Why Private Prisons Will Lock Up Your Returns

Pop quiz: What's a $74 billion industry with a potential customer pool of 1.6 million users, a monthly membership cost of $1,500, and a retention rate that would leave Sirius XM or Netflix drooling? The answer: private prisons. However, a critical look at the failings and financial fudging of these corporations reveals several reasons why this sector is destined for destruction.

A history of private prisons, abridged
Private prison companies offer the public sector something very valuable: a buyout contract with immediate revenue in exchange for incremental long-term cost. Ready to hand over the keys, decision makers from police chiefs to the federal government are happy to wash their hands of prison management and enjoy some extra cash while they're at it. Private prison companies are sweetening the deal even more with campaign contributions and promises of new jobs.

From 2000 to 2010, the number of inmates kept in private prisons rose nearly 50%, from 87,000 to 128,000. While this amounts to less than 10% of all prisoners nationwide, it represents a serious trend toward privatization as budget-squeezed states look for ways to cut costs.

The wardens
Corrections Corporation of America
(NYSE: CXW  ) and GEO Group (NYSE: GEO  ) hold half of all prison contracts and collectively pulled in $3.3 billion in revenue for fiscal year 2011. In an industry that lives by economies of scale, CCA enjoys a net profit margin of 9% -- nearly double that of GEO Group. However, both companies have seen decreases in net profit margins over the last four years, even as revenue has consistently risen. This is due in large part to decreases in prison occupancy rates. Like for Superman, less crime means less business for these companies.

In terms of stock price, CCA is trading about 25% higher than my purely quantitative calculation of intrinsic value. But a fundamental analysis of these companies and the industry at large shines an even brighter light on its dark future.

Bad news for prison blues
At a fundamental level, the mandate of a private prison is inherently different from that of a state-run institution. Whereas a state-run prison's motives center around ideals of rehabilitation and societal improvement, private prisons view inmates as a cost to society that should be minimized. While public prisons are no picnic, private prisons are known to consistently short-staff personnel, scrimp on guard training, shrink inmate medical-care services, and ignore facility maintenance.

A few tangible results from this economization include escaped felons, undisrupted gang violence, dysfunctional surveillance equipment, and cell-robbing, drug-dealing guards. In a period of 14 months at a CCA prison, there were 13 stabbings, two murders, and six violent escapes. The Department of Justice is investigating GEO Group for alleged staff sexual misconduct described as the "worst that we have seen in any facility anywhere in the nation." Now, remind me again who's supposed to be behind bars?

Cutting costs?
In an unprecedented 2010 report by the Arizona Department of Corrections, an "adjusted cost per capita" determined that private-prison costs are not significantly different in minimum-security prisons and are actually higher for medium-security prisons. "Adjusted" accounts for the fact that various private prison companies refuse to accept costly (i.e., violent, sick, and/or developmentally disabled) inmates. Looks like the bottom line just got a little fuzzy.

Source: Author, using data from Arizona Dept. of Corrections FY2010 Operating Per Capita Cost Report.

Did the prison bubble just burst?
In 2010, prison releases exceeded prison admissions for the first time since the Bureau of Justice Statistics began collecting data in 1977. Private-prison use has been falling since 2007 and has remained constant or negative over the past two years.

Source: Author, using data from Bureau of Justice Statistics.

A big increase in search-engine interest about privately managed correctional facilities suggests that the general public is paying attention, too.

Source: Author, using data from Google Trends.

And guess what the public owns? Stocks and votes. As public outcry continues to grow, contracts have already begun to flutter away. More than a third of CCA's contracts and approximately half of GEO's contracts expire in 2012, creating even more opportunities for governments to make their great escape. With no growth and no competitive advantage, it's only a matter of time until financial markets follow suit. Private prisons make neither sense nor cents, so make your break today.

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Fool contributor Justin Loiseau owns none of these stocks. You can follow him on Twitter @TMFJLo. Motley Fool newsletter services have recommended buying shares of Corrections Corporation of America. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 28, 2012, at 10:46 PM, bossman5000 wrote:

    One of the better articles I have read on Motley Fool.

  • Report this Comment On July 05, 2012, at 12:51 AM, bnemcik wrote:

    I recently was forced to retire from GeoCash (my nickname for this company). The facts presented in this article are right on the money. GEO cut everything they could to make a buck. $$$ was all that mattered. There is nothing the matter with making profit, but when it comes at the expense of quality care and professional ethics, this cannot be tolerated. Prisons should be run by the state not for profit companies. There is an inherent conflict of interest in making money on human misery. There is no real savings in privatizing the prison system because all that happens is the money flows to the top of the corporation and upper management makes huge profits and those who actually do the work make peanuts. CCA and GEO are both mercenary companies and need to be eliminated from the public dole.

  • Report this Comment On July 09, 2012, at 3:42 PM, CathrynMataga wrote:

    I'm putting together my imaginary Dr. Evil stock portfolio, Prisons are going to figure promimently.

  • Report this Comment On August 12, 2013, at 11:00 AM, Justin1977 wrote:

    Mercenary companies often get the dirty jobs done that nobody else wants. I'd rather it was a private company with horror stories about being inside than some bloated, state run nightmare that gives *criminals* everything they want. Make prison bad enough that people will actually think twice about committing crimes that will put them there. Scrimp on costs for food and medical treatment, putting profit first, instead of making sure that people who have done bad things in and to society have it better than a large number of people outside of prison. And lastly, let me make money off investing in them.

  • Report this Comment On June 26, 2014, at 1:49 PM, jessievera wrote:

    I never heard much about private prisons before. I wonder if there is an inmate lookup for those in private prisons. What type of criminals go to private vs state prison?

    Jessie | http://www.tonymadridbailbonds.com/

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