GEO Group Needs A Strategic Reset

Summary

• We believe GEO needs to immediately pivot its strategy to deal with the realities of the current political climate to protect shareholder value.
• We urge GEO to begin negotiations with the US Bureau of Prisons (BOP) and United States Marshals Service (USMS) to sell or lease Company-owned facilities to these government entities.
• We have identified 30 facilities that GEO should immediately seek to sell. These facilities encompass 24k beds and we believe GEO could monetize these assets for $1.9 – 2 billion.
• We believe the intrinsic value of the GEO equity is $14-15 per share, but it will require the Company to pivot its strategy.

The GEO Group (NYSE:GEO, the “Company”) jarred investors yesterday when it announced that it was suspending the quarterly dividend payments and undertaking a review of the Company’s structure as a REIT. The goal, according to GEO, is to maximize the use of cash flows to repay debt, deleverage, and internally fund growth. GEO did not explicitly say it will abandon the REIT structure, but we believe this is a foregone conclusion as the Company follows in the steps of CoreCivic (CXW), which abandoned the REIT structure at the end of 2020.

Given that GEO’s stock was primarily owned by income investors who coveted the predictable dividend stream and presumable safe government counterparties, we are not surprised the stock was down -20% yesterday and another -6% today to a 15-year low. We believe GEO is at an existential crossroad and the Company needs to immediately pivot its strategy to deal with the realities of the current political climate in an effort to protect shareholder value.

We propose the Company immediately embarks on the following initiatives:

• Begin negotiations with the United States Bureau of Prisons (BOP) and United States Marshals Services (USMS) to sell or lease Company-owned facilities to these government entities.
• Adopt a mindset that private prisons are not a growth industry and adjust its corporate strategy accordingly. The Board should be focused on enhancing intrinsic value per share, rather than absolute size metrics like total revenue or total beds.
• Recognize the value of GEO is now in its assets, not its future earnings.
• Conduct a thorough review of the facilities the Company is leasing from other owners and develop a strategy for letting these leases expire if the facilities do not have secure contracts in place and provide an adequate return for GEO.
• Pause all growth capital expenditures and focus instead on maintenance capital expenditures, with the goal of improving occupancy at existing Company-owned facilities.

The operating environment was fundamentally altered when President Biden issued the Executive Order

We believe the operating environment for GEO was fundamentally altered when President Biden issued the Executive Order on Reforming Our Incarceration System to Eliminate the Use of Privately Operated Criminal Detention Facilities on January 26, 2021. We are not interested in debating whether or not this is good government policy. The reality is that the US Department of Justice - via the Federal Bureau of Prisons (BOP) and the US Marshalls Service (USMS)- accounted for approximately 25% of the total revenue for GEO and CXW. We realize that the political pendulum swings left and right, but we don’t see this policy reversing until 2024 at the earliest. GEO cannot afford to sit around and hope the political winds will eventually shift. The Company needs to be proactive in monetizing its assets on behalf of shareholders. We urge GEO to begin negotiations with the United States Bureau of Prisons (BOP) and United States Marshals Services (USMS) to sell or lease Company-owned facilities to these government entities. The USMS does not have any of its own detention facilities, so presumably it is going to need to buy or lease facilities in order to continue to operate.

The Board needs to adopt a mindset that private prisons are not a growth industry and adjust its corporate strategy accordingly

It is clear that private prisons will not be a growth industry for the foreseeable future. GEO should takes steps to shrink the Company and focus on enhancing intrinsic value per share, rather than absolute size metrics like total revenue or total beds in the portfolio. We find it absurd that GEO listed a desire to “internally fund growth” as a reason for suspending the dividend. There is no growth for the foreseeable future and the sooner the Board recognizes this, the better the prospects for enhancing shareholder value.

The tobacco industry is a great example of how good management can still create significant shareholder value despite a shrinking industry. In the past 10 years, Altria Group (MO) has generated a total return of +226% whereas GEO has generated a loss of -20%, even after including all of the dividend payments.

We believe GEO needs to pivot its corporate strategy to maximize intrinsic value on a per share basis. We believe this can be achieved by monetizing its valuable assets that are currently idle or underutilized, eliminating growth capital expenditures, and developing a share repurchase strategy for when the balance sheet is properly deleveraged.

