company has a trailing P/E of 86 and a price/sales ratio of 8.1. This valuation obviously takes into account Corrections Corp.'s number one market share and its better-than-average operating margin of 18%. With $0.68 EPS expected this year, the company may be able to grow into its current valuation in a reasonable period of time. The company's growth will more than likely be enhanced by the fact that governments tend to go with established providers rather than comparison shopping when acquiring high-profile services like prison management.

The three other pure-plays in the privately run prison space are WACKENHUT CORRECTIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WHC)") else Response.Write("(NYSE: WHC)") end if %>, CORNELL CORRECTIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: CRN)") else Response.Write("(AMEX: CRN)") end if %> and CORRECTIONAL SERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCQ)") else Response.Write("(Nasdaq: CSCQ)") end if %>, formerly known as Esmor Corrections. Of the group, Cornell appears the statistically cheapest, partially because the stock only recently came public last October. Cornell trades at around $10 with $0.43 EPS expected for this fiscal year, putting the company at only 23 times forward estimates -- very low for the group. The obvious risks though are its short operating history, small float and reliance on a few key contracts for growth. Investors in YOUTH SERVICES INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: YSII)") else Response.Write("(Nasdaq: YSII)") end if %> and AMERICAN SERVICE GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ASGR)") else Response.Write("(Nasdaq: ASGR)") end if %> will recall the havoc those shares saw when a major governmental customer completely backed out of a contract.

Three companies in the corrections industry focus on juvenile detention facilities, which serve one of the fastest-growing segments of the prison population. Youth Services is obviously the giant here, with 2,300 residential beds and 1,700 non-residential beds. CHILDREN'S COMPREHENSIVE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KIDS)") else Response.Write("(Nasdaq: KIDS)") end if %> deals specifically with at-risk and troubled youths in a preventive fashion, although it does not manage a prison population. RES-CARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RSCR)") else Response.Write("(Nasdaq: RSCR)") end if %> operates juvenile facilities as well as providing residential care to individuals with mental retardation and other developmental disabilities, another business that governments are trying to pass on to private companies. Although many of these valuations are high, with the opportunity and stability of the basic business it would seem that premiums may be warranted and investors should definitely explore the business.

(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool.

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