CORRECTIONS CORP AMER CXW
February 11, 2009 - 2:08am EST by
quads1025
2009 2010
Price: 11.00 EPS $1.20 $1.19
Shares Out. (in M): 123 P/E 9.2x 9.2x
Market Cap (in $M): 1,355 P/FCF 5.3x 7.0x
Net Debt (in $M): 1,159 EBIT 304 284
TEV ($): 2,514 TEV/EBIT 8.3x 8.8x

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Description

The Opportunity

Corrections Corporation of America (CXW) is an attractive "value with a catalyst" opportunity.  On Feb 10, 2009 (today), the Company announced fourth quarter and full year 2008 earnings which were slightly ahead of consensus expectations and in-line with historical trends for growth, margins, etc.  However, for reasons discussed below, management issued 2009 earnigns guidance of $1.10-$1.20, which was below Street expectations of $1.34.  In addition, during the evening before, a special federal judge panel ruled that the State of California would have to release ~50,000 prisoners over the next several years to relieve overcrowding.  In today's trading, CXW's stock tumbled 27% from $15 to $11 (an almost 5-year low).  This appears to be quite a strong over-reaction and presents an excellent opportunity to enter the stock.

Company Description

Corrections Corporation of America is the nation's largest owner and operator of privatized correctional and detention facilities and one of the largest prison operators in the United States.  The Company owns, operates and manages prisons and other correctional facilities and provides inmate residential and prisoner transportation services for governmental agencies. In addition to providing the fundamental residential services relating to inmates, the Company's facilities offer a variety of rehabilitation and educational programs, including basic education, religious services, life skills and employment training, and substance abuse treatment. These services are intended to reduce recidivism and to prepare inmates for their successful re-entry into society upon their release. The Company also provides health care (including medical, dental and psychiatric services), food services and work and recreational programs.  Currently, the Company operates 64 facilities, including 44 company-owned facilities, with a total design capacity of approximately 85,000 beds located in 19 states and the District of Columbia.

Business Model

The value proposition that CXW provides to federal, state and local governments is that the Company offers a cost-effective way to manage the growing prison population while enabling the governments to avoid the large capital expenditures associated with new prison construction.  CXW's business model is the following:  the Company gets compensated for operating and managing prisons and correctional facilities at an inmate per diem rate based upon actual or minimum guaranteed occupancy levels.  Operating expenses are predominantly fixed (63% are salaries and benefits).  Accordingly, CXW's cash flows have historically been very predictable.

Earnings Report

In its fourth quarter and full year earnings report released today, the Company provided earnings guidance for 2009 of $1.10-1.20 per share, well below Street expectations of $1.34.  On the Company's earnings call, management stated that they are guiding to conservative EPS estimates given the lack of visibility associated with government budgets and future spending by government customers, especially state customers, as they work to cut spending to balance their budgets.

It is possible, and this is the key, that CXW will have to accept lower "per diem" rates for inmates so that states can meet their budget constraints.  Given the operating leverage in CXW's business model, slight drops in per diem rates have a relatively large effect on the Company's bottom line.

Through analysis of management's guidance, it appears that they are assuming a potential decrease in the per diem rates of 2.5%.  This appears reasonable given that the per diem rates have typically advanced 3-5% per year over the past several years.  Although anything's possible and states are desperate to trim their budgets, imposing a more drastic per diem rate cut than this appears unlikely.  The relationship between CXW and its government entity customers is such that both need each other.  Clearly, the government entities have more power/influence at the negotiating table than CXW.  However, CXW provides a lower cost alternative to government constructed and operated prisons, so positions at the negotiating table are somewhat balanced.

To mitigate any potential decline in the bottom line, CXW management is currently working with several state customers regarding potentially reducing the service levels the Company provides so that CXW's operating costs can be decreased commensurate with any per diem rate reductions it might fact.  Accordingly, CXW's margins and bottom line performance may actually remain in-line with historical levels.  In the meantime, however, management is erring on the conservative side in providing its guidance.

Judge Ruling

As mentioned above, on February 9, 2009, a special federal judge panel ruled that the state of California would have to release ~50,000 inmates over the next several years to relieve overcrowding.  Although the headline appears to be negative for private prison companies such as CXW, it's really a non-issue.  Of the 85,000 beds that CXW manages, 3,700 are in California (~4%).  So, even if all of the inmates of these facilities were released (very unlikely), it would not have much of an impact on CXW's bottom line.  Second, there are many arguments for why the release appears unlikely.  Prison release proposals, such as Governor Schwarzenegger's in 2006, have typically not progressed through California's state legislature as it is a difficult platform for a politician to "run on".  If anything, the judge ruling is likely a positive for CXW in that it might "spur" California into commissioning CXW to construct and manage additional facilities to handle the prison population.  

Fundamentals

Despite the near-term lack of visibility into federal and state budgets, the longer-term fundamental outlook for CXW is strong.  Prison populations should continue to grow as the population in general increases.  Further, prison populations are expected to increase near-term as a consequence of the weakening economy.  The Company's average occupancy for 4Q08 was 93%, down from 98% in 4Q07 primarily due to a 9.9% increase in the average available number of beds.  As CXW accomodates additional inmates, this translates into bottom line growth.  In addition, the Company has a good pipeline of new prison projects.   The Company is in the process of constructing several new facilities which will increase its total capacity from 85,000 beds to ~89,000 beds by the end of 2010, a 5% increase.  Specifically, the Company is in the process of completing a 1,020 bed expansion of its La Palma facility in Arizona, a 1,072 bed facility in Nevada, and a 2,040-bed facility in Trousdale County, Tennessee.  Of note, however, the Company has temporarily suspended the construction in progress on its Tennessee facility until there is more clarity regarding inmate accomodation needs.

The organic growth of the Company's facility base as well as its historical track record of increasing its per diem rates on inmates has translated into EBITDA growth from $217 million in 2003 to $394 in 2008, an attractive 12.7% 5-year CAGR.  Although 2009 and potentially 2010 may be "hiccups" in this growth trend, the underlying fundamentals of population growth and constrained state budgets suggests that growth in privately owned and operated prison facilities is sustainable over a very long period of time.

The Company's balance sheet is strong with total debt to LTM EBITDA of 3.0x and interest coverage of 6.0x.  The Company doesn't have any debt maturing until 2011.  The Company has plenty of cash flow as well as revolver capacity to fund its project pipeline, so liquidity is not an issue for CXW.

Financial Projections

Below I've included my financial projections for the CXW.  I have used the following assumptions in these projections:  (1) The "Revenue per Compensated Man Day" is lower in 2009 by 2.5% vs. 2008 to adjust for the potentially lower per diem rate tha CSW might have to absorb.  This is true for both the "managed facilities" as well as the "owned and managed facilities".  (2) Operating expenses were not lowered to reflect any decrease in services CXW might be able to negotiate in order to preserve operating margins. Anything they can negotiate represents upside from these numbers.  (3) Depreciation expense is higher in 2009 vs. 2008 to reflect the placing of expansion and development projects into service in 2008 (per management's guidance).  (4) The Company repurchases $28.0 million worth of stock each quarter through 2009 at an average purchase price of $18.00 per share (to exhaust the $112 million the Company has remaining in its share repurchase program).  Lower prices on share repurchases lead to upside on 2009's EPS.

