CORRECTIONS CORPORATION OF AMERICA

Transcription

1 UNIVERSITY OF OREGON INVESTMENT GROUP November 19, 2009 IME CORRECTIONS CORPORATION OF AMERICA Stock Data Price (52 weeks) $9.50 $26.25 Symbol/Exchange CXW / NYSE Beta Standard Error of Beta Shares Outstanding million Average daily volume million SELL Current market cap 2, million Valuation (per share) DCF Analysis Comparables Analysis Target Price Current Price (as of 11/19/09) Summary Financials Revenue Net Income Operating Cash Flow 2009Q million million million BUSINESS OVERVIEW Corrections Corporation of America ( CCA ) is the largest owner and operator of privatized correctional and detention facilities and one of the largest prison operators in the United States behind only the federal government and three states. CCA currently operates in 19 states and the District of Columbia, with 64 correctional and detention facilities, including 44 facilities that they own, with a total design capacity of approximately 85,000 beds. CCA also provides inmate residential and prisoner transportation services for governmental agencies through their whollyowned subsidiary, TransCor. The company offers inmates rehabilitation and educational programs, including basic Covering Analyst: Adam Block ablock@uoregon.edu The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG s portfolio. In addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG s portfolio.

2 education, religious services, life skills and employment training and substance abuse treatment. These services are intended to prepare inmates for their successful reentry into society upon their release. CCA also provides health care (including medical, dental, and psychiatric services), food services, and work and recreational programs. The company was founded in 1983 and is based in Nashville, Tennessee. BUSINESS AND GROWTH STRATEGIES CCA s primary growth strategy is to increase revenue and occupancy levels by increasing capacity, while maintaining high quality standards and their reputation as the leader in the privatized correctional facilities industry. As a result of current budget constraints, many of their customers will be looking to outsource their correctional services as an alternative to constructing new prison beds of their own. These challenges provide CCA with significant growth opportunities. Other opportunities for growth exist, including potential acquisitions of other firms within the industry to improve bed capacity or to provide complimentary services. Quality and Value. As of December 31, 2008, approximately 92% of the facilities operated by CCA are accredited by the American Correctional Association, an independent organization that establishes standards by which a correctional facility may gain accreditation. The wardens who manage their facilities have an average of over 24 years of corrections experience and an average tenure of approximately 12 years. CCA believes their high quality services and capacity offer their customers a valuable alternative. By outsourcing their correctional services, CCA s customers can reduce costs and avoid making large capital investments in new prison beds. Increase Occupancy and Revenue. As occupancy rates increase, operating costs per inmate will decrease due to the benefit of economies of scale. CCA is also looking to improve efficiency and performance by standardizing business practices, utilizing technology advancements, improving productivity and reducing employee turnover. They are focused on creating new bed capacity, attracting new customers and renewing existing contracts. COMPETITIVE ADVANTAGES Reputation. CCA is the largest and most recognized private prison operator in the United States, granting them purchasing power and the ability to achieve certain economies of scale to deliver superior value to their customers. As the manager of nearly 50% of all privately managed prison beds, their established track record provides confidence to prospective clients. Available Beds. CCA has the largest capacity of any private prison operator in the industry. As a result of recently completed bed expansions, CCA had seven facilities with vacancy, providing approximately 6,200 available beds. In addition, as of December 31, 2008, there were approximately 2,400 additional available beds at nine of their other facilities. Financial Flexibility. As of 2008, CCA had year-end cash on hand of $34.1 million and $191.3 million available out of a total of $450.0 million in credit. CCA is currently defined as a well-known seasoned issuer by the SEC, giving them the ability to file a shelf registration statement. This enables them to issue debt and equity securities quickly when conditions become favorable. 2

