- The rise of mass incarceration over the last three decades, assuming the trend will continue
- State budget cuts reducing the likelihood that state governments will spend to build more prisons, and
- A massive increase in immigration detention policies that began under Bush II and escalated dramatically under Obama.
For several years now, Grits has believed that, examining the underlying fundamentals, both firms (particularly GEO) are far too laden with debt to justify bullish advice to investors. GEO has warned in corporate filings that its debt load could soon require them to divert money from operations to pay for debt amassed to gobble up competitors. Similarly, CCA's latest 10-K report on file with the SEC says its large debt could "require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness."
Even more than their massive debt loads, though, a bigger potential problem for these companies may be the possibility that we're nearing the end of the largest incarceration boom (read: bubble) in the history of the planet. The three bulleted factors above all could easily reverse in the next few years. More states are contemplating de-incarceration measures because of budget shortfalls, for example, and states like Texas have seen their incarceration rates decline. If states implement such policy changes on a wider scale, it could reverse the upward trend mentioned in the first bullet and debunk the premise of the second - that incarceration rates will continue to increase even if states can't afford new prison construction.
Meanwhile, the boom in immigration detention is a short to medium-term phenomenon at best, driven largely by nativist sentiments that will not prevail long-term in political circles because of their radical impracticality. Even Rick Perry has suggested a program to let the 12-14 million undocumented immigrants get visas to stay here legally, while bipartisan proposals for comprehensive immigration reform, like the bygone McCain-Kennedy legislation, would likely go even farther. Immigration detention on its present scale is at best a short-term fix that will decline dramatically whenever a long-term political solution, of any sort, is finally reached. The companies' long-term debt, however, won't go away just because their number of contract beds decline.
If Grits is right that we're nearing the end of America's mass-incarceration bubble - and admittedly that may be wishful thinking, though I believe there are signs of a sea change in both elite and public opinion on the topic - then in coming years these companies' high debt loads will become entirely untenable. As CCA put it in their 10-K:
A decrease in occupancy levels could cause a decrease in revenues and profitability. While a substantial portion of our cost structure is generally fixed, a significant portion of our revenues are generated under facility management contracts which provide for per diem payments based upon daily occupancy. We are dependent upon the governmental agencies with which we have contracts to provide inmates for our managed facilities. We cannot control occupancy levels at our managed facilities. Under a per diem rate structure, a decrease in our occupancy rates could cause a decrease in revenues and profitability. When combined with relatively fixed costs for operating each facility, regardless of the occupancy level, a decrease in occupancy levels could have a material adverse effect on our profitability.These companies' biggest nightmare would be a combination of drug legalization and comprehensive immigration reform. Again from CCA's 10-K:
The demand for our facilities and services could be adversely affected by the relaxation of enforcement efforts, leniency in conviction or parole standards and sentencing practices or through the decriminalization of certain activities that are currently proscribed by our criminal laws. For instance, any changes with respect to drugs and controlled substances or illegal immigration could affect the number of persons arrested, convicted, and sentenced, thereby potentially reducing demand for correctional facilities to house them.Investing in private prisons basically is a wager that the United States has such a dysfunctional political system that we can't solve the immigration question or scale back the drug war, ever, and for many years that's seemed like a prescient gamble. Betting on the intelligence and competence of government officials will always get you poor odds. But if that longshot comes in and America's mass-incarceration bubble finally bursts, investors in both these companies will take a huge hit. The "bearish technicals" identified at CCA and the GEO Group may just indicate that, at this particular point in history, those long odds could be getting shorter. I certainly hope so.