Corrections Corporation of America (CXW)                                
Operating Model                                          
($ in millions)                                            
                                               
          Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009   2007 2008 2009 2010 2011 2012
                                               
Managed Only Facilities                                          
Revenue       $ 86.9 $ 89.3 $ 93.2 $ 93.0 $ 92.2 $ 92.2 $ 94.7 $ 94.7 $ 92.4 $ 92.4 $ 92.4 $ 92.4   $ 362.4 $ 373.9 $ 369.5 $ 379.0 $ 379.0 $ 379.0
Operating Expenses                                          
  Fixed       55.3 56.2 60.6 59.9 60.2 59.8 61.9 61.9 61.9 61.9 61.9 61.9   232.0 243.9 247.5 247.5 247.5 247.5
  Variable       18.2 20.1 20.0 21.2 20.9 20.3 20.1 20.1 20.4 20.4 20.4 20.4   79.6 81.5 81.6 81.6 81.6 81.6
  Margin       $ 13.4 $ 13.0 $ 12.5 $ 11.9 $ 11.0 $ 12.1 $ 12.7 $ 12.7 $ 10.1 $ 10.1 $ 10.1 $ 10.1   $ 50.7 $ 48.6 $ 40.4 $ 49.9 $ 49.9 $ 49.9
  Margin, %       15.4% 14.5% 13.5% 12.7% 12.0% 13.2% 13.4% 13.4% 10.9% 10.9% 10.9% 10.9%   14.0% 13.0% 10.9% 13.2% 13.2% 13.2%
                                               
Avg. Available Beds     25,866 25,938 26,373 26,622 26,751 26,751 26,651 26,651 26,651 26,651 26,651 26,651   26,200 26,701 26,651 26,651 26,651 26,651
                                               
Total Compensated Man Days   2.2 2.3 2.4 2.4 2.3 2.3 2.4 2.4 2.4 2.4 2.4 2.4   9.3 9.5 9.6 9.6 9.6 9.6
  Man Days Per Avg. Available Bed   86.8 x 89.1 x 90.7 x 89.5 x 87.8 x 87.8 x 89.9 x 90.0 x 90.0 x 90.0 x 90.0 x 90.0 x   89.1 x 88.9 x 90.0 x 90.0 x 90.0 x 90.0 x
                                               
Per Compensated Man Day                                          
Revenue       $ 38.68 $ 38.64 $ 38.93 $ 39.05 $ 39.25 $ 39.26 $ 39.56 $ 39.50 $ 38.51 $ 38.51 $ 38.51 $ 38.51   $ 38.83 $ 39.40 $ 38.51 $ 39.50 $ 39.50 $ 39.50
Operating Expenses                                          
  Fixed Expense     24.62 24.31 25.32 25.15 25.64 25.46 25.86 25.80 25.80 25.80 25.80 25.80   24.86 25.69 25.80 25.80 25.80 25.80
  Variable Expense     8.11 8.71 8.37 8.92 8.90 8.63 8.41 8.40 8.50 8.50 8.50 8.50   8.53 8.59 8.50 8.50 8.50 8.50
  Margin       $ 5.95 $ 5.62 $ 5.24 $ 4.98 $ 4.70 $ 5.17 $ 5.29 $ 5.30 $ 4.21 $ 4.21 $ 4.21 $ 4.21   $ 5.44 $ 5.12 $ 4.21 $ 5.20 $ 5.20 $ 5.20
  Margin, %       15.4% 14.5% 13.5% 12.7% 12.0% 13.2% 13.4% 13.4% 10.9% 10.9% 10.9% 10.9%   14.0% 13.0% 10.9% 13.2% 13.2% 13.2%
                                               
Owned and Managed Facilities                                        
Revenue       $ 259.2 $ 268.5 $ 279.5 $ 289.0 $ 292.6 $ 304.7 $ 314.4 $ 316.8 $ 314.4 $ 314.4 $ 314.4 $ 314.4   $ 1,096.3 $ 1,228.5 $ 1,257.8 $ 1,365.6 $ 1,412.7 $ 1,412.7
Operating Expenses                                          
  Fixed       127.7 129.7 137.8 139.8 143.9 144.8 156.1 147.4 150.0 150.0 150.0 150.0   535.0 592.2 600.0 666.8 689.8 689.8
  Variable       42.6 47.7 47.7 49.6 47.0 51.3 50.1 53.1 54.1 54.1 54.1 54.1   187.5 201.6 216.3 229.0 236.9 236.9
  Margin       $ 89.0 $ 91.1 $ 94.1 $ 99.6 $ 101.7 $ 108.5 $ 108.1 $ 116.4 $ 110.4 $ 110.4 $ 110.4 $ 110.4   $ 373.8 $ 434.7 $ 441.5 $ 469.8 $ 485.9 $ 485.9
  Margin, %       34.3% 33.9% 33.6% 34.5% 34.8% 35.6% 34.4% 36.7% 35.1% 35.1% 35.1% 35.1%   34.1% 35.4% 35.1% 34.4% 34.4% 34.4%
                                               
Avg. Available Beds     46,777 47,512 48,955 49,882 51,148 52,524 54,854 57,086 58,106 58,106 58,106 58,106   48,282 53,903 58,106 59,178 61,218 61,218
                                               
Total Compensated Man Days   4.2 4.3 4.4 4.5 4.5 4.7 4.8 4.9 5.0 5.0 5.0 5.0   17.4 18.9 20.1 21.3 22.0 22.0
  Man Days Per Avg. Available Bed   89.0 x 90.6 x 89.7 x 90.4 x 88.5 x 88.6 x 86.6 x 86.6 x 86.6 x 86.6 x 86.6 x 86.6 x   89.9 x 87.5 x 86.6 x 90.0 x 90.0 x 90.0 x
                                               
Per Compensated Man Day                                          
Revenue       $ 62.28 $ 62.37 $ 63.67 $ 64.08 $ 64.67 $ 65.49 $ 66.14 $ 64.10 $ 62.50 $ 62.50 $ 62.50 $ 62.50   $ 63.12 $ 65.09 $ 62.50 $ 64.10 $ 64.10 $ 64.10
Operating Expenses                                          
  Fixed Expense     30.67 30.14 31.39 31.00 31.81 31.14 32.84 29.81 29.81 29.81 29.81 29.81   30.81 31.38 29.81 31.30 31.30 31.30
  Variable Expense     10.23 11.07 10.85 10.99 10.38 11.04 10.55 10.75 10.75 10.75 10.75 10.75   10.79 10.68 10.75 10.75 10.75 10.75
  Margin       $ 21.38 $ 21.16 $ 21.42 $ 22.09 $ 22.48 $ 23.32 $ 22.75 $ 23.54 $ 21.94 $ 21.94 $ 21.94 $ 21.94   $ 21.52 $ 23.03 $ 21.94 $ 22.05 $ 22.05 $ 22.05
  Margin, %       34.3% 33.9% 33.6% 34.5% 34.8% 35.6% 34.4% 36.7% 35.1% 35.1% 35.1% 35.1%   34.1% 35.4% 35.1% 34.4% 34.4% 34.4%
                                               
Consolidated                                            
Revenue                                            
  Facility Management     $ 346.1 $ 357.8 $ 372.7 $ 382.0 $ 384.8 $ 396.9 $ 409.1 $ 411.6 $ 406.8 $ 406.8 $ 406.8 $ 406.8   $ 1,458.7 $ 1,602.4 $ 1,627.3 $ 1,744.6 $ 1,791.6 $ 1,791.6
  Transportation     3.5 3.5 4.1 3.1 2.7 1.5 1.6 1.6 1.6 1.6 1.6 1.6   14.2 7.3 6.3 6.3 6.3 6.3
  Rental       0.7 1.1 1.2 0.8 0.8 1.2 1.2 1.2 1.2 1.2 1.2 1.2   3.8 4.4 4.9 4.9 4.9 4.9
  Other       0.2 0.4 0.2 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   1.3 0.1 0.0 0.0 0.0 0.0
  Total       $ 350.5 $ 362.8 $ 378.3 $ 386.4 $ 388.4 $ 399.6 $ 411.9 $ 414.4 $ 409.6 $ 409.6 $ 409.6 $ 409.6   $ 1,477.9 $ 1,614.2 $ 1,638.4 $ 1,755.7 $ 1,802.8 $ 1,802.8
                                               
