Private prisons are under significant political and social scrutiny. Companies like Geo Group and Core Civic have been accused of profiting off mass incarceration. With a potential Biden Presidency on the horizon, activist investors have an opportunity to cash in on a wild rollercoaster ride come November 3rd.
As many analysts on Wall Street have been calling for a Biden win as the most likely scenario, on par with most polling averages, others like DoubleLine Capital CEO Jeffrey Gundlach maintain the thesis that Trump, the underdog, can still win. Although some analysts maintain the belief that Biden and the Democrats can sweep both houses of Congress and take the White House in a landslide because of Trump’s low approval ratings, a Trump victory may still not be just a possibility, but a probability.
Gamblers who bet big on Hillary in 2016 now understand the concept that a 10%, 5%, or even lower odds may constitute high conviction, but not absolute certainty of outcome. Trump is currently behind in: all swing state polls, fundraising, and nearly all credible national polling averages. However, Biden’s Campaign Manager Jennifer O’Malley Dillion wrote in an internal memo to supporters, “If we learned anything from 2016, it’s that we cannot underestimate Donald Trump or his ability to claw his way back into contention in the final days of a campaign.”
So what does a Trump win, Biden win, or even contested election result have to do with Private Prisons? First of all what even is the business model?
The two biggest private prison operators, and the only two publicly traded prison operators in the U.S. are: GEO Group Inc. and CoreCivic Inc. Below are the companies own descriptions of their operations (GEO Group top, CoreCivic bottom):
These companies trade on the tickers $GEO and $CXW respectively on the NYSE. Recent stock performance of both companies has been abysmal, as the markets have been pricing in a Biden victory. The consensus on Wall Street is that because of these two companies’ largely questionable human rights and ESG track record, Democrats have had a strong political vendetta against the companies since 2016 in the form of restricting their growth by sidelining and cancelling state and federal contracts, which has pummeled their share prices.
Giving some context, the Obama Administration in August of 2016 announced that private prison operators would be “phased-out.” Sally Yates, the former attorney general said that the DOJ “would ultimately end” the use of private prisons on the federal level. This move completely walloped share prices of $GEO and $CXW, as their existing federal contracts wouldn’t be renewed. To investors they were dead…enter November 8th 2016, and Donald Trump wins the presidency. Shortly after the surprise victory $GEO and $CXW surge. After Trump is inaugurated in 2017, his now former attorney general Jeff Sessions completely reversed the Obama decision and the DOJ continued to renew GEO and CoreCivic contracts, and both organizations showed growth in controversial private ICE detention facilities after Trump’s overhaul of Immigration and Customs Enforcement. After this reversal, the shares continued to rocket higher and both $CXW and $GEO broke above $20 per share. After the Trump bump however, both $CXW and $GEO began and continued to fall as pensions, hedge funds and retail investors divested over ethical concerns and fears of a Biden win hurting future growth and earnings.
The companies have recently been battered by lawsuits over human rights abuses and subject to extreme political pressure. GEO Group recently filed a defamation lawsuit alleging that the Netflix Original Film 13th is a misleading description of their business. Both companies have invested in rebranding to fit with ESG standards. CoreCivic recently rebranded from Corrections Corporation of America to improve their corporate image. Despite the federal inmate population falling because of criminal justice reform, GEO has been expanding their unit mix of facilities to include foreign operations in Australia, South Africa and the U.K. GEO remains structured as a Real Estate Investment Trust, which means that the organization is mandated by the IRS to payout 90% of taxable income in dividends to shareholders in exchange for tax benefits. REITs are also required to have 75% of their assets invested in real estate, (either debt or equity) and they receive 75% of their gross income from rents or interest. Under this legal definition, prisons (the ugliest real estate) qualify as real estate investments. REITs were created as a way for real estate investors to pool their money together in mass to invest in apartments, homes, mortgages, etc.
