Description

GEO has been written up in the past, but I want to focus more on its two levers from the immigrant crisis growth optionality in this write-up. I believe GEO can pivot its perception from “simply a prison operator” to “a diversified gov’t services business with > 50% of profit pool from recurring electronic monitoring services” helping to combat the never-ending US immigration crisis. 

Without the materialization of this growth optionality, patient capital can expect ~20% IRR over the next 3-4 years as the company continues to deleverage + starts repurchasing its shares with its resilient cash flow generation. If the growth optionality ends up happening, it can result in incremental accretion to FCF anywhere between 10% and 50%+, allowing for additional juice in this investment’s return profile.

It is a controversial stock and I fully expect a pullback in share price after the near ~100% rise over the past year. However, it is a fascinating situation worth getting familiar with so you can take advantage of dislocations should they appear. 

Business Overview

GEO is one of the few publicly-traded providers of secure services (incl. various prison / detention facilities). It develops and manages various secure facilities, immigration processing centers, and community re-entry centers. It is a leading provider of enhanced in-custody rehabilitation, post-release support, electronic monitoring, and community-based programs.

Investor presentation link: https://investors.geogroup.com/static-files/0925cfca-4df9-4561-813b-9ae16d407ed6

Zooming into BI Incorporated – the incumbent monitoring service provider to ICE and DHS for almost 20 years

GEO pioneered use of electronic monitoring product / services for alternatives to detention over 35 years ago. It is the only company to offer full suite of electronic monitoring / supervision solutions – incl. ability to perform in-house manufacturing. It is also the largest producer of electronic monitoring device. It has unmatched monitoring / case management services supported by 800+ trained service professionals to supplement technology.

With regard to mkt dominance: back in 2021, mgmt disclosed mkt share is more than double the next largest competitor. My estimate is that ICE usage (ISAP program) makes up for about 80% of revenues for this business

BI Corp has more than 20 yrs of relationship providing service to ICE, with the latest 5-yr contract effective through July 2025.  It is the sole provider of electronic monitoring solution to ICE under the ISAP program  (Intensive Supervision Appearance Program). This is a core piece of ICE’s Alternatives to Detention program – supervising non-criminal aliens who are required to comply with ICE’s Executive Office of Immigration Review court process. The program has achieved high level of compliance for participants going through immigration review process – growing steadily through the years. In terms of contract terms, there is no minimum or maximum revenues, GEO simply offers a pricing grid and ICE’s utilization fluctuates based on its needs + budgetary constraint

Let’s take a look at BI Incorporated history and growth trajectory

GEO (fortunately) acquired it in early 2011 for $415mm to position GEO to offer full continuum of care solutions + enhance correctional program outcomes.  Back then, it was only tracking ~60k offenders on behalf of ~900 correctional agencies vs. ~400k+ offenders at peak in late ‘22 across ~1,200 agencies. 

There has been phenomenal growth over time: ~$115mm of revenue in 2011 to close to $500mm LTM revenues. This is the BI Incorporated historical growth disclosed in the 2021/2022 lender presentation. Even before 2022, it was a structural low-teen % organic growth business (~12% for 15 years). Since 2020, it has further grown more than 50%+

Monetization model and profitability

The pricing varies based on different technologies and monitoring frequencies, ranging between $1 to $5 per person per day. GPS-based ankle bracelet is most expensive at ~$3+, mobile-app based technology (SMARTLINK) is least expense at ~$1.

It is an ultra profitable business: carrying segment NOI margin of ~55% in the past 2 years. As a result, this segment made up ~35-37% of FY2022 / FY2023 consolidated NOI (before corporate cost), or more in % of Adj. EBITDA (NOI less corporate cost)

According to latest ICE data on pricing (as of April 20th 2024), there are ~184k people under the ISAP program, mostly using SmartLINK and supplemented with GPS / watch. 

Keep in mind that the cost listed above are only related to technology costs, and do not include other associated contract and case management costs that are a part of the ATD program. The case mgmt revenue far exceeds the technology costs (GEO’s BI bills these since it needs to assign a case manager to supervise each person under this program).

