By Simon Lack
This week we’ve been adding to a couple of names we like, and re-entering an old favorite.
Corrections Corp. (CXW) is the largest operator of prisons in the U.S. It’s a recession-proof business that is well positioned to benefit from the pressure on many states to cut costs. Federal and state governments are inefficient operators of prisons, in part because of their unionized workforces. Growing prison populations combined with budget pressures and further prison overcrowding are going to increase the use of private sector solutions. 18 states are operating at 100% or more of capacity, with the Federal Bureau of Prisons at nearly 140% and California at 204% (as of December 2008). Only 8.9% of the prison population is in private prisons, and CXW has 45% of the market. CXW can build prisons for around $55-65,000 versus $80-250,000 for government agencies, and can operate prisons at much cheaper rates (their most recent quarter recorded revenue-per-prisoner-per-day of $58.48, as much as 50% below public sector costs and still generating a 32% operating margin).
At $24, CXW trades at around 17X next year’s earnings – not ridiculously cheap but 10% lower than it was in October. They have a good balance sheet with Debt:Equity of only 0.85 and through the first nine months of this year had repurchased $131MM of stock. CXW is one of our core holdings.
Coeur d’Alene (CDE) began to look attractive this week as gold and silver sold off. CDE is valued by our estimation at around a 25% discount to the present value of its proved and probable reserves (net of extraction costs, G&A and taxes), which is a somewhat wider discount than in the past. We prefer exposure to silver rather than gold given its highly inelastic demand and supply combined with high industrial usage (whereas gold is largely owned for speculation or investment). However, with the Kensington mine in Alaska becoming operation last year gold now makes up 38% of their revenues (as of 3Q10).
We had lost interest in CDE during the run up in gold and silver prices during November-December. However, some of the more recent and weaker speculators in bullion are in the process of being flushed out, and as a consequence we started to build a small position in CDE. We may be unfortunate in that prices could rebound from here, but hopefully the resolve of gold and silver bulls will be further tested in the weeks ahead, in which case we will gradually build our position.
Borders Group (BGP) is a highly speculative and small position that we have. There is of course a very real risk that they will go bankrupt and we will lose our investment. Revenues are falling; they recently delayed payment to their publishers; their CIO and general counsel both resigned; and Barnes and Noble apparently doesn’t want to merge (which would certainly solve Borders’ problem but would also help Barnes and Noble by closing overlapping stores, reducing IT capex and S,G&A while they compete with Amazon). Everything looks about as bad as it could for the company – even the nice people on Fast Money think it’s going down.
So it is an unloved stock. But BGP will generate $2-2.5BN in revenue in 2011, largely from its physical bookstores. Although they’re losing money, physical bookstores are not going away anytime soon and if they could just earn a 3% margin (roughly what supermarkets do) they could generate $60-$75MM in net income, compared with their market cap of $66MM.
And while the stock is priced as if bankruptcy looms, the stakeholders won’t clearly benefit from this. Publishers (who own most of the BGP debt in the form of payables on books) clearly want the #2 physical bookseller to survive if at all possible; BGP has only $56MM of long term debt; Bill Ackman and Bennett LeBow together own 53%% of the company (66% if warrants at $2.25 owned by LeBow move into the money).
Although Bill Ackman clearly got into this too early, he stands to do so much better out of a surviving BGP than a bankrupt one. Having offered to finance a takeover of BKS by BGP by providing $900MM in debt, he clearly has the resources to meet near term negative operating cashflow ($95MM during the first nine months of 2010) while they either restructure the company or find some other way to turn $2BN of annual revenue into a profit. So BGP is highly speculative, but is an interesting risk/reward.