The value of GEO is now in its assets, not its future earnings

GEO’s stock price is currently trading at the highly distressed valuation of 3x cash flow. Clearly, “the market” does not believe the earnings power of the business is sustainable. Despite us being a GEO shareholder, we agree with “the market” that the earnings power of GEO has been impaired for the foreseeable future. That said, we do not believe the value of the Company’s assets have been meaningfully impaired. The intrinsic value of GEO is now derived from its assets, not its future earnings. We have identified 30 facilities that are either currently idle or contracted with the BOP or USMS that GEO should immediately seek to sell. These facilities encompass 24,200 beds and we believe GEO could monetize these assets for $1.9 – 2 billion. GEO currently has approximately $2.65 billion of net debt. Monetizing the assets we have identified would pay off the majority of the Company’s debt and still leave shareholders with a very profitable operating company that could initiate share buybacks or resume cash dividends. We believe our estimate of the value that GEO could unlock is conservative given the replacement cost of new detention facility construction and the fact that some of these properties are located in valuable urban cores such as San Francisco, Oakland, Queens NY, and Indianapolis.

GEO and the federal government can create a win/win outcome

If the federal government is going to eliminate contracts with private operators, it will need to increase its prison capacity. Our underlying assumption is that prison populations will increase from 2020 levels as the COVID impact wanes and will return to pre-pandemic levels over time. We believe GEO can offer the federal government an easy and cost-effective solution to its pending capacity squeeze by selling or leasing facilities to the government. We believe this would remove the “for profit” optics of the Company-owned & operated facilities.

The US government is notorious for inefficient spending and the BOP has kept that traditional alive. There have not been many new prisons built by the federal government in recent years, but the few that have been built or proposed have a price tag of 3-7x the implied replacement cost of the GEO portfolio. With GEO’s stock currently trading below $6 per share, the value of its Company-owned portfolio (56,534 beds) is approximately $59,500 per bed. The most recent facility built by the BOP, the FCI Danbury Female Camp, cost $181k per bed to build. The FCI Leavenworth facility in Kansas, which is currently being proposed as a replacement for the existing facility, will have a price tag equal to $252k per bed. These two facilities actually look like a bargain compared to the BOP Letcher County facility in Kentucky that was proposed at a cost of $420k per bed. Fortunately for tax payers, the Letcher County project was cancelled in 2019.

Exhibit A:

The most conservative comps for prison construction costs comes from the Office of the Inspector General’s audit of the Federal BOP’s prison construction program that took place in the early 2000’s. At the time, the BOP was building 13 prisons at an estimated cost of $1.6 billion (see Exhibit B). These projects in aggregate were built for a cost of $106,142 per bed. Adjusted for inflation, these construction costs would be $154,297 per bed today.

Exhibit B:

As shown in Exhibit A, the GEO portfolio is currently valued at a massive discount to its replacement cost. We urge GEO to immediately take steps to close this gap by monetizing non-core, underutilized, and at-risk assets. It would be much cheaper for the federal government to buy (or lease) existing facilities from GEO than it would be for them to build new ones. These government agencies are going to need capacity in the very near-term, so this should be a favorable environment for GEO to sell assets.

There are examples of the BOP buying existing prisons in the past. For example, the BOP purchased the Thomson Correctional Center (2,100 beds) from the state of Illinois in 2012 for $165m. This purchase price equated to a value per bed of $78,571 (Exhibit C). This transaction occurred in 2012 and is not adjusted for inflation. If we assume that the GEO portfolio is worth a similar amount on a per bed basis, the equity value of GEO is approximately $14.90 per share. We believe valuing the GEO portfolio at $78k per bed is conservative; this would equate to a 50% discount from our estimate of the inflation-adjusted costs of the BOP prisons that were built in early 2000’s ($154,297 per bed, see Exhibit A & B).

Exhibit C:

Our estimated value of $78k per GEO bed would result in an enterprise value of $4.4billion for GEO. We believe this value is reasonable given that GEO has traded at an average enterprise value of $5 billion over the past five years.

Closing Remarks

In closing, we believe the GEO Board has a duty to shareholders to protect the intrinsic value of the Company by monetizing assets and shrinking its portfolio to reflect the new operating environment in the United States. In the same way that Macy’s Herald Square building in New York has retained its value, despite the Macy’s operating business declining, we believe GEO’s assets are still valuable and are not being properly valued by the public market. We believe the intrinsic value of GEO is $14-15 per share, but it will require the Company to pivot its strategy. We believe management’s old strategy of growing the portfolio was appropriate at the time, but the environment has changed and GEO needs to adjust its strategy in order to protect shareholder value.