Why is ICE’s Alternatives to Detention (ATD) program accretive to society?  

It allows individuals to be released with community supervision using GEO’s tools allow them to live in community, support their family, and give insights to supervising officers on how this population is doing in the community. It is a considerably cheaper solution to detention – studies even indicate it can be thousands of dollars cheaper than probation without electronic monitoring per person. ISAP program has achieved high levels of compliance for participants going through the immigration review process. ~99.6% of ISAP participants attended required meetings with their case specialists and 99.3% of ISAP participants attending all of their acquired immigration court hearing

From ICE website: ATD has been in place since 2004 and the number of participants has increased over time. Through the end of July 2022, approximately 4.5 million noncitizens were being overseen on ICE’s non-detained docket. Of those, more than 350,000 participated in the ATD program with absconder rates dropping dramatically over the past two years.

"The daily cost per ATD participant is less than $8 per day — a stark contrast from the cost of detention, which is around $150 per day."

GEO’s BI Incorporated has kept innovating to enhance cast mgmt services: it has moved from ankle bracelets to app to watches

SmartLINK: simplifies communication between clients and officers through secure messaging and video, calendar and resource access, and push notifications. Most popular form of supervision technology used by ICE. Check-ins use biometric facial comparison technology to confirm identity. 

VeriWatch: 2 pilot program ongoing with ICE today, more discrete version of ankle bracelet

Illegal immigration is a huge problem / even Democrats are worried about the perception that it's out of control

There appears to be no end in sight for the migrant crisis as border crossing activity keeps being elevated. ICE was detaining about ~37k as of Fall 2023, marking the highest detention since March 2020, already surpassing ICE’s current funding of ~34k beds. But vast majority of migrants are being let go. There are ramping migrant encounters and apprehensions are sending a message that Dem’s have lost control on immigration and our collective security is at growing risk

Title 42’s expiration further exacerbated the border program in US. Title 42 allowed Federal gov’t to immediately remove a significant portion of ppl encountered by Border Patrol illegally entering the US, before it expired in May 2023. Title 42 expiration was coincident with the expiration of the public health emergency declaration. The non-detained population is roaming around freely, adding to growing security risks. They may or may not be checking in with ICE on routine basis, and ICE barely knows their whereabouts in many instances

Backlog was already getting out of control before COVID

Yet we are monitoring a very small % of these people. Latest non-detained alients = 6.2mm, doubling vs. Pre-COVID.  The question is why are we only monitoring 180k to 190k  (~3%) of this population?

ICE data:

There is bipartisan support to increase border-security related spending – whether in the form of monitoring or detaining

The point is that “something has to be done” in the 2024 budget that is still not finalized / agreed to (we are in Continuing Resolution).  House and Senate have different versions of the Homeland Security Appropriations Bill for the fiscal 2024 federal budget,

House version: best for GEO at this point

1/ increase funding for ICE beds to 41k (~39k in use today vs. existing funding for 34k beds) 

2/ includes a provision requiring the use of ISAP electronic monitoring capabilities for all individuals in the non-detained docket for the entire duration of their proceedings

Senate version: not negative for GEO

1/ keeps funding for ICE beds at the current 34k 

2/ slightly increases the overall funding available for the Alternatives to Detention programs

White House also submitted a Supplemental Appropriations request to Congress. With it, it included additional funding for ICE beds and the ATD program. 