3 PRESIDENT AND CEO Damon T. Hininger was named President and Chief Executive Officer in August 2009, having previously been appointed as President and Chief Operating Officer in July He joined the company in 1992 as a correctional officer and was promoted to Training Manager in He joined the corporate office in 1995, serving as Manager, Facility Start Up for three years and continued to move up the ranks. His services have included: Director, Strategic Planning and Director Proposal Development; Vice President, Business Analysis; Vice President of Federal and Local Customer Relations; and Senior Vice President of Federal and Local Customer Relations. RECENT NEWS November 4, 2009 Corrections Corporation of America Announces Third Quarter 2009 Financial Results CCA continued to improve performance with a revenue increase of 5.5% for the third quarter of Revenues were $426.0 million compared to $403.8 million generated during the prior year period, primarily driven by a 4.5% increase in average daily inmate populations combined with a 1.3% increase in revenue per compensated man-day. Revenue generated from federal customers increased 4.9% to $166.4 million during the third quarter of 2009, primarily driven by the commencement of a new contract with the Federal Bureau of Prisons ("BOP") at their newly constructed Adams County Correctional Center. The future performance of this new facility appears promising, adding value for stockholders. During third quarter of 2009, CCA generated net income of $45.3 million, or $0.39 per diluted share, compared with net income of $37.9 million, or $0.30 per diluted share, for the third quarter of November 2, 2009 CCA Increases Total Capacity Under Contract With California Department of Corrections and Rehabilitation CCA announced that it has amended its agreement with the California Department of Corrections and Rehabilitation ("CDCR") to allow for the housing of 2,336 additional inmates from the state of California. Under the agreement California will have the ability to house additional inmates at CCA's North Fork Correctional Facility in Oklahoma and its Red Rock Correctional Center in Arizona. The 2,336 additional beds provide the CDCR the ability to house up to 10,468 offenders in five CCA owned facilities located in the states of Arizona, Mississippi and Oklahoma. CCA currently houses approximately 7,900 offenders from the state of California. CCA expects to begin receiving additional inmates pursuant to the amendment during the first quarter of 2010, with a gradual increase estimated to be completed during the first quarter of August 17, 2009 CCA Announces Damon Hininger to Succeed John Ferguson as Chief Executive Officer CCA announced that John Ferguson, the Chairman and CEO will retire as CEO effective October 15, Damon Hininger, who currently serves as CCA s President and Chief Operating Officer, has been named to succeed Ferguson as CEO and will also serve as a director. Ferguson will remain as Chairman of the Board of Directors. Considering Hiniger s long history with the company (described above under President and CEO ) and Ferguson s continued involvement as Chairman, a smooth transition should be expected as Hininger takes the reigns as CEO. August 7, 2009 Corrections Corporation of America Announces Loss of Contract with the State of Alaska The Alaska Department of Corrections notified CCA that it was not selected in their search to outsource up to 1,000 inmates from the state of Alaska. CCA currently houses approximately 765 Alaskan inmates at its 1,596-bed Red Rock Correctional Center in Arizona. CCA currently expects that Alaska will begin transferring their inmate population out of the Red Rock facility beginning in December Despite this missed opportunity and the loss of the 765 Alaskan inmates that will transfer out of the Red Rock facility, CCA s agreement with California (discussed above) will supply an additional 2,336 inmates to be housed at one of two facilities, including the Red Rock facility. The additional inmates from California should make up for the loss from Alaska, negating any significant short-term consequences. 3

4 INDUSTRY OVERVIEW INDUSTRY INFLUENCES Criminal Activity Crime Rate and Incarceration Rate. The industry is highly sensitive to criminal activity in the United States. A rise in the crime and incarceration rates would prove favorable to the industry, as these changes would result in greater occupancy in correctional facilities and increased revenues. As the graph below depicts, incarceration rates have been on the rise for the past 27 years, though actual rates vary from year to year. There is no indication that there will be any change in this pattern in the future, suggesting opportunities for growth exist throughout the industry. Considering their high proportion of fixed costs, CCA would also experience an increase in profitability as occupancy levels improve. Federal Funding. The industry is highly dependent on government expenditures. Considering the current financial crisis, local and federal governments are facing tighter budget constraints. Though this may have an adverse effect on the short-run performance of some firms in the industry, this may prove to be an opportunity for CCA as governments look to outsource their correctional services needs. By doing so, governments can avoid having to make large capital investments to build new prisons. Privatization. Despite the cost benefits local and federal governments face by outsourcing their correctional services needs, privatization of correctional and detention facilities has yet to be fully accepted by the public. This resistance could prove hazardous to private enterprises trying to obtain and renew government agency contracts, and may also lead to the loss of existing contracts. Government Regulations. Due to the nature of the services provided in the industry, all participants are subject to all rules, regulations, and policies enacted by the government. This includes current legislations by local, state, and federal governments, as well as those that may be passed in the future. However, considering CCA s quality standards and their high number of American Correctional Association (ACA) accredited facilities, the possibility of new government regulations does not present a significant threat. KEY SUCCESS FACTORS Accreditation. Recognition by correctional authorities like the American Correctional Association provides credibility and competitive advantages for firms whose practices earn them accreditation. Economies of Scale. Due to the relatively high proportion of fixed costs that make up the cost structure of many firms in the industry, economies of scale can be achieved. 4

