Geo Group: A Potential Election Play (NYSE:GEO)

Shares of prison owner/operator The GEO Group, Inc. (NYSE:GEO) have rallied forcefully since June 2021, shortly after suspending its dividend, eventually reorganizing into a C-Corp to pay down debt. The move away from the real estate investment trust, or REIT, structure was compelled by a Biden administration executive order that prohibited the renewal of federal contracts with privately owned prisons. With high-interest rates on its debt but a stable, visible, albeit tepid outlook that could improve markedly on Election Day 2024, the recent insider buying merited a deeper dive. An analysis follows below.

Company Overview:

The Geo Group, Inc. is a Boca Raton, Florida-based owner, lessee, lessor, and manager of prisons, processing centers, and reentry facilities. The company’s footprint encompasses ~81,000 beds at 100 locations in the U.S., Australia, and South Africa. Geo Group was founded as a division of Wackenhut Corporation in 1984 and went public as Wackenhut Corrections Corporation in 1994, raising net proceeds of $17.6 million at $0.50 per share (after giving effect to four stock splits). It changed to its present moniker in 2004, converted to a REIT structure in 2013, and back to a C-corp in 2021. Its stock trades just above $15.00, translating to an approximate market cap of $1.95 billion.

Operating Segments

Geo earns the preponderance of its revenue from federal, state, local, and international government contracts that payout on a per diem per inmate basis, operating under four reportable business segments: U.S. Secure Services (USSS); Reentry Services; Electronic Monitoring and Supervision (EMS), and International Services.

USSS involves the administrative, rehabilitative, educational, security, transportation, and food services at domestic prisons through public-private partnerships. The segment owns or leases 36 facilities encompassing 44,731 beds, manages 12 prisons comprising 17,557 beds, and leases out but does not manage another eight with 3,364 beds. The division was responsible for FY23 operating income of $270.0 on revenue of $1.52 billion, down 4% and up 6% from FY22 (respectively), as well as 63% of its total FY23 top line. The increase at the top line was a function of increased per diem rates offset by a decrease in compensated man-days from 17.5 million in FY22 to 16.7 million in FY23, which drove occupancy at its operating facilities from 87.8% down to 85.9%.

In addition to government agencies in the public sector, USSS services compete with the likes of CoreCivic, Inc. (CXW) – its largest rival – as well as Management and Training Corporation, among others. In terms of total beds across all its segments in the private sector, Geo holds the number one market share at 40%, followed closely by CoreCivic at 38%.

Reentry Services primarily owns, leases, and operates 40 residential reentry centers and halfway houses encompassing 9,078 beds, as well as 89 non-residential centers. It provided FY23 net income of $48.7 million on revenue of $275.1 million, representing 14% and 8% improvements, respectively, as well as 11% of total revenue. The increases at the top and bottom lines were primarily a function of higher traffic through its facilities.

EMS encompasses non-residential day reporting centers, residential reentry and youth services, rehabilitation programs, as well as monitoring technologies for ~281,000 parolees, probationers, and pretrial defendants primarily out of 98 Intensive Supervision and Appearance Program (ISAP) offices. The segment accounted for FY23 net income of $212.9 million on revenue of $425.9 million, reflecting declines of 11% and 14%, respectively, as participants counts in the ISAP dropped throughout FY23. EMS’s top line represented 18% of Geo’s total.

International Services is essentially the U.S. Secure Services division in Australia and South Africa, covering a total of four criminal detention facilities and 6,025 beds. It also provides detainee transportation services in the UK. The segment contributed FY23 net income of $11.5 million on revenue of $193.9 million, representing a 39% decrease at bottom line on a 4% increase at the top versus FY22, as increases in the Australian population were offset by higher per prisoner expenses, including those from a new health care contract.

With the public-private partnerships in which Geo engages, it isn’t a surprising that 62% of its top line is derived from various agencies of the U.S. Federal Government with Immigration and Customs Enforcement [ICE] (43%) and U.S. Marshals Service (16%) the largest benefactors. The other would-be major federal customer, the Bureau of Prisons, only accounted for 3%. More on this development below.

It should be noted that at YE23, Geo’s USSS segment had seven idle edifices representing a total of 9,732 beds, while its Reentry Services unit has three unoccupied buildings that housed another 1,689 beds. The cash carrying cost of these buildings amounts to $8.3 million. More importantly, at FY23 per diem and occupancy rates, they represent unexploited revenue of ~$350 million and annual earnings of ~$0.30 per share.

FY23 Financials and FY24 Outlook

After factoring in corporate overhead, the four segments of Geo generated FY23 earnings of $0.95 per share (non-GAAP) and Adj. EBITDA of $507.2 million on revenue of $2.41 billion, versus $1.40 per share (non-GAAP) and Adj. EBITDA of $540.0 million on revenue of $2.38 billion, representing declines of 32% and 6% (respectively) on a top-line increase of 2%. The largest factor in the bottom-line weakness was significantly higher net interest expense, which was up $61.9 million, or $0.50 a share, as nearly half the company’s debt is floating rate.

