The perverse incentives of private prisons

LAST week authorities captured two fugitives who had been on the lam for three weeks after escaping from an Arizona prison. The convicts and an accomplice are accused of murdering a holiday-making married couple and stealing their camping trailer during their run from justice. This gruesome incident has raised questions about the wisdom and efficacy of private prisons, such as the one from which the Arizona convicts escaped.

Mother Jones reporter Suzy Khimm, writing at Ezra Klein's spot, observes that the portion of Arizona's prison population now residing in privately owned and operated facilities is 20% and growing. "Nationally," Ms Khimm notes, "there's been a similar surge in private prison construction as the inmate population has tripled between 1987 and 2007: Inmates in private prisons now account for 9% of the total US prison population, up from 6% in 2000." Should we welcome this development?

Geo Group's purchase of Houston private prison company leaves it highly leveraged

From Grits For Breakfast
I noticed recent news that the Geo Group (formerly Wackenhut), a private prison company which has been expanding aggressively in Texas, saw its earnings increase last quarter not because its operations became more profitable but because they purchased yet another competitor, this time the Houston-based Cornell Group.

Geo's boosted earnings, though, also bring with them nine figures in additional debt for a company already leveraged to the hilt. In 2007, I'd quoted from their 10-K (which is an annual report filed with the Securities and Exchange Commission) which informed us that:

the company has a "significant level of indebtedness that could adversely affect our financial position," mostly spent to buy competing private prison companies. And how might this debt "adversely" affect Geo? First and foremost, the company says, it could "require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness." Translated, that means they've got so much debt they're going to have to divert funds from their facilities they're operating to help pay it off!

The same warning was included in Geo's most recent 10K, but after the purchase of Cornell it deserves to be amplified. The more debt the company has, the greater risk they must "dedicate a substantial portion of our cash flow from operations to payments on our indebtedness." (They'll also be dedicating a portion of their revenue, btw, to pay the board chairman's son-in-law a fat $144K salary plus stock options, which is the kind of executive hire that to me raises a red flag.)

According to Texas Prison Bidness, Cornell operated 10 facilities around the state, many of them housing juveniles and/or focused on treatment programming. The acquisition beefs up Geo's Texas portfolio considerably after a spate of lost contracts around the state. Texas Prison Bidness recently observed that:

GEO has lost at least 5 contracts in Texas in the past several years.  GEO lost its Bridgeport TDCJ contract earlier this summer and the 2008 re-contracting of the Estes unit to MTC.  In 2007, the state of Idaho pulled its inmates from the Dickens County Correctional Center in the wake of the suicide of inmate Scot Noble Payne and a subsequent investigation into "squalid" conditions at the lock-up.  Idaho also cut its contract the Bill Clayton Detention Center in Littlefield, Texas after the 2008 suicide of Randy McCullough.  And, as the the article indicates, the Coke County Juvenile Justice Center was shuttered in October 2007 by the Texas Youth Commission after a damning investigation into conditions at the youth detention center.

Geo has six contracts up for renewal this year, according to its 10K, and at four are in Texas (Mineral Wells, North Texas ISF, South Texas ISF, and Bridgeport, which they already lost). About 1/3 of GEO's contracts end by 2012 and must be renewed or re-bid. Five customers including the State of Texas account for most of Geo's revenue:

We have provided correctional and detention management services to the United States Federal Government for 23 years, the State of California for 22 years, the State of Texas for approximately 22 years, various Australian state government entities for 18 years and the State of Florida for approximately 16 years. These customers accounted for 63.5% of our consolidated revenues for the fiscal year ended January 3, 2010.

The lull in the immigration detention market that's left competitor CCA with 12,500 empty beds is also affecting Geo on a couple of speculative construction projects, says their 10-K:

We are currently in the process of expanding two facilities to add additional beds that we do not yet have corresponding management contracts to operate. While we are working diligently with a number of different customers for the use of these remaining beds, we cannot in fact assure you that contracts for the beds will be secured on a timely basis, or at all. While these facilities are vacant, we estimate that we will incur carrying costs ranging from approximately $1.0 million to $1.5 million per facility, per fiscal quarter. Failure to secure management contracts for these projects could have a material adverse impact on our financial condition, results of operations and/or cash flows. In addition, in order to secure management contracts for these expanded beds, we may need to incur significant capital expenditures to renovate or further expand these facilities to meet potential clients’ needs.

