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Time to ‘Lock Up’ Shares in GEO Group?

August 26, 2009 | About:
The GEO Group is a world leader in providing private corrections and detention management, health, and mental health services to federal, state and local government agencies. With operations in the US, Australia, Canada, Cuba, South Africa, and the United Kingdom; GEO offers a diversified array of turnkey services which include design, construction, financing, and operations. Their unique approach allows GEO to provide high-quality and cost-effective services with state-of-the-art designs, innovative programs and ground-breaking treatment approaches.

Their turnkey solutions include:

• Facility Management

• Facility Operation

• Facility Maintenance

• Facility Design

• Infrastructure Financing

• Construction Management

• Residential/Special Needs Services

• Secure Prisoner Escort

• Court and Immigration Custody Services

Since its inception in 1984, GEO has become successfully established within the industry through their quality of service, innovative operational solutions, and efficient cost-effective operations.

To date, GEO manages 61 facilities encompassing approximately 60,000 beds world-wide. Their 13,000 professionals are dedicated to the safety and care of the 60,000 plus individuals assigned to our custody on behalf of federal, state, and local government agencies.

*********************************************************************************

GEO Group [NYSE:GEO] August 26, 2009: $17.95 /share

52-week range: $10.98 (Feb. 23, 2009) - $26.96 (Sep. 19, 2008)

GEO has posted excellent long-term growth in providing for the outsourcing of detention services. Here are their per share numbers as reported by Value Line:



Year .........Sales .........C/F ..........EPS .........B/V ...... Avg. P/E


2003 ........22.06 .......0.70 ........ 0.12 ........3.11 ........ 43.4x

2004 ........21.55 .......1.12 ........ 0.60 ........3.50 .........11.9x

2005 ........21.08 .......0.75 ........ 0.20 ........3.74 .........44.7x

2006 ........21.80 .......1.33 ........ 0.85 ........6.29 .........15.4x

2007 ........20.10 .......1.48 ........ 0.84 .......10.35 ........31.4x

2008 ........20.58 .......1.95 .........1.19 .......11.42 ........19.0x

2009* ......20.00 .......2.15 .........1.35 .......12.45 ........13.1x

* 2009 numbers include Value Line estimates

Well-timed secondary offerings in both 2006 and 2007 were accretive to B/V while holding back Sales/Share and EPS growth initially. The extra capital has been paying off ever since as can be seen by the large jump in EPS in 2008 and into the first half of this year.

The shares look reasonably priced at today’s $17.95 quote. That’s right around 13.3x this year’s and 12.4x 2010’s estimates from both Value Line and Zacks. GEO’s 10-year median P/E has been 16x and even a rebound to 14 times year-ahead expectations would bring GEO to a target price of $20.30 /share.

That’s a very conservative goal considering GEO actually traded at $20.20 in 2006 on EPS of $0.85 and as high as $32.90 in 2007 when earnings came in at $0.84 /share. On numerous occasions GEO has traded for 2 - 3 times book value versus about 1.5x B/V currently.

Business trends look good with the last six quarters showing nice year-over-year growth.

I don’t see a low of downside here.

Here’s a nice seven month play that allows for excellent returns even if GEO’s share price does absolutely nothing.

........................................................ Cash Outlay ........... Cash Inflow

Buy 1000 GEO @ $17.95 ...................... $17,950

Sell 10 GEO Mar. $17.50 Calls @ $2.60 .................................. $2,600

Sell 10 GEO Mar. $17.50 Puts @ $2.10 ................................ $2,100

Net Cash Out-of-Pocket ....................... $13,250

If GEO shares merely remain above $17.50 through Mar. 18, 2010:

• The $17.50 calls will be exercised.

• You will sell your shares for $17,500.

• The $17.50 puts will expire worthless.

• You will have no further option obligations.

• You will end up with no shares and $17,500 in cash.

That’s a best-case scenario net profit of $4,250/$13,250 = 32%

for a seven month holding period on shares that:

• Went up.

• Stayed unchanged.

• Dipped slightly to no less than $17.50 /share.


What’s the risk?

If GEO shares are < $17.50 on Mar. 18, 2010:

• The $17.50 calls will expire worthless.

• The $17.50 puts will be exercised.

• You will be forced to buy another 1000 GEO shares.

• You will need to lay out an additional $17,500 in cash.

• You will have no further option obligations.

• You will end up with 2000 GEO shares.


What’s the break-even point on the whole trade?

On the original 1000 shares it’s their $17.95 purchase price less

the $2.60 /share call premium = $15.35 /share.

On the ‘put’ shares it’s the $17.50 strike price less

the $2.10 /share put premium = $15.60 /share.

Your overall break-even point would be $15.48 /share.

GEO shares could drop by as much as 13.7% without causing a

loss on this trade.

Note: If you want more upside in return for accepting a higher break-even point, you can do the same type trade with $20 puts and calls.