As part of its 4Q23 and FY23 financial report of February 15, 2024, management released its outlook for FY24, which included non-GAAP earnings of $0.93 a share and Adj. EBITDA of $500 million, with the former metric impacted by net interest expense of $195 million, or $1.54 a share. From an operational standpoint, the slightly downward Adj. EBITDA estimate reflects concerns regarding ICE funding. All projections are based on range midpoints.

Share Price Performance

The net interest expense line item somewhat unlocks the story of Geo and its current status as a non-REIT. After attaining REIT status in 2013, Geo grew its top line at an 8.5% CAGR through 2019, mostly via the assumption of additional debt which increased at a nearly identical 8.6% CAGR during the same period. It paid a $0.47 or $0.48 quarterly disbursement during most of the Trump administration, but its operating model was negatively impacted primarily due to a net decrease in detainees at its ICE facilities and a drop in court sentencing at federal courts – both caused by the pandemic – resulting in a FY20 revenue decline of 5% to $2.35 billion while long-term debt rose 6% to $2.6 billion. Determining that some of its slightly diminished cash flow would be better employed in the reduction of its debt, management decided to cut the company’s quarterly dividend in October 2020 from $0.48 to $0.34.

Then on January 26, 2021, newly elected President Biden signed an executive order banning the renewal of any federal government contracts with privately operated criminal detention facilities, meaning no further revenue from the Bureau of Prisons (BOP) or (theoretically) the U.S. Marshals Service (USMS) beyond the terms of Geo’s current contracts. In response to this action, the company cut and then suspended its dividend and restructured as a C-corp. The net effect of the executive order left Geo with no BOP secure correctional facility contracts at YE23, but because the USMS (unlike the BOP) does not own or operate detainee housing and had no place to house prisoners awaiting trial, practically won out, and it has renewed contracts with Geo.

That said because its ICE business has picked-up considerably during the Biden administration, revenue has remained relatively flat since FY18, in a tight range of $2.26 billion (2021) to $2.48 billion (2019). Except for FY23, the same narrow range applies to non-GAAP net income, which spanned from $1.30 (2020) to $1.60 a share (2019). However, shares of GEO had been on a protracted decline from shortly after President Trump’s 2017 inauguration, peaking at an all-time high of $34.32 in April of that year, only to bottom out at $4.96 in May 2021, down 86%.

This nadir closely coincided with the upheaval from turning over most, if not all of its shareholder base when it cut and then suspended its dividend and later reorganized as a C-corp. That realignment provided (at that time) a new management team an opportunity to use free cash flow and asset sales –predominantly reentry facilities totaling ~$150 million to date – to reduce the company’s net leverage, which at that time was ~4.4, based on its FY21E Adj. EBITDA.

Balance Sheet & Analyst Commentary:

And to that end, management has had some success, lowering its debt by $197 million to $1.85 billion during FY23 and its leverage to 3.3, although that metric is up from 3.1 at YE22. Between its unrestricted cash and untapped revolving credit facility access, Geo had available liquidity of $283 million. With half its debt floating rate, its weighted average interest rate in FY23 was north of 10%, punctuating the need to retire it as quickly as possible and continue to forego paying a dividend. Its publicly traded bonds are rated junk (CCC+/Caa1) by S&P and Moody’s, respectively.

Towards that end, earlier this month, the company raised $1.275 billion in aggregate notes as well as opened a new $450 million credit facility. The proceeds from these two funding sources will be used to retire $1.5 billion in current debt and push out debt maturities to 2029.

So far in 2024, Wedbush ($14 price target), Northland Securities ($15 price target) and Noble Financial ($17 price target) have all reissued Buy ratings on the stock. On average, they expect (like management) the company to earn $1.01 a share (non-GAAP) on revenue of $2.45 billion in FY24, followed by $1.37 a share (non-GAAP) on revenue of $2.52 billion in FY25.

Also, bullish is Founder, former CEO, and current Executive Chairman George Zoley, who purchased 50,000 shares at an average price of $12.48 on March 14, 2024, marking the first insider buy since June 2021.

Verdict:

Possessing a steady, secure, and somewhat capped revenue base, Geo will continue to slowly pay down its high-interest debt. With its stock up 164% from its low in May 2021, it’s all about whether the market will expand or compress its multiples. Its P/E on FY24E EPS is currently 15 and its EV/FY24E Adj. EBITDA is under eight. These are fair valuations, albeit not overly compelling.

However, they will look a lot better if there is a Republican sweep on Election Day 2024, which would likely reverse the Biden executive order while simultaneously increasing resources for the company’s federal agency client base, meaning potential employment of its idle facilities or an increase in ISAP. Perceptions of a potential sweep will likely put a floor in its stock, making it a solid covered call candidate until the election. I also prefer this strategy to holding straight equity for its downside risk mitigation and as the stock is hitting up against analyst firm price targets. Otherwise, I would wait until the stock pulled back around the $12 – $13 level, where the CEO recently added to his stake in the company, before initiating an initial holding in The GEO Group, Inc. shares.