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Dr. Paul Price
Dr. Paul Price
Articles (513)  | Author's Website |

Cornell Companies – Don’t Buy this one on a “Break-Out”

August 25, 2009 | About:
Cornell Co. (CRN) August 25, 2009 close: $20.61 /share

52-week range: $13.42 (Mar. 9, 2009) - $28.45 (Sep. 18, 2008)

Cornell Companies, Inc. provides privatized correctional, detention, and pre-release services for adults and juveniles. The Company provides facility development, design, construction, and operational services to governmental agencies within secure institutional correctional facilities, juvenile treatment and educational services, and pre-release correctional services divisions.

Cornell now has 70 facilities serving 4 Federal agencies, 15 states, the District of Columbia and

many local government entities.

Cornell’s 35 years of experience with a wide range of services allows customers access to programs and services focused on treatment and release preparation. Among the services offered are:

• substance abuse/addiction counseling, education and treatment

• individual, family and group counseling

• vocational training

• gender-specific treatment

• behavior management strategies

• individual case management

• therapeutic communities

Constricted budgets at all levels of government, has led to a greater outsourcing of detention services for both youths and adults. Cornell Companies have been benefiting from this trend. Earnings per share surged by 84% (from $0.82 in 2007 to $1.51) in 2008.

First half 2009 profits continued the trend at $0.84 versus $0.68 (+23.5%). Unfortunately this is a growth business.

Here are their per share numbers as reported by Value Line:

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

2003 ........20.83 .......1.12 .........0.30 ........12.75 .......41.5x

2004 ........21.89 .......1.40 .........0.38 ........12.13 .......33.9x

2005 ........22.54 .......1.40 .........0.29 ........12.00 .......47.5x

2006 ........25.66 .......2.05 .........0.89 ........12.91 .......18.0x

2007 ........24.78 .......1.92 .........0.82 ........13.77 .......27.6x

2008 ........26.25 .......2.72 .........1.51 ........15.46 .......14.8x

Zacks now sees 2009 sales and earnings hitting new all-time highs. They look for EPS of $1.73 this year and $1.89 next. That makes the current multiple just 11.9 times 2009’s and 10.9x their 2010 estimate.

Ironically, as fundamentals have gotten better and better, the valuation has become quite cheap. This was a ‘glamour’ stock with a ridiculous multiple from 2003 through 2007 and now looks to be a proven growth company at a non-growth price.

A rebound to even 14x this year’s $1.73 expectation would bring these shares back to $24.22/ share. That target price jibes with Standard and Poors’ view. They see ‘fair value’ as $24.70 /share.

A move to the mid-$24’s would make for an 18% – 19% gain by early next year. That’s not bad, but here’s what I see as a better trade that I made earlier today. These are the actual prices I obtained.

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

Bought 1000 CRN @ $20.48 ...................... $20,480

Sold 10 Mar. $22.50 calls @ $2.05 /share .............................. $2,050

Sold 10 Mar. $22.50 puts @ $3.70 /share ............................. $3,700

Net Cash Out-of-Pocket ............................ $14,298

If Cornell shares rise to at least $22.50 (+ 9.9%) from my purchase price by the March 19, 2010 expiration date:

• The $22.50 calls will be exercised.

• I will sell my shares for $22,500.

• The $22.50 puts will expire worthless.

• I will have no further option obligations.

• I will own no shares and hold $22,500 in cash.

That’s a best-case scenario net profit of $8,202/$14,298 = 57%

achieived in just seven months on shares that only needed to go up by 9.9%.

What’s the risk?

If Cornell shares finish below $22.50 on March 19, 2010:

• The $22.50 calls will expire worthless.

• The $22.50 puts will be exercised.

• I will be forced to buy another 1000 CRN shares.

• I will need to lay out an additional $22,500 in cash.

• I will have no further option obligations.

• I will end up with 2000 CRN shares.

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

On the original 1000 shares it’s their $20.48 purchase price less

the $2.05 /share call premium = $18.43 /share.

On the ‘put’ shares it’s the $22.50 strike price less

The $3.70 /share put premium = $18.80 /share.

My overall break-even will be $18.62 /share.

CRN could drop by up to 9.1% without causing me a loss on this trade.


Cornell Companies looks to be 15 – 20% undervalued at today’s quote.

If it recovers by 9.9% or better (to at least $22.50) by March 19th I can make a 57% cash-on-cash return (by selling the puts against marginable equity already in my account).

I have a 9.1% margin of safety on this trade from my inception price of $20.48 /share.

Disclosure: Author went long CRN shares and short CRN options today.

About the author:

Dr. Paul Price


Visit Dr. Paul Price's Website

Rating: 3.8/5 (4 votes)


Wanna Kamdason
Wanna Kamdason - 8 years ago    Report SPAM
You funny man. I'm going to lock up some shares.
Dr. Paul Price
Dr. Paul Price - 8 years ago    Report SPAM
Barrons like the 'for profit' private prison companies...

Arresting Developments


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

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?

Dr. Paul Price
Dr. Paul Price - 7 years ago    Report SPAM

GEO to buy Cornell in $685 million deal…

(MarketWatch) — Prison management company GEO Group Inc. (GEO 20.61, +0.57, +2.84%) said Monday it has agreed to buy Cornell Cos.(CRN 26.42, +0.68, +2.64%) for stock and/or cash in a deal with an estimated enterprise value of $685 million. The company said the deal includes the assumption of around $300 million in Cornell debt. Cornell shareholders will receive 1.3 shares of GEO for each share of Cornell. Alternatively, up to 20% of shareholders can opt for a cash consideration equal to the value of 1.3 GEO shares, or one GEO share plus $6, whichever is the greater. Assuming the maximum cash uptake, the offer implies a value of $24.96 per Cornell share, or a 35% premium to Friday’s closing price.

CRN shares are up to $26.60 in afternoon trading today.

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