Analyst’s Disclosure: I am/we are long GEO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The author and/or employer may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be accurate as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. This article represents best efforts to convey a fact-based opinion. My conclusions may be incorrect. This is not a recommendation to buy or sell any securities. I am long GEO and may change my position at any time without notice.

Comments

[Jcb331]

holy cow. $8.50 up 33%

[Navy Fightin' Blue]

GEO going to run up huge today. Deep value play that nobody wants to own. I believe it will be a multi-bagger in the next several years.

[5733621]

@Johnny Wad Is there any reason that it's rising premarket?

[Navy Fightin' Blue]

@5733621 Massive short squeeze.

[5733621]

@Johnny Wad Evidence for that? Just curious.

[6228371]

Hugh, there are two very interesting, very cheap South African stocks that I suggest you look at. They are SBSW and NPSNY. SBSW is the largest miner of rhodium and platinum, and second largest palladium miner. The stock is trading at under 4 times 2021 expected earnings. They have more cash than debt, and pay high dividends.

NPSNY is the largest South African company. Their 72.5% owned subsidiary Prosus owns 28.9% of Tencent. Prosus and Naspers have other investments as well, and more cash than debt. Naspers itrading at well under just the value of the Tencent stake, and is at around half its NAV.
Naspers invested $32 million in Tencent 20 years ago. Even after selling around $25 billion of the holding, the remainder is worth over $200 billion.

[Hugh Akston Investments]

This news today is the blueprint for GEO and CXW to navigate the Biden Executive Order....

CLEVELAND, Ohio — Authorities on Thursday agreed to a contract that will keep inmates at a pretrial detention facility in Northeast Ohio, a move that prevents federal officials from shipping 350 detainees to Pennsylvania.

The Northeast Ohio Correctional Center, a facility in Youngstown owned by private corrections company CoreCivic, will continue to house federal inmates through a compromise with the Mahoning County Sheriff’s Department. The U.S. Marshals Service has contracted with the company since the early 2000s.

The issue became clouded after President Biden took office and ordered a stop of federal contracts with private prisons. CoreCivic’s contract with the marshals ended in March, but it was extended to the end of this month.

Federal court officials in Cleveland feared that marshals would move inmates to a federal facility in Lewisburg, Pennsylvania, which is more than five hours from Cleveland. They became concerned about how defense attorneys would be able to defend their clients because of the distance.

Because Biden’s order prevented a contract between CoreCivic and the marshals, the issue appeared dead. But Mahoning County Sheriff Jerry Greene stepped in.

Greene, fearing a loss of jobs in the region, offered a plan to lease a section of CoreCivic’s facility and let his corrections officers monitor the inmates. That plan fell through.

Greene then sought for his office to contract with CoreCivic to monitor the inmates. The marshals would then reimburse Greene’s office the cost of the agreement. The deal was finalized this week.

In simple terms, instead of the marshals paying CoreCivic, they are paying Greene’s office to pay the company.

“This is an awesome deal for this area, as it keeps people working, and it is incredibly important for the marshals, as they don’t have people scattered all over,” Greene said.

On Thursday, the Mahoning County commissioners approved the three-year contract with CoreCivic in what they called “an intergovernmental agreement.”

“We’re relieved that our clients won’t be moved,” said Stephen Newman, the federal public defender for northern Ohio. “We’re glad that we will continue to be able to have access to them in a place that is close by.”

The facility houses about 600 inmates awaiting trial or sentencing in federal courts in Akron, Youngstown and Cleveland.

It also has about 850 prisoners from the Ohio Department of Rehabilitation and Correction. It is one of three privately run facilities that contracts with the state.

U.S. Marshal Peter Elliott thanked Greene and cited the work of U.S. District Judge Patricia Gaughan, Newman and U.S. Sen. Sherrod Brown, as well as the Marshal Service’s headquarters. He said the officials worked with the Justice Department and White House to make the agreement possible.

A spokeswoman for CoreCivic did not return messages seeking comment.

[chankay]

@Hugh Akston Investments Interesting, anything / some nuance preventing GEO from following this same approach?

[mhansensdca]

@Hugh Akston Investments Good find. I don't see this happening with other facilities, but perhaps it will catch on.

[rdsm]

@Hugh Akston Investments Thanks for the update. Creative solution.