I'd also pointed out back in 2007 that GEO making its debt payments required the company to rely on payments from subsidiaries that it could not guarantee:

The 10-K declares that Geo relies on "distributions" (i.e., "profits") from its subsidiaries to pay its increasingly large debt. Profits from subsidiaries made up more than 28% of Geo revenue last year, but the 10-K cautions that "Our subsidiaries are separate and distinct legal entities and are not obligated to make funds available for payment of our other indebtedness in the form of loans, distributions or otherwise."

In other words, we're not solvent without payments we can't ensure will keep coming, and our subsidiaries are "separate and distinct legal entities" who we don't control. That works out nicely for Geo if they go bankrupt, doesn't it?

That was written when subsidiaries made up 28% of Geo's revenue. Today, according to Geo's 10K, "For the fiscal year ended January 3, 2010, our subsidiaries accounted for 50.1% of our consolidated revenue, and, as of January 3, 2010, our subsidiaries accounted for 59.0% of our total segment assets." If the Cornell acquisitions are treated as subsidiaries, that risk will be even further magnified. The Geo Group is a heavily leveraged company.

In closing, here are a few more Texas-specific tidbits culled from Geo's 10-K:

"On May 4, 2009, we announced that we executed a contract with Bexar County, Texas Commissioners’ Court for the continued operation of the 688-bed Central Texas Detention Facility located in San Antonio, Texas. This facility, which is owned by Bexar County, houses detainees predominately for the U.S. Marshals Service. We have managed this facility since 1988. The new contract will have a term of ten years, effective April 29, 2009."

Some of the company's gains were "offset by a decrease in revenues of $20.6 million due to the termination of our management contract at the Sanders Estes Unit in Venus, Texas, Newton County Correctional Center in Newton, Texas, Jefferson County Downtown Jail in Beaumont, Texas, Fort Worth Community Corrections Facility in Fort Worth, Texas, and the Tri-County Justice & Detention Center in Ullin, Illinois."

"Effective June 15, 2009, our management contract with Fort Worth Community Corrections Facility located in Fort Worth, Texas was assigned to another party. Prior to this termination, we leased this facility (lease was due to expire August 2009) and the customer was the Texas Department of Criminal Justice."

"On September 8, 2009, we exercised our contractual right to terminate our contracts for the operation and management of the Newton County Correctional Center, referred to as Newton County, located in Newton, Texas and the Jefferson County Downtown Jail, referred to as Jefferson County, located in Beaumont, Texas."

"[R]evenues increased $24.1 million in total due to the activation of three new contracts in Third and Fourth Quarter 2008 for the management of Joe Corley Detention Facility in Conroe, Texas, Northeast New Mexico Detention Facility in Clayton, New Mexico and Maverick County Detention Facility in Maverick, Texas ... [and] revenues increased $24.6 million in 2009 as a result of our opening of our Rio Grande Detention Center in Laredo, Texas in Fourth Quarter 2008."

"On September 15, 2006, a jury in an inmate wrongful death lawsuit in a Texas state court awarded a $47.5 million verdict against us. In October 2006, the verdict was entered as a judgment against us in the amount of $51.7 million. The lawsuit, captioned Gregorio de la Rosa, Sr., et al., v. Wackenhut Corrections Corporation, (cause no. 02-110)  in the District Court, 404th Judicial District, Willacy County, Texas, is being administered under the insurance program established by The Wackenhut Corporation, our former parent company, in which we participated until October 2002. Policies secured by us under that program provide $55.0 million in aggregate annual coverage. In October 2009, this case was settled in an amount within the insurance coverage limits and the insurer has now paid the settlement amount. On February 8, 2010, the Court of Appeals, 13th  District of Texas, entered judgment dismissing the appeal and the case has been concluded."