GEO Group has retained their quarterly dividend, cutting it from $0.48 per share to $0.34 per share this year to deal with additional COVID expenses and conserve cash to pay off debts. CoreCivic has been “de-REITed” and has changed their structure from REIT back to C-corp and has eliminated their dividend to pay off debt, in the process improving their balance sheet, however also incurring massive tax liabilities. Investors have punished GEO Group shares, even after the dividend cut the stock still yields more than 12%.
Another worry of investors, is both companies’ large amount of debt, with notes coming due in the next few years it poses a problem for firms like GEO, who can’t get American banks to underwrite bond offerings because of the extreme political pressure to divest. GEO Group management intends to go to foreign banks to underwrite their bond offerings in dollars, although more expensive, working with Deutsche Bank or Nomura would likely be their only alternative to roll over their debt.
GEO Group and CoreCivic shares have been on a massive rut over the last few months as investors have been pricing in a Biden win. If Biden does win and the stocks “knee-jerk” lower, GEO Group’s very high dividend yield and undervalued fundamentals will likely attract further investment.
Ultimately, GEO and CoreCivic present a contrarian investment set-up. Both investments are shunned for ethical concerns. Pension funds are selling, big banks are divesting and no one wants to be associated with the train wreck of negative publicity these firms have faced. Bulls argue that despite ethical concerns, the political rhetoric is overplayed and that massive funding short-falls for the Bureau of Prisons, combined with the U.S. government’s inability to manage these facilities, makes a full on ban on private prisons in one presidential term nearly impossible and a logistics and management nightmare for the Bureau of Prisons. Bulls further argue that even a Democrat sweep would only affect contracts on the federal level. Red States in the southeast along with Texas are unlikely to follow, as these companies have a large percentage of their facility unit mix invested in state and foreign prisons, they are therefore not completely reliant on federal contracts.
Owning a “political stock” has to be really interesting, especially in 2020. The bearish case is that Biden wins and private prisons have their contracts pulled from out under them or are substantially phased-out. This conclusion is unlikely and in some instances legally impossible as many of these contracts are long-term and GEO and CoreCivic in many cases actually own the underlying real estate and are engaged in leasing agreements with state and federal governments. Some see the federal government immediately taking over the management of hundreds of large prisons as unrealistic. Both companies have been trying to improve their balance sheets by paying off debts and diversifying growth globally. Whether GEO and CoreCivic are good long-term holds despite the headwind of ESG and ethical concerns, is still locked in the crystal ball. Right now it’s all about the election.
Companies like GEO and CoreCivic are contrarian investments. Whether you think Trump delivers another surprise victory on November 3rd, or Biden performs in-line with polling averages, private prison stocks will likely face significant volatility in the weeks ahead. Savvy options speculators anticipating extreme price volatility in either direction could either “strangle” or “straddle” puts and calls on $CXW and $GEO to profit from a large bear or bull move. The argument can be made that if Biden wins these stocks may fall less than they would rise if Trump wins because Biden victory sentiment may already be priced in ahead of November 3rd, while a Trump win would be unexpected.
Historically, volatility bets can generate significant capital gains in the event of extreme political uncertainty. $GEO and $CXW are no exception. Savvy activist or contrarian investors looking to short these stocks ahead of a Biden win, or looking to speculate on an asymmetric payoff in the event of a Trump win, have something to analyze. Major changes in investor sentiment may come after the election, undervalued fundamentals, and an already priced-in Biden victory provide risks to the short-term election volatility thesis for $CXW and $GEO.
Disclaimer: the author Kevin Habek is not a registered financial advisor. This article constitutes the opinion of the author and should not be misconstrued as financial or investment advice. Derivatives and options speculation is highly risky and investors employing these investment strategies run the risk of losing all or more than their original invested principal. The author recommends readers perform their own research and due diligence and consult with a qualified investment professional before entering into any investments. The article in reference: “Private Prisons are Betting the Farm on a Trump Win” by Kevin Habek, is designed for entertainment and informational purposes only.