Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Corrections Corporation Of America Is A Low Risk, High Uncertainty Play (Wrote On 2016/10/12)

|Includes: CoreCivic, Inc. (CXW)

Since I deleted my personal blog from blogspot in order to concentrate my energy on Seeking Alpha alone, I just want to save an article that I wrote before here for record.

I. Introduction

Corrections Corporation of America (NYSE: CXW) is America's largest owner of partnership correctional, detention, and reentry facilities. It is a real estate investment trust (REIT).

With the recent news that:

  • the Bureau of Prisons (BOP) will phase out private prison contracts with the eventual goal of eliminating their use in the federal prison system
  • the Department of Homeland Security (NYSEARCA:DHS) indicated that it might discontinue the use of private prison operators
  • Hillary's tweets that called for end of private prisons

There are a lot of political headwinds for CXW. While politics is one thing, the reality is different. Private prisons may not be a pleasant thing, but it costs less than public prisons, at least on paper. Government officials tend to be slow to change course, and with documents that show private prisons can save money, it is hard for officials to end contracts with the private prison. State budgets are tight, so I found it unrealistic for states to build their own prisons. My guess is that the federal government and some state governments will lend prisons from the existing private prison owners, but the government will be in charge of the operations. The progress will be slow, and CXW will have plenty of time to adjust.

II. Qualitative evaluation

Economic moats:

  • Barriers to entry: It is very hard to build a private prison. The business model involves a lot of business relationships with the government officials as well.

Good's:

  • The United States government, being democratic, is slow to change so that any political risk can be handled by the company in a smooth transition manner.
  • The business is immune to economic cycles.
  • Stable and reliable revenue stream because the customers are government agencies.

Bad's

  • Running a private prison is not a business with high morale.
  • Political risk, especially from the soon-to-be president Hillary Clinton. However, from my understanding of Hillary, she will not push too hard on the incumbents like Corrections Corporation of America and The GEO group.

III. Sweeteners

The insiders including the CEO had purchased a bit over 20,000 shares in August, right after the tweets from Hillary which called for the end of private prison. This is an encouraging sign.

IV. Valuation

I like to calculate a "buy limit" in valuation. A buy limit is the maximum price that I would pay for the stock.

My minimum return of an investment is 10%, independent of inflation. For CXW, I use a required return of 10% with no assumption of perpetual growth so that I can calculate my buy limit with a simple ten times of CSOE (conservatively-speaking owner earnings).

I get CSOE by starting with the 2016 full year outlook from 2016 Q2 earning, which has normalized FFO at $2.64 per share. Share-based compensation is about 5% of it, so $0.13. I assume the revenue coming from the federal government (which is about 51% of the company's revenue) will have a 50% impact, translated to 25% impact in FFO. I assume there is minimal impact on the rest of the revenue. That leads to:

CSOE = $2.64 * (1 - 25%) - 0.13 = $1.85.

My buy limit is thus 10 * $1.85 = $18.50 per share.

While there is uncertainty regarding the future business model of the company coming from the government, the stock has very low risk at current market price of around $14.50.

Disclaimer: I am not a licensed investment adviser. As I have no knowledge of individual investor circumstances, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. This article is for my personal opinion sharing and for informational purposes only - any opinion expressed in this article and elsewhere on the internet is not a form of investment advice provided to you. I use information in my articles I believe to be correct at the time of writing them, which information may or may not be accurate and may or may not be up-to-date. I am not liable for any losses suffered by any party because of any information published on this article. Beware, past performance is not a guarantee of future performance.

Disclosure: I am/we are long CXW.