[GuyRien1]

Crap I thought $6 was the bottom after the strong guidance. But now we are going to get below $5

[Stockmir]

They recently sold their interest in the Talbot Hall reentry center in New Jersey, resulting in net proceeds to GEO of $13,2m which counts 536 beds (~$25k/bed). They also marketed eight of its idle facilities to potential customers, for example: is D. Ray James Correctional Facility with 1900 beds valued $53,946m (~$29k/bed), Moshannon Valley Correctional Facility with 1878 beds at $56,47m (~$30k/bed), and many other. You get the point: all of them already sold or about to be sold at a price very far off your estimates. What do you think about it?

[GuyRien1]

@Stockmir When you say "very far off your estimates" who and what are you referring to? You seem to have some good insight but at least I don't understand the context.

[Stockmir]

@GuyRien1 Sorry, I didn’t express my thought properly. What I meant was that by reading the last GEO’s filings I saw all these data so I calculated the average price/bed which is not even close to what the author considered in the article in order to justify his stock valuation. My question was directed to him, I wanted to know if he has something to add after these new data came out.

[GuyRien1]

@Stockmir This is a fair piont. The fact that the 2026 bonds are trading at a 35% discount to face value is astounding. It seems many think this company is going BK.

[atpalpha]

There’s a simple solution to the problem facing GEO and CXW. Just give Biden’s son Hunter a sweetheart deal where he can sit on the boards of the companies, do nothing of course, and collect a few million bucks in the process. I’m sure things will work out just fine. It worked well for the Russians with their natural gas pipeline to Germany and the Chinese will soon be collecting on their most bizarre investment arrangement with the Biden and Kerry boys. You gotta think like a criminal to do business with a criminal. You’d think these private prison companies would know that, given their clientele. Wink Wink 😉

[Ronan111]

sad news, Burry sold all of his GEO position

[Maschuette]

@Ronan111 Yes he did. He bought GEO in 4th quarter when the stock was at $10. What a stupid purchase right? It was a covered call. He was shorting GEO because he was betting that Biden was going to do the executive order and that GEO would drop their dividend which would drop their price. Why else would he have a larger position in GEO than in CXW when CXW was clearly a better investment.

[Maschuette]

@Ronan111 Also, he added shares in CXW over the same period (he is still holding and bought more). GEO didnt cut their dividend until early april but the 13F is only till March. So he probably exercised his short position when Biden did the executive order on both GEO and CXW, sold his GEO stock, clearly held his CXW stock, and then i am guess that he bought back GEO after they cut their dividend in April. Especially after he saw the CXW rebound.

[4Logos]

@Maschuette so is he long CXW right now?

[OscarSmith]

any thoughts following the amazing earnings?

[Clark158f1]

@OscarSmith

The results were really good but they have a long way to go. If you see it in the $ 5's its a strong buy. I got some $ 5.90 on the last dip and sold for .35.

Another option would be to sell puts at the $ 6 strike. You either get the stock put to you or the option expires worthless. Seems like a low risk play to me.

I'll buy it back if it drops but it doesn't look good today.....still holding my core position.

[worldly]

@Clark158f1 do you think it is a risky long term hold if one bought in the low 20's?

TIA

[Clark158f1]

@worldly

Its not risky if you bought in the $ 20's. You have already lost as much money as you possibly can imo. The problem is it will take alot of time to recover.

My basis is really low so I'm selling covered calls.

[Charlie's Munger]

New Geo bonds are at sub level - thats how desperate they are

[J D R]

Thoughts on the bonds, anyone?
I expected them tho rise after the dividend cancellation, but they dropped further in price.
The one due in 2026 offers over 16%/yr return now.

[6228371]

@UUII

Why buy the bonds when you can buy the stock? If you are bullish on the company then buy the stock. Otherwise avoid both the stock and the bonds.

[J D R]

@6228371 What if I'm not bullish on the company but content that they will be able to service the debt one way or the other? Thanks for the comment.

[6228371]

@UUII

"@6228371 What if I'm not bullish on the company but content that they will be able to service the debt one way or the other? Thanks for the comment."

The bonds might not go up so much. I don't even know how liquid they are. Are you thinking about buying the bonds and holding them to maturity?

[Arbitrage- Technologies]

1- USMS and BOP will have to increase their beds one time or another
2- They will not build because of time shortage or costs.
3- Biden order is a marketing/makeup

prisons are just playing the clock, and its smart, they don't pay nothing until rep. will come back in 2024 or usms/bop have no choice to contract with them again...really guys, who could reasonably think that its the end of prisons?!?!

i am long geo and cxw, and i am happy with their policy to improve their balance sheet by cutting the div...

prisons are nor good or bad, they are just a need like we need electric power grid...sorry to choc everybody but that the truth reality

[Baloney Sandwitch]

@Arbitrage- Technologies How can we account for the fact that more of the US population is incarcerated than any almost any other country in the world? www.statista.com/...