Operating Expenses                                          
  Fixed       183.0 185.9 198.4 199.7 204.2 204.7 218.0 209.2 211.9 211.9 211.9 211.9   767.0 836.1 847.5 914.4 937.3 937.3
  Variable       60.8 67.8 67.7 70.8 67.9 71.6 70.3 73.3 74.5 74.5 74.5 74.5   267.1 283.1 297.9 310.6 318.5 318.5
  Transportation     4.9 5.4 7.3 4.1 4.6 4.0 4.1 4.0 4.0 4.0 4.0 4.0   21.7 16.7 16.0 16.0 16.0 16.0
  Other       0.5 0.1 0.0 0.1 0.6 2.9 0.2 0.2 0.2 0.2 0.2 0.2   0.7 3.9 0.8 0.8 0.8 0.8
  Margin       $ 101.4 $ 103.5 $ 104.8 $ 111.6 $ 111.1 $ 116.4 $ 119.3 $ 127.7 $ 119.1 $ 119.1 $ 119.1 $ 119.1   $ 421.4 $ 474.4 $ 476.2 $ 514.0 $ 530.2 $ 530.2
  Margin, %       29.3% 28.9% 28.1% 29.2% 28.9% 29.3% 29.2% 31.0% 29.3% 29.3% 29.3% 29.3%   28.9% 29.6% 29.3% 29.5% 29.6% 29.6%

Corrections Corporation of America (CXW)                                
Income Statement                                          
($ in millions)                                            
                                               
          Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009   2007 2008 2009 2010 2011 2012
                                               
Revenues       $350.5 $362.8 $378.3 $386.4 $388.4 $399.6 $411.9 $414.4 $409.6 $409.6 $409.6 $409.6   $1,477.9 $1,614.2 $1,638.4 $1,755.7 $1,802.8 $1,802.8
  % Growth       N.A.  3.5% 4.3% 2.1% 0.5% 2.9% 3.1% 0.6% (1.2%) 0.0% 0.0% 0.0%   11.6% 9.2% 1.5% 7.2% 2.7% 0.0%
                                               
Cash COGS       249.1 259.2 273.5 274.7 277.3 283.2 292.6 286.7 290.5 290.5 290.5 290.5   1,056.6 1,139.8 1,162.2 1,241.7 1,272.6 1,272.6
  Cash Gross Profit     101.4 103.5 104.8 111.6 111.1 116.4 119.3 127.7 119.1 119.1 119.1 119.1   421.4 474.4 476.2 514.0 530.2 530.2
  % Margin       28.9% 28.5% 27.7% 28.9% 28.6% 29.1% 29.0% 30.8% 29.1% 29.1% 29.1% 29.1%   28.5% 29.4% 29.1% 29.3% 29.4% 29.4%
                                               
General and Administrative     17.3 18.8 18.4 19.9 19.6 19.8 20.9 20.1 21.0 21.0 21.0 21.0   74.4 80.3 84.0 87.8 90.1 90.1
  % of Revenue     4.9% 5.2% 4.9% 5.2% 5.0% 5.0% 5.1% 4.8% 5.1% 5.1% 5.1% 5.1%   5.0% 5.0% 5.1% 5.0% 5.0% 5.0%
Other Operating Expenses     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
  % of Revenue     0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%   0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
  Total Operating Expenses     17.3 18.8 18.4 19.9 19.6 19.8 20.9 20.1 21.0 21.0 21.0 21.0   74.4 80.3 84.0 87.8 90.1 90.1
  % Margin       4.9% 5.2% 4.9% 5.2% 5.0% 5.0% 5.1% 4.8% 5.1% 5.1% 5.1% 5.1%   5.0% 5.0% 5.1% 5.0% 5.0% 5.0%
                                               
EBITDA       84.1 84.7 86.4 91.7 91.5 96.6 98.4 107.6 98.1 98.1 98.1 98.1   347.0 394.1 392.2 426.2 440.1 440.1
  % Margin       24.0% 23.4% 22.9% 23.7% 23.6% 24.2% 23.9% 26.0% 23.9% 23.9% 23.9% 23.9%   23.5% 24.4% 23.9% 24.3% 24.4% 24.4%
                                               
Amort. of Goodwill and Intangibles   0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
Depreciation       18.2 18.9 20.1 21.4 21.4 22.2 23.6 24.3 27.0 27.0 27.0 27.0   78.6 91.4 108.0 96.0 96.0 96.0
  Total Depreciation and Amortization   18.2 18.9 20.1 21.4 21.4 22.2 23.6 24.3 27.0 27.0 27.0 27.0   78.6 91.4 108.0 96.0 96.0 96.0
                                               
EBIT       65.9 65.8 66.4 70.4 70.1 74.4 74.9 83.3 71.1 71.1 71.1 71.1   268.4 302.7 284.2 330.2 344.1 344.1
  % Margin       18.8% 18.1% 17.5% 18.2% 18.1% 18.6% 18.2% 20.1% 17.3% 17.3% 17.3% 17.3%   18.2% 18.8% 17.3% 18.8% 19.1% 19.1%
                                               
     Total Interest Expense     13.9 13.7 13.2 12.9 13.7 13.9 15.1 16.7 15.4 15.4 15.4 15.3   53.8 59.4 61.5 61.0 57.4 53.8
                                               
Interest Income     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.3 0.3 2.2
Other Income/(Expense)     0.0 0.1 0.2 (1.6) (0.1) 0.1 0.4 (0.6) 0.0 0.0 0.0 0.0   (1.3) (0.2) 0.0 0.0 0.0 0.0
                                               
EBT       51.9 52.2 53.3 55.9 56.4 60.6 60.1 66.0 55.7 55.7 55.6 55.7   213.3 243.0 222.7 269.6 287.0 292.5
  Taxes       19.6 19.6 20.2 21.2 21.6 23.1 22.0 25.0 21.0 21.0 21.0 21.0   80.5 91.7 84.0 101.1 107.6 109.7
  Tax Rate       37.7% 37.5% 37.8% 37.9% 38.3% 38.1% 36.7% 37.9% 37.7% 37.7% 37.7% 37.7%   37.7% 37.7% 37.7% 37.5% 37.5% 37.5%
  Net Income       $32.4 $32.6 $33.2 $34.7 $34.8 $37.5 $38.1 $41.0 $34.7 $34.7 $34.7 $34.7   $132.8 $151.3 $138.7 $168.5 $179.4 $182.8
                                               
Minority Interest     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
Preferred Dividends     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
  Net Income to Common     $32.4 $32.6 $33.2 $34.7 $34.8 $37.5 $38.1 $41.0 $34.7 $34.7 $34.7 $34.7   $132.8 $151.3 $138.7 $168.5 $179.4 $182.8
  % Margin       9.2% 9.0% 8.8% 9.0% 8.9% 9.4% 9.2% 9.9% 8.5% 8.5% 8.5% 8.5%   9.0% 9.4% 8.5% 9.6% 9.9% 10.1%
                                               
  FD Shares Outstanding     124.7 125.3 125.6 125.9 126.1 126.3 126.5 124.5 122.4 120.9 119.3 117.8   125.4 123.2 117.0 117.0 117.0 117.8
  FD EPS       $ 0.26 $ 0.26 $ 0.26 $ 0.28 $ 0.28 $ 0.30 $ 0.30 $ 0.33 $ 0.28 $ 0.29 $ 0.29 $ 0.29   $ 1.06 $ 1.23 $ 1.19 $ 1.44 $ 1.53 $ 1.55
  Growth, %     N.A.  0.2% 1.4% 4.5% (0.0%) 7.8% 1.3% 9.3% (13.9%) 1.2% 1.3% 1.5%   284.4% 15.9% (3.4%) 21.4% 6.5% 1.2%

Valuation and Price Target

Several different valuation methodologies indicate that CXW is undervalued.

Free Cash Flow Yield

With 2009E EBITDA of $392mm, maintenance capital expenditures (excluding newbuild/expansion capex) of $53.6 million, interest expense of $61.5mm and cash taxes of $84mm, CXW should generate FCF for 2009 of $192.9 million.  With a market cap of $1,355mm, this equates to a FCF Yield of 14.2%.  This is attractive on an "absolute" sense for the Company.  Trading up to a still-attractive 9% FCF Yield equates to a share price of $17.40, 58% higher than the stock's current price.

Current Valuation Relative to Historical Valuation  

CXW has traded over the past 3 years primarily above a 20x PE multiple.  Applying a discounted 15x multiple on the low-end of 2009E, management guided, conservative earnings of $1.10 generates a share price of $16.50, representing 50% upside from current levels.

