Description

CoreCivic has been discussed six times on Value Investors Club, first in 2004 and most recently nearly four years ago in September 2020. This write-up should be read in conjunction with the recent strong write-up by Chaulkbaggery on GEO Group (GEO), which provides background on both the private prison industry and the electronic monitoring (ISAP) contract, which is key to my thesis.

While I think both CXW and GEO are attractive investments from here, I believe the risk/reward on CXW is better at these levels due to a potentially significant call option that could play out over the next 3 to 12 months and currently receives little attention from the investment community. I will discuss this further below.

Business Description:

CoreCivic is the largest private prison owner/operator in the United States, with about 40% of all beds. The Geo Group (GEO) is a close second with about 38%. CoreCivic operates 43 correctional and detention facilities (39 of which are owned) with about 65,000 bed capacity. It also owns and operates 23 residential reentry centers with 5,000 beds. Its revenues, net income, and Adjusted EBITDA in CY 2023 were $1,896.6 million, $67.6 million, and $311.0 million, respectively.

The company currently generates most of its business through contracts with state and local governments for state prison contracts (~48% of revenue) and the federal government for the ICE and U.S. Marshals program (~52% of revenue).

The company is levered about 2.7x Net debt/EBITDA and recently completed a favorable refinancing transaction. It has no significant maturities until 2027 ($250M) and then not until 2029 ($500M). The company has been using its free cash flow to repurchase stock at these levels, at a pace of about $150M annualized over the last several quarters, or 9% of the current market cap. It recently increased its buyback authorization significantly, and I expect the company to continue using excess free cash flow for share repurchases.

Investment Thesis:

Stable State Prison Business with Improving Supply and Demand Fundamentals: CXW's core state and local prison business (48% of revenue) provides stable, recurring revenue with high renewal rates. It is diversified, with no single state accounting for more than 10% of total revenues. After years of declining prison populations driven by COVID-19 and policy trends reducing incarcerations in certain regions, incarceration rates are once again rising across the country. Additionally, almost no new prisons are being built in the U.S., and many existing prisons are aging and in need of significant repairs. CXW estimates that over 500 prisons need major upgrades or repurposing. CXW currently has 8 idle facilities that could be reopened under favorable contract terms. I believe revenue for this business should increase with CPI or slightly better, with stable or slightly improving margins for the foreseeable future.

Potential Upside from Greater Federal Government Business through Increased ICE Funding (~30% of Revenue): The federal government ICE contract was recently increased from 34,000 to a minimum of 42,000 beds. While the government is currently operating under a continuing resolution, I think it is likely that bed funding will remain at this level or higher for the foreseeable future. As we approach the election and the summer months, when border crossings typically increase, the number of funded beds may rise above this number. CXW is conservatively assuming only about 36,000 to 38,000 ICE detention beds in their annual guidance, though they noted on their last earnings call that bed utilization increased near the end of April and early May.

Free Call Option from Winning Some of the Federal Government's ISAP (Intensive Supervision Appearance Program) Contract: While I believe CXW is an attractive business as is and deserves to trade at a much higher multiple, the company has the potential to gain a significant new and high-margin revenue stream over the next year. The Federal Government's ISAP program, which is its electronic monitoring alternative to detention (ATD) program, will be out for RFP by Q3/Q4 of this year and awarded in Q2 or early Q3 2025. Chalkbaggery did an excellent job discussing the details of this contract in the GEO write-up on April 27th, 2024. The Geo Group won the entire contract when it was last out for bid and has held it for the last 20 years. CXW bid on it aggressively last time but did not win, as the government was not confident in their ability to deliver on the contract at the price they bid.

Currently, GEO generates about $450M in revenue and $250M in EBITDA annually from this contract. The value of this contract could increase substantially if the government boosts funding for ATDs under the ISAP program. CXW management is keen to win some of this valuable contract and is investing significant time and energy into its pursuit. We do not yet know the structure of the RFP, but we will in Q3/Q4 when the details are released publicly. If the contract is split into multiple parts (currently it is not), it significantly increases the chances that CXW will win some of it. It is also possible that the ISAP contract expands materially, as Biden has requested a substantial funding increase for this contract in the preliminary 2025 budget. If the contract were to expand materially, the government would very likely select multiple providers.

While it is impossible to model the contract's impact precisely without knowing the details, the potential uplift to revenue and EBITDA if CXW wins some of this business is substantial and is not included in any street models or discussed by any analysts. I estimate that each 10% of the current GEO contract that CXW wins would increase EBITDA by 7% and EPS by about 13%. This potential also has the chance to improve CXW's stock multiple, providing another high-margin revenue stream, increasing growth, free cash flow, and reducing leverage, allowing for further capital returns.

Valuation:

The stock currently trades at about a 12% levered FCF yield on 2025 consensus and 8x 2025E EV/EBITDA. I believe this multiple is too low for a stable contract business with potential upside from greater ICE funding and contract wins. Historically, this business traded at 9x to 10x prior to COVID-19 and Biden's subsequent industry attack. Assuming CXW wins 10% of the current ISAP contract and trades to 10x forward EV/EBITDA, I estimate a share price of about $22, or 50% higher than the current stock price. If the ISAP contract grows by 50% and CXW wins 20% of this new contract, CXW EBITDA could grow by ~20% and EPS by ~45%, implying a share price of $27.50 or 90% higher.  (Note: Clearly these numbers are meant to be illustrative rather than precise, but it clearly highlights the upside to numbers from this ISAP contract)

Risks:

I believe the downside risks for CXW are fairly limited at this point.

Stock sentiment may be impacted by election odds (Trump viewed favorably, Biden unfavorably), though I believe there are very limited downside risks from a Biden victory at this point. The Biden administration has requested substantially higher funding for both ICE and the ISAP program consistently over the last six months.

There is the potential that the company could lose a state contract, though historical retention rates have been excellent (high 90s), and the company has successfully "re-tenanted" in the past if a contract is lost.

Catalyst

Re-rating from continued buybacks and market confidence in cash flows

Potential for successful bid on ISAP contract