Trend hasn’t been GEO's friend in this business segment recently

ISAP / ADT enrollment has been experiencing a recent decline / normalization given lack of funding.  This has been acknowledged as a recent of lower DHS budget – it over-allocated a lot of budget in 2022 on ISAP program to accommodate its growth. Number has stabilized in recent months / post summer 2023

ADT enrolment stats (this number stands at 184k per latest data)

As a result, the softening ISAP/ADT enrollment has also translated into recent softness in segment revenues. With that said, NOI margin (segment profit %) is very resilient in the mid-50s

Increase beds for detention can be another source of tailwind (in addition to increased monitoring)

ICE detention volume (and contracted capacity) is also significantly below pre-COVID due to lack of funding. There are ~11k people in GEO’s ICE detention facilities vs. peak of 14-15k pre-COVID, that 3k+ of upside unlocks a lot of incremental profit dollars. House bill already calls for an increase in detention funding level. If ICE increases detention census, it automatically benefits GEO and others in the private sector given its own beds are full. GEO has about 1/3 of ICE detainee market share (90% outsourced to private sector x 42% market share)

If Republicans wins the upcoming election (i.e. Trump), the probability of bed count # goes higher would be even bigger

ICE detention census over past few years 

ICE pretty much only relies on private sector for detention capacity

What about the short case? The stock has about a 15-20% short interest still.  Frankly, GEO’s business is more sticky than skeptics give it credit for. I believe a lot of shorts have been wrong about the company’s durability

Exhibit on GEO’s 2023 renewal progress: ~98% contract renewal rate – highest in 5 yrs

1) At this point, ~40-45% of revenue from ICE are very sticky (whether the detention center ops or electronic monitoring business) with growth optionality. Let’s face it, US border security needs its help

2) US Marshall business (~17% of revenues) is also stable for now with no renewal risk in 2024

US Marshall (under DoJ) did exercise non-renewal options for some “direct contracts” with GEO’s facilities back in 2021-2022 but subsequently have been converting “direct contracts” into indirect contracts given its massive reliance on private sector

For entire Calendar Year 2024, there is zero USMS contract that would be up for extension or renewal – no headline risk potential

3) Federal Bureau of Prisons (< 3% of revenues) have cut every contract it could by now, there is no more poison here. Remaining exposure isn’t secured operation (prison) but rather re-entry facilities / half-way houses – this business is here to stay.

4) State secured ops business (~25%) has been rather stable last few years, States are mostly reliant on private sector given aging infrastructure and budgetary constraints. Half of the State businesses – “managed only” contracts, not even a real-estate based business. A county in Pennsylvania did give notice to GEO that it was taking over mgmt of a contract back in early 2022, leading to a segment decline that year, but there have been new contract wins to offset it too. At this point, the segment is < 9% of NOI.  The other half of State business are owned / leased operations with quite a lot of diversification, biggest State (Oklahoma) has a 2% revenue exposure

5) International (~8%) – stable to growing business.  7% out of the 8% revenue here is Australia, where it has a great relationship with GEO since 1991. GEO entered into contract with State of Victoria DOJ for delivery of primary health services across 13 public prisons just last year – adding another $33mm incremental annual revenue

6) GEO is no longer over-levered. It has delevered meaningfully over last 2 yrs with FCF + noncore asset sales, net leverage went from 5.5x in 2021 to < 3.5x today with more deleveraging to come / shareholder return once lvg is < 3x.  

Company recently completed a comprehensive debt refinancing transaction, extending maturity out to 2029/2031 while lowering interest coupon. Before the refi, GEO was on track to pay ~$190mm of annual cash interest. Post the refi (and with some upcoming SOFR moderation expected in forward curve), I believe cash interest steps down towards ~$160mm by 2026E.  Frankly, I believe these coupons are still too high given GEO’s improved leverage profile and there is more progress to be made in another refinancing transaction a few years down the line,

https://investors.geogroup.com/news-releases/news-release-details/geo-group-prices-senior-notes-offering-and-new-term-loan

Importantly, after the debt refinancing, company removed previously restrictive covenants and can now be in the position to initiate capital return via dividend and share repurchase

Valuation / Return Expectation

Given the political nature of GEO’s upside drivers (growth in electronic monitoring / ICE detention business require upsize in DHS/ICE budget, which depends on congressional approvals), I’d like to think about them as optionality. Therefore, we should first establish the return expectation if status-quo remains and this optionality does not play out

