In August, a decision by the U.S. Department of Justice put the business model of the for-profit prison system in doubt. The move injected a large dose of uncertainty into what had previously been considered a rather stable business.
The DOJ announced on August 18 that the federal government would take steps to curtail its use of private prisons.
Subsequently, shares in Corrections Corporation of America [$CXW] suffered a dramatic decline. Simultaneously, implied volatility for the stock skyrocketed, as the future prospects for the company were thrown into question.
Implied Volatilty for CXW spiked when the DOJ announced their decision. The measure had been in a range for the preceding several months around the 20 level, bouncing around between about 15 and 25. The announcement, it jumped suddenly above 91.
For more, visit CXW's Implied Volatility Charts page
The stock price plunged as well, dropping from above $27 to $17.57 the day the news broke. After an initial rebound, the slide resumed, with the stock now sitting below $15 (trading at $13.89 at this writing).
There was similar action in GEO Group [$GEO], the other major player in the sector. When the DOJ announcement took place, Implied Volatility jumped from around 25 to about 90. The stock price plunged from the previous day's close of $32.29 to finish at $19.51 the day following the announcement.
For both stocks, implied Volatility gave up a large amount of the initial spike, but the figure remains well above previous levels. For both, Implied Volatility is currently sitting in the mid-40s.
The ATM Straddle premium for the October 21 expiration for CXW is currently at $1.37, or 9.8%. For November 18, it is $2.97, or 21.3%.
Since the announcement, at least one lawfirm is building a class action lawsuit against the firm, arguing that company executives did not adequately inform shareholders about the risks. The basic argument is that the company should have kept shareholders better informed at how its prisons performed relative to government-operated prisons and should have offered more warning that the DOJ could cut back its relationship with CXW.
This week, Corrections Corporation of America announced that it is taking steps to lower costs in the wake of the recent setbacks. The company said it is cutting 50 to 55 corporate positions, about 12% of the workforce at its headquarters.
The company said this is part of a plan to diversify its business, a strategy "to grow [its] reentry and real estate platforms."
In its most recent earnings report, released two weeks before the DOJ announcement, the company, which is organized as a real estate investment trust, reported revenue of $463.3 million, up 0.9% from the previous year. FFO was $81.0 million, or $0.69 per share, down from $87.5 million, or $0.74 per share, last year. Net income fell to $57.6 million, compared to $65.3 million last year.
The federal government contributed about 51% of CXW's revenue in 2015. However, August's DOJ announcement only affected certain contracts within the federal Bureau of Prisons. Corrections Corp. also has contracts with the U.S. Immigration and Customs Enforcement, for example, which is not part of the Department of Justice, but instead is part of the Department of Homeland Security. The company also has contracts with other governments, such as state governments, which are unaffected by the announcement.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.