Disclosure: Author is long GEO shares and short GEO options.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.gurufocus.com/peter_lynch.php
http://www.TalkMarkets.com
http://www.MutualFunds.com

Visit Dr. Paul Price's Website


Rating: 2.0/5 (6 votes)

Comments

kfh227
Kfh227 premium member - 5 years ago
Holy crow. Over the past 10 years, I think GEO has negative free cash flow if you add all the years up. The number is something like -$100 million in FCF for this $900 million market cap.

This is not a net-net play seeing how current assets is dwarfed by total liabilities.

How does this company stay afloat?

Regardless, the FCF number looks like a roller coaster. Accept the inclines are tiny and the drops fantastic. I don't understand its value. So, what is this company worth? Why?

Past numbers are meaningless and EPS even more so. GAAP accounting can make a company look wonderful like Enron did but one look at FCF numbers and no one should have invested.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
I don't know what cash flow numbers you are looking at.

See the chart above for the reported figures.

Debt is 45% of capital and total interest coverage is 4.5x.

Value Line gives them a B+ for financial strength.

EPS hit all-time highs in 2008 and are up nicely at mid-year for 2009.

GEO shares have outperformed 85% of all 1700 stocks in the Value Line universe over the long term.

Management was smart enought to issue over 10 MM new shares in 2006 and another 10.5 MM new shares in 2007 when the market was hot and these shares were trading at very high multiples. It appears that kfh227 did not take the secondary issues into account when figuring out their free-cash flow numbers.

Perhaps kfh227 is the one who doesn't understand this company instead of his view that

everyone else is clueless.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago


Barrons likes the 'for profit' private prison group...

Arresting Developments



By KOPIN TAN

For-profit prison operators are gaining as demand for cells outstrips supply.









AMERICA HAS 5% OF THE PLANET'S POPULATION, but 25% of its prisoners. This should be good news for the private prisons that absorb the spillover from our congested federal and state penitentiaries, but, alas, the recession has ruffled the economics even of law and order. Cash-strapped states seeking to cut the cost of housing inmates are mulling drastic measures, ranging from quicker paroles to earlier releases. Not only have the headlines alarmed some citizens, they have frightened investors as well.

As a result, private-prison stocks are selling at unusual -- and untenable -- discounts. The three biggest companies are Corrections Corp. of America (ticker: CXW), which controls 39% of private-prison beds, Geo Group (GEO), which runs 25%, and Cornell (CRN), with 10%. While their stocks have rebounded this year, they still trade at 12 to 18 times what each is expected to earn in 2010 -- compared with multiples pushing 30 before the budget crisis.









Darrin Klimek/Getty Images
Iron bars might not a prison make, but they're certainly needed to control criminals. And just about the only cells being built are operated by private companies.


THE GRIM SHARE PRICES DWELL TOO much on states' stop-gap attempts to curb incarceration costs, and overlook private prisons' steady profitability, their stranglehold on a tough-to-penetrate industry and the widening chasm between supply and demand. In an extensive recent report, Barclays analyst Manav Patnaik pegs the annual demand for new prison beds at 35,000. That's being met by a supply of just 20,000 from both the public and private sectors. Patnaik's conclusion: "It's an imbalance that works in favor of private-prison operators."

Today, budget-constrained states can ill afford the time or capital to build new facilities, and many find it cheaper to outsource part of their incarceration system. That explains why half the new inmates during the past year were sent to private prisons, even though less than 9% of U.S. prison beds are privatized. Regions whose public employees are heavily unionized have tended to resist the shift, but reality and overcrowding usually force a compromise.

Even California, which runs the largest U.S. prison system and has no shortage of convicts or unions, has succumbed, tapping Corrections Corp. of America to handle its flood of felons. And this year, for the first time in recent memory, Florida earmarked no funds to build new prisons. It also passed laws allowing inmates to be transferred outside its borders. Some may go to private facilities in other jurisdictions.

Investors in the triad of Corrections Corp. of America (or CCA), Geo Group and Cornell have other perks: Private prisons earn recurring revenue, impervious to seasons or business cycles. They build decades-long ties with a fairly reliable customer -- the government, be it state or federal. And if the customer is the feds, the companies are selling to a client that doesn't even have to balance the budget, and can print money at will.

Barriers to entry into the business are forbidding, and customers don't defect easily to newer rivals. What public official would want to say, after a prison break, that he had picked an unproven company to run the facility, instead of one of the more experienced outfits?



On top of that, prison facilities, replete with concrete and steel, tend to be durable, low-maintenance and immune to changing architectural whims.

A LONG STAY IN PRISON, according to an industry joke, cures very little except heterosexuality. Yet our prison population has more than tripled over the past quarter-century, jumping from roughly 700,000 in 1984 to 2.38 million this year, the fastest pace of any country on earth.