5 Provision of Services. To remain competitive within the industry, participants must offer the essential services required for everyday operation. Further, firms may benefit from providing inmates with additional services including, but not limited to, education and religious services, life skills and employment training. KEY PLAYERS Major Player Market Share Range Corrections Corporation of America 9.6% (2009) The GEO Group, Inc. 5.0% (2009) Cornell Companies, Incorporated 1.9% (2009) Other 83.5% (2009) S.W.O.T. ANALYSIS STRENGTHS Reliable Clients. CCA s customer base consists of federal, state, and local agencies that generally have credit ratings of single-a or better. Industry Leader. As the manager of nearly 50% of all privately managed prison beds in the U.S., CCA has purchasing power and the ability to achieve economies of scale. High Occupancy. For the years 2008, 2007, and 2006, the average compensated occupancy of all of the facilities CCA owned or managed, was 95.5%, 98.2%, and 95.0%, respectively. Stability. CCA provides services under contracts with terms between one and five years, which contribute to relatively predictable and stable revenues. WEAKNESSES Substantial Fixed Costs. While a substantial portion of CCA s cost structure is fixed, a substantial portion of their revenues is variable, which depends on per diem rates based on occupancy levels. Therefore, costs are relatively high regardless of occupancy. This cost structure makes them very sensitive to occupancy rate. Public Resistance. The private operation of correctional and detention facilities has not been fully accepted by either the public or the government. Some still believe the government should be solely responsible for correctional and detention facilities and services. OPPORTUNITIES Growing Incarceration Rate. Imprisonment in the U.S. has been increasing over the last 27 years and shows no sign of letting up. International Markets. CCA has yet to explore cross-border and overseas markets. 5

6 THREATS Loss of Contracts. CCA currently manages some facilities that are owned by the government. These clients may decide to assume the management of these facilities upon the termination of the existing contract. Additionally, if these customers have capacity at their facilities, they may take inmates currently housed in CCA s facilities and transfer them to government-run facilities. Government Regulation. Local, state, and federal government regulation can have potentially negative consequences on company performance. However, this does not appear to be a significant threat due to CCA s high operating standards. PORTER S 5 FORCES ANALYSIS Supplier Power Due to the current economic crisis, some government agencies are facing budget constraints which have increased the demand for outsourced services, increasing the bargaining power of private firms. Some government agencies may experience cost savings by outsourcing their correctional services needs instead of increasing capacity of their own facilities. CCA also manages nearly 50% of all privately managed prison beds in the U.S. As a result, supplier power is medium. Barriers to Entry Barriers to entry in this industry are high. Participation is very capital intensive considering the large facilities firms build and operate. To earn credibility with prospective clients, firms need gain accreditation by the ACA. Even further, accreditation is generally required before a government agency will agree to a contract with a privatized company. Also, firms are subject to heavy government regulation, further discouraging new players. Buyer Power The bargaining power of customers is very high. The only customers are local, state, and federal governments who have high buyer power because of their legislative authority. Governments also have the ability to handle their correctional services needs internally, so their dependence on private firms is low. Threat of Substitutes The threat of substitutes is medium in this industry, due to the low number of competitors and the relative lack of product differentiation. Degree of Rivalry Taking the industry forces into account, the degree of rivalry in the Correctional Facilities is medium to low, which is an advantage to CCA as an established leader in the industry. CATALYSTS UPSIDE Diminishing capacity in federal prisons Increasing incarceration Economies of scale 6

7 DOWNSIDE Government budget constraints Disadvantageous legislation COMPARABLES ANALYSIS For my comparables analysis, I chose the two companies in direct competition with CCA in the correctional facilities industry. Corrections Corporation, Cornell Companies (CRN), and The GEO Group (GEO) are the only publicly traded companies in the industry. All three offer very similar services and have comparable characteristics. Despite their smaller sizes in overall market cap, both Cornell and GEO compete with CCA for the same customers and face the same risks and opportunities. After closely reviewing both companies, I decided to weight GEO more heavily (67%) over Cornell (33%) due to their more comparable financial position. COMPANIES (all profiles obtained from respective investor relations websites) CORNELL COMPANIES, INC. (CRN:NYSE) WEIGHT: 33% Cornell Companies, Inc. is a leading private provider of corrections, treatment and educational services outsourced by federal, state and local governmental agencies. Cornell provides a diversified portfolio of services for adults and juveniles, including incarceration and detention, transition from incarceration, drug and alcohol treatment programs, behavioral rehabilitation and treatment, and grades 3-12 alternative education in an environment of dignity and respect, emphasizing community safety and rehabilitation in support of public policy. The Company ( has 70 facilities in 15 states and the District of Columbia with a total service capacity of 20,192. THE GEO GROUP, INC. (GEO: NYSE) WEIGHT: 67% The GEO Group, Inc. is a world leader in the delivery of diversified services to government agencies around the globe. They design, construct, finance and manage jails, state and federal prisons, immigration and detention centers, and special-purpose institutions, including those focused on education, substance abuse treatment, counseling, work programs, and community corrections services. They develop and manage medical and mental health rehabilitation facilities and services, and we deliver various other management services such as secure prisoner escort, court and immigration custody services, and facility maintenance services. Their world headquarters office is located in Boca Raton, Florida. They also have regional offices in Carlsbad, California; New Braunfels, Texas; and Charlotte, North Carolina. Their international offices are located in Sydney, Australia; Sandton, South Africa; and Reading, England. 7