In the base case, core secured operations / re-entry services business has reached stabilization after 2 years (2021-2022) of being White House/DoJ’s “cancel” target. The steady-state growth should be > 2% without growth CapEx, LT CPI-like growth on a revenue per man-day basis. There should be continued recovery in re-entry center / half-way house services which got disrupted the most post COVID. There will be activation of new projects every year, to take advantage of idled facilities. There will be incremental international growth opportunity (now offering healthcare services in Australia). For example, the Segment Income (excluding Electronic Monitoring) is guided to grow closer to ~3-5% YoY in 2024E

Do not overly-focus on GAAP Net Income: GAAP net income to FCF conversion is strong given CapEx of ~$75 is substantially less than D&A of ~$126mm. I think GEO can initiate a dividend with remainder of excess FCF deployed into share repurchase, allowing for MSD to HSD % share count reduction in a few years (while assuming GEO share price grows at a CAGR of 15%). With net leverage < 3x by early 2025, this should be able to re-rate to ~11.5x FCF / 8x EBITDA, allowing for low-to-mid 20% IRR

Analysis on comparable multiples

Peer CXW is very similar to GEO, except it appears to have a worse growth profile in recent years (and no electronic monitoring growth to support the Biden-driven declines). It’s less levered than GEO at ~3x and has an active share repurchase program.  It recently guided 2024 EBITDA at a slight decline of 1.5% YoY after a 1.5% decline in 2023

I’ve made all the equivalent adjustments and CXW still trades at ~11.5x FCF / 8.3x EBITDA

While skeptics may think GEO only deserves 8x FCF, one can argue it could very much trade at 15x FCF under a Republican administration that is more friendly to this type of business model.

CXW’s recent EBITDA trajectory

CXW multiple after we add back SBC

What if growth optionality plays out?

Growth optionality #1: Physical detention upside 

If Trump / Hardcore Republican President takes over to push for normalization in physical detention space, there is meaningful EBITDA + FCF upside. ICE detention volume (and contracted capacity) is significantly below pre-COVID (under Trump administration) due to lack of funding. There are ~11k people in GEO’s ICE detention facilities vs. peak of 14-15k pre-COVID, that 3k+ of upside unlocks a lot of incremental profit dollars

House bill already calls for an increase in detention funding level. If ICE increases detention census, it automatically benefits GEO and others in the private sector given its own beds are full (reminder: GEO has 1/3 of ICE detainee mkt share)

One can pencil out a 10-20% accretion to the baseline FCF/share if physical detention demand increases from here

Growth optionality #2: Electronic monitoring upside 

We are still in a wait-and-see mode here, we can only watch for budgetary news / funding developments. Back in February, there was the failed border security from the Senate, which suggested a $1.29bn incremental budget “for increased enrollment capabilities and related activities within the Alternatives to Detention programs”. In addition, the bill provides funds for ICE to keep at least 50,000 detention beds available, an increase of 47 percent from the 34,000 beds allocated in 2023, 2022, and 2021. Unfortunately, Republicans don’t want to hand Biden a win on immigration / border security ahead of November election, so the bill was “dead on arrival”. But I can see something like this gets done after the election, especially under a Republican president.

https://www.americanimmigrationcouncil.org/research/analysis-senate-border-bill

Even if only ~5-10% of migrants on non-detained docket get monitored, one can pencil out 35-65% kind of FCF accretion. The table below assumes a reduced technology cost per person based on volume discount, and further assumes a lower case management revenue multiple than what is in the contract today

Recent insider buying and NAV disclosure – positive signaling?

George Zoley (founder/chairman) disclosed open market purchase of 50k shares in March. 

GEO also put in an NAV slide in its latest investor deck pointing to $30/share, based on "internal valuation of replacement cost for facilities. Secure services and youth facilities valued at $75,000 per bed ; Re-entry facilities valued at $50,000 per bed". This was the first time it included an NAV estimate.

Risks: gov't contract non-renewals due to change in policy or competitive environment; inflationary pressure in excess of pricing increase leading to margin compression

Catalyst

Initiation of dividend and share repurchase

Upward funding tailwind for ICE physical detention capacity and/or alternatives to detention