Wednesday, October 21, 2009
Ackman on Corrections Corporation of America (CXW)
Bill Ackman fired up CXW yesterday at the Value Investing Congress, presenting it as a long idea. Of course, it is not an "idea" per se, he's already long big time and owns nearly 10% of the company. I like reading Ackman's materials: I have been a fan of his product ever since I read his old 2002 Gotham Partners 66-page white paper on the bond insurers. Over the last two-three years, I have seen several other pieces from his fund: Wendy's, Fannie and Freddie, Target, Wachovia, General Growth, updates on the bond insurers.
More recently, I saw his Realty Income (NYSE: O) presentation. He is short, and I agree with his thesis: low quality tenants in lower tier properties should be over the current 7-7.5 cap. He has a few other auxiliary arguments regarding disclosure, management incentives and how O is marketed to the unsuspecting and naive. You can see it here.
Of course, Pershing would get hurt if cap rates are up across the board: they have a large position in the bankrupt mall owner General Growth Properties (GGWPQ), and he argues that GGP's cap rates should be about as low as they get. I had GGP puts last fall largely based on Reggie Middleton's research. I almost wonder if O is a hedge on the highly appreciated GGP position: shorting the lower quality operator, long the higher-presumably- quality company.
There is a substantial real estate component in many of Pershing's activist investments. They play book is generally the same: separation of real estate from op co, and then, if applicable, transforming op co to a full franchiser to the extent possible. The argument goes that the split would help with raise the overall value through both asset transparency and self-selecting investor constituents. The first case with this was McDonald's back in 2004, if I remember correctly. The most famous case was the recent proxy fight with Target. The idea was to separate and spin-off Target's real estate into a separate entity, and have the stores there on a long-term contract. Presumably, this would be a very high quality REIT that would achieve a superior valuation, while old TGT would be a pure-play opco. He was also (rightfully) critical of TGT's holding credit card risk instead of moving to a private-label credit card provider.
So, on to CXW. The Investment Linebacker, one of the better blogs I follow on Reader, has notes on the argument for CXW.
Again, it is viewed as a real estate-type play. Ackman likens it to a healthcare REIT (think long-term care), which is about as close of a comp as one can get.
I am swiping most of the TILB notes from yesterday:
Rehashing the same ole private prison thesis: Only 7.8% of nationwide inmates are housed in private facilities. CCA does it cheaper, and "better". In 2007, private prisons took ~50% of incremental industry "growth". (Trend is sloping up and to the right). Currently industry (public + private) is operating at 94% occupancy. Doesn't see that declining as states can't afford to build new, current are overcrowded, and nationwide # of prisoners trends up and to the right Catalysts: 1) Recession is good for prison operators • More Crimes • States/Munis constrained to build new facilities 2) Operating Leverage from incremental prisoners is very high 3) Stock Buyback Bought 8% of stock back in Feb / March (at $10.61, now trading at $24.50). After-tax ROIC are 20-30% (low/high case). # of beds has increased from 46k to 61k in last 3 yrs, should be very accretive as occupancy on new beds increases. 5% of equity held by the Board. VALUATION 13x FCF, 12.2% Cap Rate (above where he thinks Realty Income will trade - Bill thinks its a good pair trade - see prior TILB post on Ackman's O short here) Key Qualitative Investment Factors: CRE Business, Govt is sole tenant, Triple-Net Lease (sorta), LT Secular Growth, Low Maintenance Capex (~2%), High ROIC, Local Monopoly/Nationwide Oligopoly Best comp is a Healthcare REITs (trade at 7% cap rate) From 1997 to 1999 operated as a REIT. Had to give up REIT status as a result of a large acquisition at the time. But at least it created a lot of NOLs. Company makes much higher margins on owning & operating than just management contracts. Recently expanded # of beds in owned facilities. Increasing margins. 25-33% of contracts roll each year, so decent predictability [TILB note: also allows for replacing in an inflationary environment]. All in all very simple. Clearly a lot of regulatory risk, but Bill thinks its mitigated by supply / demand dynamics in incarceration industry. Pershing owns 9.5% of company. "
I agree with his thesis overall. Before you rush to buy CXW, there are a few things to consider.
(1) Ackman bought at $10, the stock is now at $25+. Your "margin of safety" just went poof.
(2) The prison population has been growing but there is a limit to this: the US already has the highest incarceration rate in the world.
(3) The reason for it is the enforcement of drug offenses, and the federal government just made its first step loosening the enforcement of those.
(4) Another reason for the high population is the popularity of the so-called 3-strikes laws which have led to some absurd sentences, and are now being looked at more critically.
(5) More crimes does not mean more prisoners: he is assuming that enforcement will stay the same. It will not: state and local budgets are suffering big time, and this sometimes means less policemen on the street, and same number of detectives working on a lot more cases.
(6) The "government" as a sole tenant: this is a double-edged sword. If more states start issuing IOU's or reviewing state contracts for "savings," having this one tenant might not be such a great deal. On the flip side, it might help with privatization.
The image above is from CXW's site. I love it how companies put all those happy families and puppies on their sites, but not CXW.
Update 1 10/23/2009: The Investment Linebacker has posted the full CXW presentation here. Essentially, as described with some more relevant detail, i.e. capex lower than depreciation due to the nature of the construction, benefits of own vs. manage, incarceration trends, and others.
Update 2 10/25/2008: So here's something about the pushback against the mandatory sentences from the NYT: "Last Wednesday, changes to New York's notorious Rockefeller drug laws went into effect, allowing judges to shorten the prison terms of some nonviolent offenders. This measure will further reduce New York's prison population, which has already declined, in the past 10 years, from about 71,600 in 1999 to about 59,300 today. (The state's crime rate also dropped substantially during that time.) Nevertheless, mainly because of opposition from the correction officers' union and politicians from the upstate areas where most of our correctional facilities are, the state has been slow to close prisons. It was not until earlier this year that policymakers in Albany, confronted with fiscal crisis, mustered the will to shut three prison camps and seven prison annexes--a total of about 2,250 prison beds--in a move that is expected to save $52 million over the next two years. ... The prison system still has more than 5,000 empty beds in 69 prisons. What's more, there are other ways to lower the prison population. For starters, state lawmakers could repeal the Rockefeller mandatory sentencing provisions that remain on the books. ... In addition, the state could reduce the number of people--last year, more than 9,000--who are returned to prison for technical parole violations like missing a meeting with an officer or breaking curfew. ... Also, more prisoners with good institutional records could be given parole. ... After New York passed the Rockefeller drug laws in 1973, a mandatory sentencing movement swept the country, raising the nationwide prison population to nearly 2.4 million, from 300,000"
So be careful with the slides that Ackman has about the rising tide. There might not be one. This then makes it much harder for someone like CXW to swim against it: everyone's a champ with the wind in his sails. Again, remember that if you buy now, you do not have Ackman's margin of safety. He's already up 150% and might well be a seller, at least partially.
Posted by Barbarian Capital at 23:38