Valuation Relative to Peers

Based on the projections above, CXW is trading at 6.4x 2009E EBITDA of $392mm and 9.2x 2009E earnings of $1.19.  CXW is actually trading at a discount to its closest comp The Geo Group Inc. (GEO) which is trading at 6.5x 2009E EBITDA and 10.1x 2009E earnings (based on consensus projections).  This is despite the fact that CXW has significantly better margins (~24% EBITDA margins vs. ~16% for GEO) and identical leverage.  The only other publicly traded prison company of size is Cornell Companies (CRN) but is significantly smaller at only $225 million in market cap.

Discount to Asset Value

Although this is a far from exact methodology, it does provide some sense of the underlying asset value of CXW through a quick replacement cost analysis (based on recent construction prices).  CXW recently completed the construction of its 1,668-bed Adams County, MS facility at a total cost of $105mm.  This equates to $63,000/bed.  CXW is also close to completing the construction of its 3,060-bed La Palma, AZ facility at a cost of $205mm.  This equates to $67,000/bed.  CXW is also engaged (although the project has currently been put on hold) in the construction of the 2,040-bed facility in Trousdale County, TN at a cost of $143mm.  This equates to $70,000/bed.  The average construction cost of these facilities is therefore ~$67,000/bed.  Currently, CXW owns facilities with a total bed capacity of about 58,000.  Multiplying the 58,000 owned beds by the current construction cost of $67,000/bed equates to an asset value of $3.9 billion.   This is vs. the Company's current enterprise value of $2.5 billion.  Subtracting the net debt of $1.2 billion equates to an equity value of $2.7 billion, or $22 per share.  Note that this valuation DOES NOT include the value of the contracts that CXW has for managing the facilities that it doesn't own.  The $22 per share value represents 100% upside from current levels.

One could easily argue that construction costs have come down commensurate with the slowdown in the US economy and that the $67,000/bed figure is too high.  Even if you discount the figure, however, the underlying asset value of CXW is still much higher than its current trading value.

Based on all of these valuation methodologies (combined with where the stock traded less than 1 month ago), it is very reasonable to think that the stock should trade at a level of at least $16, representing 45% upside from its current price. 

Summary 

Overall, CXW represents an attractive "value with a catalyst", near-term opportunity with easily 45% upside from its current pcie.  Its a good company with an attractive valuation on several parameters, a strong balance sheet, and a business model that for the most part is non-economically sensitive.  Further, the catalysts listed below should provide near-term upward pressure on the stock.

Catalyst

 There are two main catalysts to drive CXW's stock upward near-term:

  • Share Repurchases - First, the Company will likely be aggressively purchasing shares near-term (next 2-3 days) at these depressed levels. The Company has $112 million of capacity left in its share buyback program (the program was announced on November 14, 2008 and has $150 million in total capacity). From November through February 6, 2009, the Company repurchased 2.5 million shares at an average price of $15.16. If the Company was purchasing stock at $15 per share, the likelihood that they will be purchasing at $11 is very high. In addition, on the earnings conference call today, an analyst asked how long the Company would have to wait before "re-entering" the market as far as buying shares. Management stated that although there can be restriction periods in terms of buying back shares on a discretionary basis, the Company can work around those windows by having pre-determined buybacks in place. From management's body language and from talking with analysts who cover the stock, it seems management has a pre-determined period for buybacks already in place that will engage right after earnings. This should provide upward pressure on the stock.
  • Strong Interest in the Stock - From talking with analysts who cover the stock, a lot of people are showing interest init. According to analysts,a lot ofinvestors were looking at the stock when it dropped to $12 in mid-November.It's "defensive", non-sensitive to the overall economy nature was driving the interest by investors trying to find some save havens toallocate capital. However, the stock quickly ran to $18 and people weren't able to build positions. From talking with analysts, all the people who missed it the first time view this as another chance to get in. The interest level appears to be high.
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    Description

    The Opportunity

    Corrections Corporation of America (CXW) is an attractive "value with a catalyst" opportunity.  On Feb 10, 2009 (today), the Company announced fourth quarter and full year 2008 earnings which were slightly ahead of consensus expectations and in-line with historical trends for growth, margins, etc.  However, for reasons discussed below, management issued 2009 earnigns guidance of $1.10-$1.20, which was below Street expectations of $1.34.  In addition, during the evening before, a special federal judge panel ruled that the State of California would have to release ~50,000 prisoners over the next several years to relieve overcrowding.  In today's trading, CXW's stock tumbled 27% from $15 to $11 (an almost 5-year low).  This appears to be quite a strong over-reaction and presents an excellent opportunity to enter the stock.

    Company Description

    Corrections Corporation of America is the nation's largest owner and operator of privatized correctional and detention facilities and one of the largest prison operators in the United States.  The Company owns, operates and manages prisons and other correctional facilities and provides inmate residential and prisoner transportation services for governmental agencies. In addition to providing the fundamental residential services relating to inmates, the Company's facilities offer a variety of rehabilitation and educational programs, including basic education, religious services, life skills and employment training, and substance abuse treatment. These services are intended to reduce recidivism and to prepare inmates for their successful re-entry into society upon their release. The Company also provides health care (including medical, dental and psychiatric services), food services and work and recreational programs.  Currently, the Company operates 64 facilities, including 44 company-owned facilities, with a total design capacity of approximately 85,000 beds located in 19 states and the District of Columbia.

    Business Model

    The value proposition that CXW provides to federal, state and local governments is that the Company offers a cost-effective way to manage the growing prison population while enabling the governments to avoid the large capital expenditures associated with new prison construction.  CXW's business model is the following:  the Company gets compensated for operating and managing prisons and correctional facilities at an inmate per diem rate based upon actual or minimum guaranteed occupancy levels.  Operating expenses are predominantly fixed (63% are salaries and benefits).  Accordingly, CXW's cash flows have historically been very predictable.

    Earnings Report

    In its fourth quarter and full year earnings report released today, the Company provided earnings guidance for 2009 of $1.10-1.20 per share, well below Street expectations of $1.34.  On the Company's earnings call, management stated that they are guiding to conservative EPS estimates given the lack of visibility associated with government budgets and future spending by government customers, especially state customers, as they work to cut spending to balance their budgets.

    It is possible, and this is the key, that CXW will have to accept lower "per diem" rates for inmates so that states can meet their budget constraints.  Given the operating leverage in CXW's business model, slight drops in per diem rates have a relatively large effect on the Company's bottom line.

    Through analysis of management's guidance, it appears that they are assuming a potential decrease in the per diem rates of 2.5%.  This appears reasonable given that the per diem rates have typically advanced 3-5% per year over the past several years.  Although anything's possible and states are desperate to trim their budgets, imposing a more drastic per diem rate cut than this appears unlikely.  The relationship between CXW and its government entity customers is such that both need each other.  Clearly, the government entities have more power/influence at the negotiating table than CXW.  However, CXW provides a lower cost alternative to government constructed and operated prisons, so positions at the negotiating table are somewhat balanced.

    To mitigate any potential decline in the bottom line, CXW management is currently working with several state customers regarding potentially reducing the service levels the Company provides so that CXW's operating costs can be decreased commensurate with any per diem rate reductions it might fact.  Accordingly, CXW's margins and bottom line performance may actually remain in-line with historical levels.  In the meantime, however, management is erring on the conservative side in providing its guidance.

    Judge Ruling

    As mentioned above, on February 9, 2009, a special federal judge panel ruled that the state of California would have to release ~50,000 inmates over the next several years to relieve overcrowding.  Although the headline appears to be negative for private prison companies such as CXW, it's really a non-issue.  Of the 85,000 beds that CXW manages, 3,700 are in California (~4%).  So, even if all of the inmates of these facilities were released (very unlikely), it would not have much of an impact on CXW's bottom line.  Second, there are many arguments for why the release appears unlikely.  Prison release proposals, such as Governor Schwarzenegger's in 2006, have typically not progressed through California's state legislature as it is a difficult platform for a politician to "run on".  If anything, the judge ruling is likely a positive for CXW in that it might "spur" California into commissioning CXW to construct and manage additional facilities to handle the prison population.  