Proponents say that incarceration protects society from dangerous offenders, acts as a deterrent and allows re-education, thus fulfilling the criminal justice system's three main goals of prevention, punishment and rehabilitation. As a result, our federal prisons are at 137% of capacity, and state jails have shot past 110%. (It should be noted that prison populations of some nations, such as China, are held somewhat in check by the government's willingness to execute people for crimes that would rate only a prison term stateside.)

A study by the nonpartisan Pew Research Center points to an arresting development in the land of the free: For the first time, one in every 100 adults is behind bars, and state funds spent annually on corrections have swelled from $10.6 billion in 1987 to $44 billion. While the Department of Justice says violent crime has declined since 1993, drug arrests and reported crimes have increased.

This has galvanized proponents of sentencing reform, and change is on the way. States from Ohio to Oregon have enacted, or are considering, laws that would award sentence-shortening credits for prisoners who behave well or who participate in substance-abuse programs.



A SIGNIFICANT REDUCTION of the U.S. incarceration rate, the highest in the world, would rattle private prisons. But bulls say this is unlikely and that the stocks already factor in much of the threat.

According to the Vera Institute of Justice, an independent policy center, at least 26 states have cut funding for corrections in fiscal 2010. Yet this hasn't thwarted the big private-prison operators, all three of which see profits growing next year. And investors may be underestimating the role that private outfits play in helping the prison system operate efficiently. Many changes -- some states now let prisoners serve their time in facilities in other states -- benefit private outfits. Their facilities span the country, and they can build wherever they see demand.

IRONICALLY, FREEING INMATES could create a larger need for prisons down the road. According to the Bureau of Justice, two of every three convicts released are rearrested within three years for a new crime.



To be sure, pricing will be pinched in the months ahead, but not too severely. "Private prisons have built up a lot of ancillary services over the years that can now be cut if their per-diems are cut, without too much damage to their bottom line," says Eric Marshall, director of research at Dallas-based Hodges Capital Management. Besides, pricing will rise again as the budget crisis passes, and private prisons aren't without bargaining power. "There are only so many nonviolent criminals that can be let out, and it isn't like states can run out and quickly build another prison."

Case in point: Colorado wants to reduce its prison population by 26%, or 6,000 inmates, during the next two years. This could hurt Corrections Corp. of America, which runs three prisons, or nearly 4,700, beds there. But Signal Hill analyst T.C. Robillard doubts the state "can classify a quarter of its inmates as low-risk or near the end of their sentences." Even if that were possible, Barclays' Patnaik pegs the impact at just 1,000 beds, because releases will be offset by the arrival of new inmates. Also, the state probably will let CCA decide the most cost-effective way to release prisoners, so the company will retain considerable sway.

WHICH PRISON STOCK is the best bet?

Marshall finds all three worth considering but owns Geo, partly because the Boca Raton, Fla., outfit has the most international exposure. The privatization of prisons is in its infancy abroad -- penetration rates run from 17% in Australia to just 3% in South Africa -- and Geo earns 13% of its revenue overseas. Another 12% comes from its higher-margin criminal mental-health facilities.

Last month, Geo snagged a contract to run an 832-bed prison in Sydney, its fifth facility Down Under. A plan to raise $250 million -- by selling eight-year notes yielding roughly 8.25% -- also bespeaks ambitions to expand its balance sheet and give rival Corrections Corp. a run for its money.

CCA and Cornell have no overseas exposure, partly because U.S. demand has been strong. Corrections Corp. runs 64 prisons in 19 states and owns nearly two-thirds of them, a boon because owned prisons generate margins averaging 25%, compared with 15% for managed facilities. CCA's massive inventory makes it the go-to company for federal and state customers. One worry: Because it has so many beds, investors fret that a large number could go unused. Earlier this year, 11,000 were empty, but new government contracts had trimmed the total to 6,500 by summer.



The Bottom Line

Shares of Corrections Corp. of America, Geo Group and Cornell are selling at unrealistically low prices, considering the Big Three's solid prospects and steady profitability.

Corrections Corp. is the go-to stock for many investors as well. At 24, its shares trade at 17.9 times expected 2010 profits, compared with 13.5 times for Geo and 12.1 times for Cornell.

CORNELL DOESN'T GET THE SAME RESPECT, because 26% of its revenue comes from lower-margin juvenile-detention facilities. But it is also the most sensitive to economic swings -- it doesn't take much to move Cornell's needle -- and hence more suitable for traders with an appetite for risk.

Signal Hill's Robillard rates all three Buy, but he gives the short-term edge to Cornell over Geo, and to Geo over CCA over the next six to 12 months. CCA's recent run has already "priced in a lot of the growth re-acceleration," he says, "while Cornell and Geo can still catch up." In fact, analysts' conservative price targets put Cornell at 26, 10% above its recent quotes.

Over the long run, however, Robillard argues that CCA's bigger balance sheet gives it the most options. Crime increases in a recession, but as the economy revs up, so should spending on crime and punishment. Who said crime doesn't pay?

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