[Dollarman1971]

@Baloney Sandwitch That we are obviously not putting prisoners to death quickly enough.

[Arbitrage- Technologies]

@Baloney Sandwitch that true. In My country, France, people do not go to jail for everything. but the true questions is NOT to ask the sates of usa to not use prison, but to reform the us Justice code...unfortunatelly, this will not be achieved by any president (too hard, too long). thats why i write that biden order is a makeup. Financially and sadly speaking, prisons have long future until the Justice system will not be reshaped...

[Clark158f1]

Hearing Big News next week....Time will tell

CXW above $ 8 again...Conference call was good.

If we have a good call I expect a nice bounce higher

[ppmaj86]

Well I don't think the goverment would buy the prison for 1,9-2 BN dollars when the whole GEO group is worth now about 600 mln. I'm guessing that 1 BLN would be enough to make it private.

[6228371]

@ppmaj86

"Well I don't think the goverment would buy the prison for 1,9-2 BN dollars when the whole GEO group is worth now about 600 mln. I'm guessing that 1 BLN would be enough to make it private."

The enterprise value of GEO is $3.45 billion.

[TundraXD]

@ppmaj86 Market cap does not take into account assets and liabilities.

[Maschuette]

@TundraXD I think what he is saying is why would the government give 4 billion dollars to GEO when they could purchase the entire business through stock purchases for 600 million. Which is a valid point.

[GuyRien1]

On State replacements for Fed facilities.

I hold both GEO and CXW long but I wouldn't get your hopes up. For one thing we don't know whether the cost per bed will be the same for state versus federal contracts. If I were a state, I believe I would be in a position of power to negotiate hard.

[chankay]

@GuyRien1 Perhaps, but assuming the state is willing to sit down because they themselves are running out of space, now is not the best time to build it yourself due the outrageous supply shortages and inflation going around. So that balances it back in GEO favor. If states genuinely anticipate needing space they probably should not get too cute.

[Maschuette]

@GuyRien1 The states dont want to lose these prisons and the jobs they bring. They are probably approaching each other on equal terms because both want a deal that will avoid shutdown.

[anomaly1]

next conference call or news should reveal asset sale(s) and/or progress

[anomaly1]

@anomaly1 selling or leasing facilities to the government

[Clark158f1]

Just listened to the CXW conference call. It went very well with plans for facilities that were going to be vacated which were well along into the process of obtaining replaceent occupants.

If the GEO conference call goes as well I will be very pleased.

[chankay]

@Clark158f1 what are they doing with plans for facilities that are going to be vacated?

[Maschuette]

@chankay They said they are in talks with the state of Ohio to take over the Ohio facility and they have already found other states to take over the other facilities that are expiring in September and December. The USMS only rented out a portion of these facilities. They are also still in contact with the USMS to discuss ways to work together.

[4Logos]

@Clark158f1 thanks Clark...why is it tanking then?

If GEO can look forward to 6% decline after the earnings release, don't you think we should wait to enter?

[anomaly1]

"Nearly 100 COVID-infected migrants transferred to Aurora ICE facility amid surge in border crossings."

# of migrants detained are increasing. Impossible to close ICE detention centers. Government (Biden) can't house the detainees wihtout GEo Group.

[Baloney Sandwitch]

Lock em up.

[4Logos]

@Baloney Sandwitch "em" is a gender neutral term, and I think offensive now ...it has a male connotation...do you me "her", as in Hillary, or him more broadly, or 50 shades of gender, constantly morning before our eyes?

Just curious

[Clark158f1]

I'm still expecting GEO to blast higher as earnings are announced. If we also get good news along with the earnings I agree that $ 8 would happen almost instantly with the number of shorts in the stock.

$ 5.50 was solid with buyers all over it.

[GuyRien1]

Short squeeze coming?

There is a Bloomerg article today (see Ameritrade news) driving up CXW (10%) and GEO (5%).

[KarenP07]

@GuyRien1

You can't predict short squeezes but Bloomberg thinks things are turning around. If they are right we could be in the $ 8's in a blink of the eye.

[Maschuette]

@GuyRien1 I cant find this article. Do you have a link?

[GuyRien1]

@Maschuette Yeah, it's hard to find and SA doesn't do a great job with these articles.

Here it is:

www.wsj.com/...