    Fundamentals

    Despite the near-term lack of visibility into federal and state budgets, the longer-term fundamental outlook for CXW is strong.  Prison populations should continue to grow as the population in general increases.  Further, prison populations are expected to increase near-term as a consequence of the weakening economy.  The Company's average occupancy for 4Q08 was 93%, down from 98% in 4Q07 primarily due to a 9.9% increase in the average available number of beds.  As CXW accomodates additional inmates, this translates into bottom line growth.  In addition, the Company has a good pipeline of new prison projects.   The Company is in the process of constructing several new facilities which will increase its total capacity from 85,000 beds to ~89,000 beds by the end of 2010, a 5% increase.  Specifically, the Company is in the process of completing a 1,020 bed expansion of its La Palma facility in Arizona, a 1,072 bed facility in Nevada, and a 2,040-bed facility in Trousdale County, Tennessee.  Of note, however, the Company has temporarily suspended the construction in progress on its Tennessee facility until there is more clarity regarding inmate accomodation needs.

    The organic growth of the Company's facility base as well as its historical track record of increasing its per diem rates on inmates has translated into EBITDA growth from $217 million in 2003 to $394 in 2008, an attractive 12.7% 5-year CAGR.  Although 2009 and potentially 2010 may be "hiccups" in this growth trend, the underlying fundamentals of population growth and constrained state budgets suggests that growth in privately owned and operated prison facilities is sustainable over a very long period of time.

    The Company's balance sheet is strong with total debt to LTM EBITDA of 3.0x and interest coverage of 6.0x.  The Company doesn't have any debt maturing until 2011.  The Company has plenty of cash flow as well as revolver capacity to fund its project pipeline, so liquidity is not an issue for CXW.

    Financial Projections

    Below I've included my financial projections for the CXW.  I have used the following assumptions in these projections:  (1) The "Revenue per Compensated Man Day" is lower in 2009 by 2.5% vs. 2008 to adjust for the potentially lower per diem rate tha CSW might have to absorb.  This is true for both the "managed facilities" as well as the "owned and managed facilities".  (2) Operating expenses were not lowered to reflect any decrease in services CXW might be able to negotiate in order to preserve operating margins. Anything they can negotiate represents upside from these numbers.  (3) Depreciation expense is higher in 2009 vs. 2008 to reflect the placing of expansion and development projects into service in 2008 (per management's guidance).  (4) The Company repurchases $28.0 million worth of stock each quarter through 2009 at an average purchase price of $18.00 per share (to exhaust the $112 million the Company has remaining in its share repurchase program).  Lower prices on share repurchases lead to upside on 2009's EPS.

    Corrections Corporation of America (CXW)                                
    Operating Model                                          
    ($ in millions)                                            
                                                   
              Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009   2007 2008 2009 2010 2011 2012
                                                   
    Managed Only Facilities                                          
    Revenue       $ 86.9 $ 89.3 $ 93.2 $ 93.0 $ 92.2 $ 92.2 $ 94.7 $ 94.7 $ 92.4 $ 92.4 $ 92.4 $ 92.4   $ 362.4 $ 373.9 $ 369.5 $ 379.0 $ 379.0 $ 379.0
    Operating Expenses                                          
      Fixed       55.3 56.2 60.6 59.9 60.2 59.8 61.9 61.9 61.9 61.9 61.9 61.9   232.0 243.9 247.5 247.5 247.5 247.5
      Variable       18.2 20.1 20.0 21.2 20.9 20.3 20.1 20.1 20.4 20.4 20.4 20.4   79.6 81.5 81.6 81.6 81.6 81.6
      Margin       $ 13.4 $ 13.0 $ 12.5 $ 11.9 $ 11.0 $ 12.1 $ 12.7 $ 12.7 $ 10.1 $ 10.1 $ 10.1 $ 10.1   $ 50.7 $ 48.6 $ 40.4 $ 49.9 $ 49.9 $ 49.9
      Margin, %       15.4% 14.5% 13.5% 12.7% 12.0% 13.2% 13.4% 13.4% 10.9% 10.9% 10.9% 10.9%   14.0% 13.0% 10.9% 13.2% 13.2% 13.2%
                                                   
    Avg. Available Beds     25,866 25,938 26,373 26,622 26,751 26,751 26,651 26,651 26,651 26,651 26,651 26,651   26,200 26,701 26,651 26,651 26,651 26,651
                                                   
    Total Compensated Man Days   2.2 2.3 2.4 2.4 2.3 2.3 2.4 2.4 2.4 2.4 2.4 2.4   9.3 9.5 9.6 9.6 9.6 9.6
      Man Days Per Avg. Available Bed   86.8 x 89.1 x 90.7 x 89.5 x 87.8 x 87.8 x 89.9 x 90.0 x 90.0 x 90.0 x 90.0 x 90.0 x   89.1 x 88.9 x 90.0 x 90.0 x 90.0 x 90.0 x
                                                   
    Per Compensated Man Day                                          
    Revenue       $ 38.68 $ 38.64 $ 38.93 $ 39.05 $ 39.25 $ 39.26 $ 39.56 $ 39.50 $ 38.51 $ 38.51 $ 38.51 $ 38.51   $ 38.83 $ 39.40 $ 38.51 $ 39.50 $ 39.50 $ 39.50
    Operating Expenses                                          
      Fixed Expense     24.62 24.31 25.32 25.15 25.64 25.46 25.86 25.80 25.80 25.80 25.80 25.80   24.86 25.69 25.80 25.80 25.80 25.80
      Variable Expense     8.11 8.71 8.37 8.92 8.90 8.63 8.41 8.40 8.50 8.50 8.50 8.50   8.53 8.59 8.50 8.50 8.50 8.50
      Margin       $ 5.95 $ 5.62 $ 5.24 $ 4.98 $ 4.70 $ 5.17 $ 5.29 $ 5.30 $ 4.21 $ 4.21 $ 4.21 $ 4.21   $ 5.44 $ 5.12 $ 4.21 $ 5.20 $ 5.20 $ 5.20
      Margin, %       15.4% 14.5% 13.5% 12.7% 12.0% 13.2% 13.4% 13.4% 10.9% 10.9% 10.9% 10.9%   14.0% 13.0% 10.9% 13.2% 13.2% 13.2%
                                                   
    Owned and Managed Facilities                                        
    Revenue       $ 259.2 $ 268.5 $ 279.5 $ 289.0 $ 292.6 $ 304.7 $ 314.4 $ 316.8 $ 314.4 $ 314.4 $ 314.4 $ 314.4   $ 1,096.3 $ 1,228.5 $ 1,257.8 $ 1,365.6 $ 1,412.7 $ 1,412.7
    Operating Expenses                                          
      Fixed       127.7 129.7 137.8 139.8 143.9 144.8 156.1 147.4 150.0 150.0 150.0 150.0   535.0 592.2 600.0 666.8 689.8 689.8
      Variable       42.6 47.7 47.7 49.6 47.0 51.3 50.1 53.1 54.1 54.1 54.1 54.1   187.5 201.6 216.3 229.0 236.9 236.9
      Margin       $ 89.0 $ 91.1 $ 94.1 $ 99.6 $ 101.7 $ 108.5 $ 108.1 $ 116.4 $ 110.4 $ 110.4 $ 110.4 $ 110.4   $ 373.8 $ 434.7 $ 441.5 $ 469.8 $ 485.9 $ 485.9
      Margin, %       34.3% 33.9% 33.6% 34.5% 34.8% 35.6% 34.4% 36.7% 35.1% 35.1% 35.1% 35.1%   34.1% 35.4% 35.1% 34.4% 34.4% 34.4%
                                                   
    Avg. Available Beds     46,777 47,512 48,955 49,882 51,148 52,524 54,854 57,086 58,106 58,106 58,106 58,106   48,282 53,903 58,106 59,178 61,218 61,218
                                                   
    Total Compensated Man Days   4.2 4.3 4.4 4.5 4.5 4.7 4.8 4.9 5.0 5.0 5.0 5.0   17.4 18.9 20.1 21.3 22.0 22.0
      Man Days Per Avg. Available Bed   89.0 x 90.6 x 89.7 x 90.4 x 88.5 x 88.6 x 86.6 x 86.6 x 86.6 x 86.6 x 86.6 x 86.6 x   89.9 x 87.5 x 86.6 x 90.0 x 90.0 x 90.0 x
                                                   
