Strong Cash Flows Support Private Correctional Firms’ Credit Profiles

By Jane Cotroneo, Moody's Investors Service

Similar to REITs and real estate operating companies, private correctional companies have contractual revenues for their facilities, providing a steady stream of earnings. Unlike REITs, these companies are not required to pay a dividend. Instead, they have chosen to invest their free cash flow into increasing their number of contracted beds.

Similar to REITs and real estate operating companies, private correctional companies have contractual revenues for their facilities, providing a steady stream of earnings. Unlike REITs, these companies are not required to pay a dividend. Instead, they have chosen to invest their free cash flow into increasing their number of contracted beds.

Over the last several years, the two private correctional companies that Moody’s rates, Corrections Corp of America and The Geo Group have dramatically increased revenues, clearly enhancing their leadership in the industry. Corrections Corp’s annualized revenues have grown to $1.7 billion from $1.3 billion in 2006 and Geo’s to an estimated $1.6 billion from $744 million over the same time period. They have accomplished this growth through significant development and expansion of facilities as well as industry consolidation.

Increased revenues have translated into greater cash flow, strengthened coverage ratios and improved margins. Geo’s fully loaded fixed charge coverage has strengthened to 2.2x in 2010 from 1.5x in 2006 and CXW’s has also improved to 2.5x from 2.3x. Operating margins have been one rating focal point and have trended higher over the last few years. GEO’s grew to 18.0 percent in 2010 from 13.1 percent and Corrections Corp’s increased to 25.5 percent from 22.6 percent. Leverage is considered solid, typically ranging between 2.5x and 3.5x debt to earnings before interest, taxes, depreciation and amortization. Corrections Corp’s improved to 2.7x in 2010 from 3.2x in 2006. Geo’s leverage, though still considered good, jumped to 4.6x following its acquisition spree yet is expected to moderate back to its historical range over the next several quarters as the company applies cash from operations to pay down debt.

Clients include federal, state and local governments as well as international entities. These clients have turned to U.S. private correctional companies to alleviate overcrowding at their own facilities as prison populations have swelled over the last few decades. Federal prisons are currently operating at 136 percent of capacity and are increasingly turning to the private correctional companies, who can quickly build facilities as needed.

Demand for beds has been strong, however, some uncertainty lies ahead. While federal demand shows no signs of easing, state and local governments present a mixed picture. Statistics from 2008-2009 show 26 state governments reduced prison populations while 24 states increased them. State policy-makers have looked to reduce prison populations through the early release of non-violent prisoners, and through programs to address the high rate of recidivism, which have had some success.

Credit concerns for the industry currently center on government budget deficits as contracts could be cancelled or per diem usage reduced. So far such reductions have not been significant. Ongoing credit considerations also include the special purpose nature of prisons and limited re-use possibilities as well as the industry’s vulnerability to shifts in public opinion.