Thursday, May 3, 2012

CCA Announces Possible Restructuring Strategy

Posted by on Thu, May 3, 2012 at 3:02 PM

In a morning conference call with company executives and investors, Nashville-based Corrections Corporation of America announced that it is considering a potential conversion into a real estate investment trust (REIT), a move intended to reap higher quarterly dividends for shareholders and raise capital amid stagnant stock prices and a barren outlook for state-level private prison appropriations.

CCA CEO Damon Hininger said the company plans to partner with JP Morgan-Chase bank and other legal, financial and business companies to explore the company's possible transition into a taxable real estate holding subsidiary (aka a "TRS"). This new and improved CCA would essentially have two branches: One that purchases and leases private prison properties to itself, and a managerial arm that oversees the operations and maintenance of its facilities.

In a press release sent out today, the company listed the benefits of such a conversion.

"The Company initiated the REIT Project to evaluate the potential benefits the TRS Structure could provide, including an increase in long-term shareholder value, a more tax-efficient corporate structure with higher cash flow, and a lower cost of capital, while maintaining access to ample capital to fund future growth," the release read.

But CCA experimented with REITs over a decade ago, with disastrous results.

In 1997, CCA created the CCA Prison Realty Trust, a REIT separate from the company and which acted to buy up CCA properties and lease them back to CCA for massive profits. Acording to the Certified Commercial Investment Member Institute, the plan initially worked well.

The well-known prison REIT, CCA Prison Trust, was created because Corrections Corp. of America, the largest private operator of correctional facilities in the United States, was growing at a phenomenal rate. The company’s niche is to contract with governmental authorities to privatize the housing of prisoners, saving the local governmental authority significant dollars.

However, in this case, the company was so successful that its financial results arguably began to suffer because of the substantial real estate on its books. The solution? The company spun off all of its real estate, including a pipeline of nine construction projects, into the IPO of a REIT, CCA Prison Trust, that would lease back the facilities to Corrections Corp. The leaseback provides CCA Prison Trust with an 11 percent yield. So far, the REIT has more than $500 million in assets. And, given the shortage of detention space, the REIT believes vacancy will not be an issue.

Basically, the realty trust acted as a kind of hedge fund for investors to raise capital on the stock market that CCA would use to build new prisons. Once those prisons were built, the trust would buy them and rent them back to CCA. The cash CCA would net from the "sale" of those properties (essentially to itself) would in turn be used to build new prisons, which the trust would then purchase and lease back to CCA, so on and so forth like a giant, greasy snake devouring its tail.

As you can imagine, this artificial economic bubble wasn't burst-proof.

From the report "CCA: A Critical Look at It's First 20 Years":

In July 1997, CCA Prison Realty Trust, a REIT registered in Maryland, made an initial public offering of 21.3 million shares, priced at $21, raising more than $400 million. Most of the proceeds of the offering were used to purchase nine facilities from CCA, which leased them back and continued operating them under government contracts. This process improved the look of CCA’s finances but amounted to the kind of off-balance-sheet transactions that would later become notorious in connection with the fall of Enron. Back in 1998 an investment banker told the financial magazine Investment Dealers’ Digest that REITs such as Prison Realty were “an off-balance-sheet financing vehicle if you want to pursue more acquisitions.”

The Ponzi scheme imploded just a few years after Prison Realty Trust went public. Sluggish occupancy rates forced the trust to leverage roughly $1 billion, which it defaulted on in 2000 prior to a bailout from (of all places) the now-defunct Lehman Brothers. A class-action shareholder lawsuit alleged the trust inflated managerial services fees to parent CCA, forcing the company to cough up $120 million in settlements. In 2002, CCA paid out a $52 million settlement to the IRS over "questionable" tax deductions taken by the trust. All the while, CCA Prison Realty's stock price plummeted to a fraction of its initial perceived worth, and by 2000 the two companies merged into the present-day Corrections Corporation of America.

Alex Friedmann — a former CCA prisoner-cum-activist, private prison critic, associate editor of Prison Legal News, and CCA stockholder — questions the wisdom of the company's decision to potentially repeat history.

"Those who fail to learn from the past are condemned to repeat it," Friedmann tells Pith. "CCA tried becoming a REIT before ... with disastrous results due to poor management decisions and issues with the REIT market at the time. CCA's stock dropped to under $.20 per share and they were at risk of being delisted. That directly led to a replacement of CCA's management team, with John Ferguson becoming CEO. The company reversed its REIT structure and recovered."

"I'm not an expert on such matters," he continues, "but given CCA's history in this regard it seems to be a questionable proposition. That, as well as recent lower than projected earnings, may be why CCA's stock is currently taking a hit; investors likely see the writing on the prison wall..."

Pith sent a detailed list of questions to CCA spokesman Mike Machack addressing these and others issues, who sent us the following response:

As our news release (issued this morning) states, and as execs reiterated on the earnings call, we are assessing the feasibility of a REIT conversion. Please review both releases below for the extent of our comments/explanation on this topic. CCA does not characterize/speculate on what shareholders are thinking. The company continues to be a premier provider of correctional services to states, as our new contracts/facilities with Ohio and Georgia indicate.

But with cash-strapped state legislatures failing to appropriate additional funding for private prisons for three straight years in a row, and a desperate strategy to buy up even more prisons amid declining national crime rates, it remains to be seen if CCA's gambit will pay off.

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