    Per Compensated Man Day                                          
    Revenue       $ 62.28 $ 62.37 $ 63.67 $ 64.08 $ 64.67 $ 65.49 $ 66.14 $ 64.10 $ 62.50 $ 62.50 $ 62.50 $ 62.50   $ 63.12 $ 65.09 $ 62.50 $ 64.10 $ 64.10 $ 64.10
    Operating Expenses                                          
      Fixed Expense     30.67 30.14 31.39 31.00 31.81 31.14 32.84 29.81 29.81 29.81 29.81 29.81   30.81 31.38 29.81 31.30 31.30 31.30
      Variable Expense     10.23 11.07 10.85 10.99 10.38 11.04 10.55 10.75 10.75 10.75 10.75 10.75   10.79 10.68 10.75 10.75 10.75 10.75
      Margin       $ 21.38 $ 21.16 $ 21.42 $ 22.09 $ 22.48 $ 23.32 $ 22.75 $ 23.54 $ 21.94 $ 21.94 $ 21.94 $ 21.94   $ 21.52 $ 23.03 $ 21.94 $ 22.05 $ 22.05 $ 22.05
      Margin, %       34.3% 33.9% 33.6% 34.5% 34.8% 35.6% 34.4% 36.7% 35.1% 35.1% 35.1% 35.1%   34.1% 35.4% 35.1% 34.4% 34.4% 34.4%
                                                   
    Consolidated                                            
    Revenue                                            
      Facility Management     $ 346.1 $ 357.8 $ 372.7 $ 382.0 $ 384.8 $ 396.9 $ 409.1 $ 411.6 $ 406.8 $ 406.8 $ 406.8 $ 406.8   $ 1,458.7 $ 1,602.4 $ 1,627.3 $ 1,744.6 $ 1,791.6 $ 1,791.6
      Transportation     3.5 3.5 4.1 3.1 2.7 1.5 1.6 1.6 1.6 1.6 1.6 1.6   14.2 7.3 6.3 6.3 6.3 6.3
      Rental       0.7 1.1 1.2 0.8 0.8 1.2 1.2 1.2 1.2 1.2 1.2 1.2   3.8 4.4 4.9 4.9 4.9 4.9
      Other       0.2 0.4 0.2 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   1.3 0.1 0.0 0.0 0.0 0.0
      Total       $ 350.5 $ 362.8 $ 378.3 $ 386.4 $ 388.4 $ 399.6 $ 411.9 $ 414.4 $ 409.6 $ 409.6 $ 409.6 $ 409.6   $ 1,477.9 $ 1,614.2 $ 1,638.4 $ 1,755.7 $ 1,802.8 $ 1,802.8
                                                   
    Operating Expenses                                          
      Fixed       183.0 185.9 198.4 199.7 204.2 204.7 218.0 209.2 211.9 211.9 211.9 211.9   767.0 836.1 847.5 914.4 937.3 937.3
      Variable       60.8 67.8 67.7 70.8 67.9 71.6 70.3 73.3 74.5 74.5 74.5 74.5   267.1 283.1 297.9 310.6 318.5 318.5
      Transportation     4.9 5.4 7.3 4.1 4.6 4.0 4.1 4.0 4.0 4.0 4.0 4.0   21.7 16.7 16.0 16.0 16.0 16.0
      Other       0.5 0.1 0.0 0.1 0.6 2.9 0.2 0.2 0.2 0.2 0.2 0.2   0.7 3.9 0.8 0.8 0.8 0.8
      Margin       $ 101.4 $ 103.5 $ 104.8 $ 111.6 $ 111.1 $ 116.4 $ 119.3 $ 127.7 $ 119.1 $ 119.1 $ 119.1 $ 119.1   $ 421.4 $ 474.4 $ 476.2 $ 514.0 $ 530.2 $ 530.2
      Margin, %       29.3% 28.9% 28.1% 29.2% 28.9% 29.3% 29.2% 31.0% 29.3% 29.3% 29.3% 29.3%   28.9% 29.6% 29.3% 29.5% 29.6% 29.6%

    Corrections Corporation of America (CXW)                                
    Income Statement                                          
    ($ in millions)                                            
                                                   
              Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009   2007 2008 2009 2010 2011 2012
                                                   
    Revenues       $350.5 $362.8 $378.3 $386.4 $388.4 $399.6 $411.9 $414.4 $409.6 $409.6 $409.6 $409.6   $1,477.9 $1,614.2 $1,638.4 $1,755.7 $1,802.8 $1,802.8
      % Growth       N.A.  3.5% 4.3% 2.1% 0.5% 2.9% 3.1% 0.6% (1.2%) 0.0% 0.0% 0.0%   11.6% 9.2% 1.5% 7.2% 2.7% 0.0%
                                                   
    Cash COGS       249.1 259.2 273.5 274.7 277.3 283.2 292.6 286.7 290.5 290.5 290.5 290.5   1,056.6 1,139.8 1,162.2 1,241.7 1,272.6 1,272.6
      Cash Gross Profit     101.4 103.5 104.8 111.6 111.1 116.4 119.3 127.7 119.1 119.1 119.1 119.1   421.4 474.4 476.2 514.0 530.2 530.2
      % Margin       28.9% 28.5% 27.7% 28.9% 28.6% 29.1% 29.0% 30.8% 29.1% 29.1% 29.1% 29.1%   28.5% 29.4% 29.1% 29.3% 29.4% 29.4%
                                                   
    General and Administrative     17.3 18.8 18.4 19.9 19.6 19.8 20.9 20.1 21.0 21.0 21.0 21.0   74.4 80.3 84.0 87.8 90.1 90.1
      % of Revenue     4.9% 5.2% 4.9% 5.2% 5.0% 5.0% 5.1% 4.8% 5.1% 5.1% 5.1% 5.1%   5.0% 5.0% 5.1% 5.0% 5.0% 5.0%
    Other Operating Expenses     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
      % of Revenue     0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%   0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
      Total Operating Expenses     17.3 18.8 18.4 19.9 19.6 19.8 20.9 20.1 21.0 21.0 21.0 21.0   74.4 80.3 84.0 87.8 90.1 90.1
      % Margin       4.9% 5.2% 4.9% 5.2% 5.0% 5.0% 5.1% 4.8% 5.1% 5.1% 5.1% 5.1%   5.0% 5.0% 5.1% 5.0% 5.0% 5.0%
                                                   
    EBITDA       84.1 84.7 86.4 91.7 91.5 96.6 98.4 107.6 98.1 98.1 98.1 98.1   347.0 394.1 392.2 426.2 440.1 440.1
      % Margin       24.0% 23.4% 22.9% 23.7% 23.6% 24.2% 23.9% 26.0% 23.9% 23.9% 23.9% 23.9%   23.5% 24.4% 23.9% 24.3% 24.4% 24.4%
                                                   
    Amort. of Goodwill and Intangibles   0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
    Depreciation       18.2 18.9 20.1 21.4 21.4 22.2 23.6 24.3 27.0 27.0 27.0 27.0   78.6 91.4 108.0 96.0 96.0 96.0
      Total Depreciation and Amortization   18.2 18.9 20.1 21.4 21.4 22.2 23.6 24.3 27.0 27.0 27.0 27.0   78.6 91.4 108.0 96.0 96.0 96.0
                                                   
    EBIT       65.9 65.8 66.4 70.4 70.1 74.4 74.9 83.3 71.1 71.1 71.1 71.1   268.4 302.7 284.2 330.2 344.1 344.1
      % Margin       18.8% 18.1% 17.5% 18.2% 18.1% 18.6% 18.2% 20.1% 17.3% 17.3% 17.3% 17.3%   18.2% 18.8% 17.3% 18.8% 19.1% 19.1%
                                                   
         Total Interest Expense     13.9 13.7 13.2 12.9 13.7 13.9 15.1 16.7 15.4 15.4 15.4 15.3   53.8 59.4 61.5 61.0 57.4 53.8
                                                   
