U.S. citizens enjoy a full measure of every kind of freedom.  So it’s something of a paradox that our great nation also leads the world in incarceration.  The U.S. has more human beings behind bars than any other nation on earth, and by a wide margin — four times the world average. The United States imprisons more of its citizens than Russia under communism or South Africa under apartheid.

The United States, the land of the free, has 5% of the world’s population and nearly 25% of the world’s prisoners.

This comes at a tremendous cost.  An academic study in 2001 found the national and state average annual cost to be roughly the same, about $22,600.  Adjusting for inflation, the current annual cost figure would amount to $28,200.  The federal government’s Bureau of Justice Statistics says that 2,310,984 people are in state and federal correctional facilities.  That implies an annual cost of $65 billion.  For those of you keeping score at home, that’s more than global beverage giant Coca-Cola’s (NYSE: KO) entire annual revenue in 2008.

There’s no national movement afoot to reduce the prisoner headcount.  Quite the opposite, in fact.  A number of interest groups continue to lobby for harsher mandatory sentencing for several offenses, and they’re having success.  The incarceration rate grew at a faster pace than the population rate in 2007.  Some 19 states and the federal prison system are at or above capacity.  The federal prison system is bulging at the seams: It was at 36% above capacity at the end of 2007.  The Pew Charitable trust projects the prison system will grow by more than 153,000 inmates by the end of 2011 — roughly the population of Springfield, Missouri.

In addition to these legislative changes, the recession is also having an impact on prisons.  Though studies suggesting economic downturns lead to increased crime are debatable, what’s absolutely not debatable is that most states are facing dire budget shortfalls as a result of higher unemployment and other economic factors.  At the same time, the majority of state prisons are still being forced to operate at beyond their capacity.  Drastic budget shortfalls make building new facilities impossible.

The only viable solution — short of a governor committing political suicide by commuting thousands of prisoner’s sentences — is outsourcing.  Some states have done this successfully for years.  When a jail in New Mexico has unused capacity, it might board guests from overburdened facilities in Texas at a per diem rate.  Several companies have followed suit and built facilities of their own.  Adding in the profit motive the state prisons lack, the thinking goes, perhaps a private vendor can improve service, reduce costs and turn a tidy profit.

One company — the market leader — has proven adept at all three.

It’s a $1.6 billion outfit based in Nashville that owns or manages half the outsourced prison beds in the country.  It keeps the 44 facilities it owns and the 20 it leases full: In 2008, 2007 and 2006, its average compensated occupancy was 95.5%, 98.2%, and 95.0%, respectively. That’s far better and with a greater economy of scale than the nation’s hotels, which were only 58.5% full as of April 2009.
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Given the national preoccupation with sending even the most minor offenders to the hoosegow, this firm literally can win as much business as it wants.  To capitalize on the opportunity, it added more than 10,000 beds in 2008 and early 2009, some through entirely new facilities and about 4,000 by expanding its existing properties.
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That’s a big number, and I don’t want to overlook what it means.  Let me just present the facts and we’ll skip to the bottom line…
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 Average inmate annual cost:  $28,236
 (times) New Beds 10,364
 (equals) Potential Revenue $292.6 million
 (less) Occupancy rate 95%
 (equals) Gross Revenue $278.0 million
 (times) Net Margin 10.3%
 (totals) Net Earnings $28.6 million
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This company, the first private company to manage a private maximum security facility for the federal government, earned $150 million on $1.6 billion in revenue last year.  The additional beds alone will increase earnings +18.6%, and that’s on top of any contractually-mandated cost increases for existing customers.  It also assumes the highest reported vacancy rate in the past few years.  At 18 times earnings — which is well below its three-year average earnings multiple of 27.3 — the stock will have a fair value at the end of 2009 of $25.92, roughly +89.5% ahead of its current price.
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The company agrees with this assessment of its share price and prospects.  In November 2008 — as the market cratered — its board of directors gave the green light to a $150 million stock buyback.  “Given current market conditions, we believe that it is appropriate to repurchase common stock at prices which would equal or exceed the rates of return we require when we invest in new beds.”  In other words, earning +90% on their stock — and decreasing the number of shares by as much as 10% — is better than earning +10% on building even more new prison beds.

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