8 METRICS In my comparables analysis I used EV/Revenue, EV/Capacity, EV/EBITDA, and EV/OCF as my metrics. EV/Revenue was chosen to compare total revenue streams generated by each firm, while accounting for overall company size. It was crucial to use EV/Capacity to evaluate performance with respect to capacity. This industry specific metric is used to determine how well each company utilizes capacity to add value to their firm. Considering the capital intensiveness of the industry, EV/EBITDA was used get a more precise measure of each firm s efficiency at generating earnings, without having to account for their depreciation schedules. EV/OCF was used to compare how well each company produced operating cash flows, again accounting for company size. After applying these metrics in the evaluation of CCA, I came to an implied price of $ With a current price of $24.19, my comparables analysis determined CCA is overvalued by 54.19%. DISCOUNTED CASH FLOW ANALYSIS For my discounted cash flows analysis I projected revenue growth on the basis of capacity growth. After reviewing the company s 10-K, I estimated the growth of additional beds based on recently completed projects and tentative plans for the future BETA A Beta of was derived using a five year monthly regression against the S&P 500. After comparing this Beta with the value calculated by professional analysts and considering the nature of the industry, I trust this Beta to be an accurate implication of the company s sensitivity to fluctuations in the S&P 500. This Beta is also close to the Beta of The GEO Group calculated by Yahoo!finance. REVENUES To forecast future revenues I applied a model using capacity growth as a key variable, as well as compensated man-day and occupancy rates to predict revenues: Revenue= (Compensated Man-Day 365) (Occupancy Capacity) Occupancy is expected to remain steady around a rate of 95% as predicted by company advisors. Based on my research I expect the growth of compensated man-days to stabilize near 3.5%. This growth rate was used to calculate the future values of compensated man-days, which were then multiplied by 365 to determine an annual value. Information obtained from the company s 10-K has led me to believe that capacity will increase relatively significantly over the next two years, at which point growth will slow and stabilize at a rate of 1500 additional beds per year. The capacity obtained from this annual growth was then multiplied by the 95% expected occupancy rate. Finally, the product if these terms yielded annual revenue projections. COST OF DEBT The interest rates on all outstanding debt were fixed as of December 31, 2008, with the exception of the interest rate applicable to $217.2 million outstanding under CCA s revolving credit facility, with a total weighted average effective interest rate of 6.5%. I decided to use this 6.5% as the company s cost of debt. TAX RATE I have projected CCA s tax expense using a 35% tax rate, and there has been no evidence to suggest any inadequacy. 8

9 CAPITAL EXPENDITURES Historical data shows average capital expenditures hovering near 15% of revenue, with significant fluctuations over the past five years. I believe this value is too high for long term, so I used a more conservative 12.5% to project future capital expenditure costs. RECOMMENDATION My final recommendation is based on 70% DCF and 30% comparables analyses weightings. I decided to place less emphasis on my comparables analysis considering there are only two comparable companies within the industry. Additionally, both of these companies are significantly smaller in total market cap than CCA. My DCF and comparables analyses yielded implied prices of $28.24 and $10.35, respectively. Using the appropriate weightings, I reached a final target price of $ The current market price for CXW as of November 19, 2009 was $ This variance from my target price suggests the market has overvalued the company by 5.46%. I am recommending a SELL for the Tall Firs and Svigals portfolios for Corrections Corporation of America. 9

10 APPENDIX 1 COMPARABLES ANALYSIS ¹EV = MARKET CAP + DEBT + PREFERRED SHARES - EXCESS CASH ²TRAILING TWELVE MONTHS DATA (TTM) 10

11 APPENDIX 2 DISCOUNTED CASH FLOWS ANALYSIS 11

12 APPENDIX 3 DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS APPENDIX 4 BETA SENSITIVITY ANALYSIS APPENDIX 5 REVENUE PROJECTIONS APPENDIX 6 SOURCES Any sources that you used for information whether you directly cited them or not should be listed here REVENUE= (COMPENSATED MAN-DAY 365) (OCCUPANCY CAPACITY) COMPENSATED MAN-DAY: Represents the revenue CCA generates and expenses they incur for one inmate for one calendar day. 12

13 APPENDIX 6 SOURCES -Reuters.com -Sec.gov -Yahoo!Finance - IBISWorld -correctionscorp.com - cornellcompanies.com - thegeogroupinc.com - ojp.gov/bjs/welcome.html 13