    Interest Income     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.3 0.3 2.2
    Other Income/(Expense)     0.0 0.1 0.2 (1.6) (0.1) 0.1 0.4 (0.6) 0.0 0.0 0.0 0.0   (1.3) (0.2) 0.0 0.0 0.0 0.0
                                                   
    EBT       51.9 52.2 53.3 55.9 56.4 60.6 60.1 66.0 55.7 55.7 55.6 55.7   213.3 243.0 222.7 269.6 287.0 292.5
      Taxes       19.6 19.6 20.2 21.2 21.6 23.1 22.0 25.0 21.0 21.0 21.0 21.0   80.5 91.7 84.0 101.1 107.6 109.7
      Tax Rate       37.7% 37.5% 37.8% 37.9% 38.3% 38.1% 36.7% 37.9% 37.7% 37.7% 37.7% 37.7%   37.7% 37.7% 37.7% 37.5% 37.5% 37.5%
      Net Income       $32.4 $32.6 $33.2 $34.7 $34.8 $37.5 $38.1 $41.0 $34.7 $34.7 $34.7 $34.7   $132.8 $151.3 $138.7 $168.5 $179.4 $182.8
                                                   
    Minority Interest     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
    Preferred Dividends     0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0   0.0 0.0 0.0 0.0 0.0 0.0
      Net Income to Common     $32.4 $32.6 $33.2 $34.7 $34.8 $37.5 $38.1 $41.0 $34.7 $34.7 $34.7 $34.7   $132.8 $151.3 $138.7 $168.5 $179.4 $182.8
      % Margin       9.2% 9.0% 8.8% 9.0% 8.9% 9.4% 9.2% 9.9% 8.5% 8.5% 8.5% 8.5%   9.0% 9.4% 8.5% 9.6% 9.9% 10.1%
                                                   
      FD Shares Outstanding     124.7 125.3 125.6 125.9 126.1 126.3 126.5 124.5 122.4 120.9 119.3 117.8   125.4 123.2 117.0 117.0 117.0 117.8
      FD EPS       $ 0.26 $ 0.26 $ 0.26 $ 0.28 $ 0.28 $ 0.30 $ 0.30 $ 0.33 $ 0.28 $ 0.29 $ 0.29 $ 0.29   $ 1.06 $ 1.23 $ 1.19 $ 1.44 $ 1.53 $ 1.55
      Growth, %     N.A.  0.2% 1.4% 4.5% (0.0%) 7.8% 1.3% 9.3% (13.9%) 1.2% 1.3% 1.5%   284.4% 15.9% (3.4%) 21.4% 6.5% 1.2%

    Valuation and Price Target

    Several different valuation methodologies indicate that CXW is undervalued.

    Free Cash Flow Yield

    With 2009E EBITDA of $392mm, maintenance capital expenditures (excluding newbuild/expansion capex) of $53.6 million, interest expense of $61.5mm and cash taxes of $84mm, CXW should generate FCF for 2009 of $192.9 million.  With a market cap of $1,355mm, this equates to a FCF Yield of 14.2%.  This is attractive on an "absolute" sense for the Company.  Trading up to a still-attractive 9% FCF Yield equates to a share price of $17.40, 58% higher than the stock's current price.

    Current Valuation Relative to Historical Valuation  

    CXW has traded over the past 3 years primarily above a 20x PE multiple.  Applying a discounted 15x multiple on the low-end of 2009E, management guided, conservative earnings of $1.10 generates a share price of $16.50, representing 50% upside from current levels.

    Valuation Relative to Peers

    Based on the projections above, CXW is trading at 6.4x 2009E EBITDA of $392mm and 9.2x 2009E earnings of $1.19.  CXW is actually trading at a discount to its closest comp The Geo Group Inc. (GEO) which is trading at 6.5x 2009E EBITDA and 10.1x 2009E earnings (based on consensus projections).  This is despite the fact that CXW has significantly better margins (~24% EBITDA margins vs. ~16% for GEO) and identical leverage.  The only other publicly traded prison company of size is Cornell Companies (CRN) but is significantly smaller at only $225 million in market cap.

    Discount to Asset Value

    Although this is a far from exact methodology, it does provide some sense of the underlying asset value of CXW through a quick replacement cost analysis (based on recent construction prices).  CXW recently completed the construction of its 1,668-bed Adams County, MS facility at a total cost of $105mm.  This equates to $63,000/bed.  CXW is also close to completing the construction of its 3,060-bed La Palma, AZ facility at a cost of $205mm.  This equates to $67,000/bed.  CXW is also engaged (although the project has currently been put on hold) in the construction of the 2,040-bed facility in Trousdale County, TN at a cost of $143mm.  This equates to $70,000/bed.  The average construction cost of these facilities is therefore ~$67,000/bed.  Currently, CXW owns facilities with a total bed capacity of about 58,000.  Multiplying the 58,000 owned beds by the current construction cost of $67,000/bed equates to an asset value of $3.9 billion.   This is vs. the Company's current enterprise value of $2.5 billion.  Subtracting the net debt of $1.2 billion equates to an equity value of $2.7 billion, or $22 per share.  Note that this valuation DOES NOT include the value of the contracts that CXW has for managing the facilities that it doesn't own.  The $22 per share value represents 100% upside from current levels.

    One could easily argue that construction costs have come down commensurate with the slowdown in the US economy and that the $67,000/bed figure is too high.  Even if you discount the figure, however, the underlying asset value of CXW is still much higher than its current trading value.

    Based on all of these valuation methodologies (combined with where the stock traded less than 1 month ago), it is very reasonable to think that the stock should trade at a level of at least $16, representing 45% upside from its current price. 

    Summary 

    Overall, CXW represents an attractive "value with a catalyst", near-term opportunity with easily 45% upside from its current pcie.  Its a good company with an attractive valuation on several parameters, a strong balance sheet, and a business model that for the most part is non-economically sensitive.  Further, the catalysts listed below should provide near-term upward pressure on the stock.

    Catalyst

     There are two main catalysts to drive CXW's stock upward near-term:

    Messages


    SubjectRE: returns on capital
    Entry02/11/2009 11:11 AM
    Memberquads1025

    As far as returns on capital, I actually don't think that they are that bad.  They certainly aren't stellar, but they are reasonably attractive.

    The Company generated Net Income of $104.7mm, $132.8mm and $151.3mm in 2006, 2007 and 2008, respectively.  The average equity balance for those years was $983.2mm, $1,135.8mm and $1,301.2mm.  The equates to a ROEs of 10.6%, 11.7% and 11.6%, respectively.  I agree that there are industries with higher returns than this, but these are definitely reasonable.

    As far as competitive advantages, the main one for CXW is its length of track record.  The Company has a 25+ year history of successfully constructing and operating prison facilities.  This is a very strong selling point in soliciting new contracts from government entities.  Given the nature of the industry, CXW is primarily competing with the main alternative for government entities of building and operating new facilities themselves.  So, the competitive dynamics are different than for other "more traditional" industries.  From the federal and state government perspectives, as long as CXW can provide cheaper prison operating costs than government entities (which it does) and fronts all the capital for the investment (which the government likes), it's a positive situation for all.  True, other prison companies are competing for this same business, but CXW has an advantage here in that it's the largest in the business and one of the most experienced.


    SubjectHealth Insurance
    Entry02/11/2009 11:19 AM
    Membergreenshoes93

    I'd heard recently from an insider in healthcare that because HIV/AIDS rates are so high in prisons (and increasing) that insurance companies are refusing to now insure prisoners given the high cost of anti-retrovirals. May not be an issue here, but is insurance a cost currently borne by the government or the prison management cos?


    SubjectRE: Health Insurance
    Entry02/11/2009 12:03 PM
    Memberquads1025

    Overall, insurance costs are not much of a concern for CXW.  According to the Company, Inmate medical care for CXW currently represents less than 1% of total operating costs.  In addition, CXW has been able to keep the rise of inmate medical costs to a "single digit" growth rate, as opposed to the double digit growth rate experienced for the broader US population.

    As far as the cost of the insurance and who bears it, for CXW it depends on the contract.  Sometimes CXW bears all of the medical expenses, sometimes the relevant government entity does, and sometimes it's a mixture.  According to the Company, under the majority of its contracts it bears the cost of medical care and insurance.  Further, 100% of pharmaceutical costs are typically born by CXW.  However, contracts where CXW bears the medical costs carry a higher per diem rate which tends to offset the additional cost of medical care.  Accordingly, the relevant government entity is still effectively picking up the tab for medical care.

    As far as HIV/AIDS in prison, you are correct in that the rates are definitely high and going up.  One thing that is interesting is that CXW has provisions in its contracts that restrict the HIV/AIDS population in its prisons to the same percentage that exists in similar government-managed facilities.  Accordingly, if a government facility has an HIV/AIDS population of 2%, and CXW in the same area/jurisdiction can't have an HIV/AIDS rate of greater than 2%.  This is to prevent government entities from transferring HIV/AIDS carriers into privately managed facilities in order to lower costs.


    SubjectRE: ROC
    Entry02/11/2009 02:57 PM
    Memberquads1025

    CXW targets a cash-on-cash, unlevered return of 13-15% on invested capital, particularly new facilities.  For considering new projects, they calculate a facility EBITDA at 95% occupancy and divide by the cost of the facility (which they quoted at $65,000 / bed).

    As just a check on these numbers to see if the Company is meeting its internal targets, CXW generated $292.2mm, $347.0mm and $394.1mm in EBITDA in 2006, 2007 and 2008.  The average asset balance for these years was $2,168.6mm, $2,368.3mm and $2,678.6mm.  This equates to EBITDA / Assets ratios of 13.5%, 14.7% and 14.7% for those years, in-line with management's targets.

    In the event that the cost of capital or the projected EBITDA generation makes that return target of 13-15% unlikely, the Company holds back on building the facility.

    I totally agree with you that the cost of capital for pretty much everything is going up and the pressure on per diem rates could make these return targets hard to meet.  As long as management is disciplined, however, about new facility construction, the Company's ROIC should not suffer materially.


    SubjectStructure of the Prison Industry
    Entry02/16/2009 10:26 PM
    Memberdoobadoo802

    Good overview of the company, my only concerns are more industry wise which you don't do a good job of explaining in the write up. 

    As a person who's not (yet) been incarcerated i am faily ignorant of just how the prison system works.  My understanding is that when some one is arrested they are taken to a holding cell.  These are not run by CXW right, thats the local PD or sheriff's facility, right??  Then they stand trail or plea bargain (most plea) and depending on the alledged offense's severity may be taken to a prison while on trial.  (Eg Riker's Island).  Does CXW particiapate in this?

    Lastly, It is taken as an assumption that prison growth will track population growth.  Have you no optimism of progress? ;-(  But doesn't the US have the highest incarceration rate of any industrialized society and many developing nations as well?  Much of this has to do with the "War on Drugs" and other 'victimless' vice crimes like prostitution, gambling, immigration/trafficing people etc.  This is particularly relevant as it pertains to the federal facilities.  They are full of people caught running dope and 'migrant workers' across the Mexican border.  Obama has stated that he doesn't support decrim, but were the DEA and ICE to change their policy towards Joe Smoe with 9 lbs of weed hidden in his spare tire getting picked up at the border, how could that impact their exposure to federal trafficing crimes?  After all Massachusettes just reduced possession to the legal equivalent of a parking ticket, and that was done by popular ballot measure of over 60%.

    Not to mention immigration.  How many in CXW's facilities are awaiting their deportation hearing?  Certainly, almost any reform of immigration laws would either A) secure the border with a 'closed door' policy and allow for some kind of normalization of current residents, or B) secure the border with a more liberal immigration policy, or C) not really secure the border with a more open door policy.  Either way, the current policy means lots of 'illegals' and no secure border.  Thats the optimal scenario for increasing the number of CXW's "cutomers."

     

    What i'm really getting at here, in the most apolical way possible is: what if the US incarceration rates were to one way or another fall in line with other industrialized nations due to various reform etc...  My guess is that gov't operated facilities get priority of prisoners.  Are CXW's guards considered government employed corrections officers or are they on the cxw payroll.  I suggest the latter, it is unlikely the gov't lays its own folks off and shuts in their own facilities before they let a CXW contract lapse.  And just what do you do with such prime real estate as a prison?


    SubjectPricing, Contracts and Margins
    Entry02/18/2009 03:28 PM
    Membercanuck272

    what are the key terms of the contracts with government agencies with respect to pricing, and how often is pricing reset?  when a contact is up, is it put out for bid again, and if so, what happens to the existing facility?  can the government or new winning bidder take it over at a certain price?  also, why are CXW's margins higher than GEO's?  GEO seems to have a great backlog of new projects, so maybe they have been more aggressive on pricing of new contracts.

    thanks in advance for your answers.


    SubjectRE: Pricing, Contracts and Margins
    Entry02/19/2009 03:19 PM
    Memberquads1025

    For the facilities that CXW owns and manages, pricing on the contracts is typically negotiated annually, and depending on the contract for the specific state or other government agency, tends to escalate by (i) a fixed "per diem" dollar amount, (ii) a fixed % increase in the "per diem" rate, or (iii) tied to CPI or other inflation index.  In the event that the government body wants to break the contract with CXW, they cannot take over the facility because CXW owns it.  To your question about what happens to the existing facility, it's really up to CXW on what to do with it (its "alternative use" value would be very low, I'm sure).

    For the facilities that CXW manages but does not own, contracts are negotiated for periods 2-5 years in length.  Rates and escalators are pre-negotiated over the length of the contract.  When contracts are up for renewal, alternative providers can make competing bids to manage the facility.

    Of note, in all of CXW contracts, the government agencies have the ability to cancel the contracts at any time without cause.  They won't sign the contracts without this provision.  There's not a history of this happening, but it's always a possibility.

    As far as GEO's margins, for 2008 about 12% of GEO's revenues came from their International business and another 11% came from GEO Care, which is their mental health treatment business.  The margin on the International business was 10% and the margin on GEO Care was 12%.  In addition, GEO's Facility Construction business generated 8% of GEO's 2008 revenues and generated about 0% margin.  Still further, GEO's US Correctional business is more skewed toward "managed but not owned" business which carries a lower margin than "owned and managed".  As CXW's business is composed predominantly of US correctional "owned and managed" facilities, it's margins are much higher than GEO's.


    SubjectRE: Structure of the Prison Industry
    Entry02/19/2009 03:42 PM
    Memberquads1025

    OK.  Several questions here.

    I haven't been incarcerated either, but I believe your assessment of the process for standing trial, etc. is correct.  CXW has some exposure to facilities like Riker's Island, but it's a very small percentage of the population they hold (according to the company).

    As far as the US incarceration rate vs. other nations, in all honesty, I can't opine on what would happen if massive, sweeping changes were made to rules/regulations/laws as far as "victimless" crimes.  As far as immigration, from talking with the Company, I do know that the govenment is reviewing legislation such that (i) illegal aliens who arrived prior Jan 1, 2007, would be given a "path to citizenship" and (ii) aliens arriving here after that date would be subject to deportation.  This legislation is just under consideration right now, but it's out there.

    To your final question, I'm sure that if the prison population (for whatever reason) dropped significantly, CXW's business would get hurt as they get compensated on a per diem basis.  Whatever changes would take place, though, I'm sure would take place over a relatively lengthy period of time.  CXW's guards are the Company's employees, not the government's.  I have no idea what someone could do with a "shut down" prison facility, but I imagine the answer is "not much".  But hey, human creativity is very powerful.  No one thought there was any value to a bunch of underground bunkers that were built in Japan during WWII, till some entrepreneur turned them into wine storage facilites which they are perfect for!


    SubjectRE: Structure of the Prison Industry
    Entry02/19/2009 03:47 PM
    Memberquads1025

    One other thing I forgot to mention in my response to your question is that CXW's ICE population generated 13% of revenues in 2008, according to the Company.  The majority of that population is incarcerated not because they were caught crossing the border or had a work visa expire, but because they commited a crime in the US for which they were arrested.  They just happen to be illegal aliens as well.

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