Fitch Affirms Corrections Corp. IDR at 'BB+' Considering REIT Conversion
NEW YORK -- January 31, 2013
Fitch Ratings has affirmed the credit ratings of Corrections Corp. of America
(CCA) as follows:
--Issuer Default Rating (IDR) at 'BB+';
--$785 million secured credit facility at 'BBB-';
--$645 million senior unsecured notes at 'BB+'.
The Rating Outlook is Stable.
The affirmation of CCA's ratings considers the company's intention to convert
to a REIT from a C-Corp. with a Taxable REIT Subsidiary (TRS) structure, which
would become effective Jan. 1, 2013 given a favorable Private Letter Ruling
(PLR) from the IRS. This outcome is likely in Fitch's opinion, especially
given the announcement of a favorable PLR for GEO Group (CCA's primary
competitor) on Jan. 18, 2013.
While the conversion does not place pressure on the rating or Outlook, Fitch
views CCA's REIT conversion negatively from a credit perspective, driven
primarily by the requirement to distribute at least 90% of taxable income to
shareholders per regulations governing REITs. Fitch estimates the enhanced
dividend stream will more than offset the potential tax savings and
deteriorate the free cash flow (FCF) profile by roughly $90 million as
compared to the pre-REIT conversion company. This will restrain the company's
ability to build more than one new correctional facility per year with FCF,
and it will increase reliance on consistent capital market access to grow and
The secured debt market for prisons remains undeveloped and is unlikely to
become as deep as that for other commercial real estate asset classes,
weakening the contingent liquidity provided by CCA's unencumbered asset pool.
Fitch would view more positively an increase in institutional secured lender
interest for prisons through business cycles and this increase would mitigate
the reduced financial flexibility stemming from the conversion. Fitch expects
that the company will retain strong access to capital via the unsecured bank,
bond and equity markets, given our expectation for strong credit metrics
following the conversion that are supported by the niche property type's
stable cash flows derived from providing essential governmental services.
Fitch calculates CCA's total debt/ LTM EBITDA at 2.6x as of Sept. 30, 2012.
Following conversion to REIT status with a TRS structure, Fitch continues to
expect the company will manage leverage to around 3x when allocating capital
toward additional share repurchases and/ or dividends.
The 'BB+' IDR incorporates CCA's financial policies, including the willingness
to increase leverage to a cap of around 4x that would only be reached via
opportunistic growth investments such as facility acquisitions and/or
construction of multiple facilities in a relatively short period of time. The
timing of such growth opportunities is difficult to predict, returns on
capital have been attractive, and its main competitor (GEO) is more highly
leveraged. These factors support the potential for leverage to increase.
In the event leverage were to increase to the 4x range due to growth
opportunities, Fitch expects that discretionary capital allocation policies
would shift toward reducing leverage to around 3x within a relatively short
period. However, the reduced FCF profile from the REIT conversion will limit
its ability to deleverage quickly, so the timing of any deleveraging could be
influenced by the company's willingness to issue equity to partially fund any
SOLID SECULAR CREDIT FACTORS AND COMPETITIVE POSITION
The long-term credit characteristics of the private correctional facilities
industry are attractive, including: overcrowding of public prisons, modest
private sector penetration of prison populations, and economically defensive
characteristics of prison populations.
CCA maintains a leading position (44% market share of private prison beds) in
the industry, which is highly concentrated and has significant barriers to
entry. GEO Group is its largest competitor with about 29% market share. Fitch
also views the industry in the context of a comparable set that includes
hotels, hospitals, private prisons, and REITs.
The U.S. private correctional facilities should continue to exhibit modest
growth in the long-run. Although the privatization of correctional facilities
dates back to the early 1980s, only about 10% of beds are currently
outsourced. The number of outsourced beds has grown to more than 209,000
through the end of 2011 from 11,000 in 1990, a CAGR of 15.1% over that time
frame. In contrast, roughly 20% of hospitals are investor-owned.
CCA's business reflects the stability tied to contractual income. CCA enters
into contracts with the federal, state, and/or local governments that
guarantee a per diem rate or a take or pay arrangement that guarantees minimum
occupancy levels. However, the short-term nature of the contacts with
governmental authorities is a concern. Typical contracts are for roughly three
to five years with multiple renewal terms but can be terminated at any time
Additionally, contracts are subject to legislative bi-annual or annual
appropriation of funds, so strained budget situations at federal, state, and
local levels could pressure negotiated rates. The company received six
requests for assistance with contracts in 2009-2010, but only one in 2011 and
one in 2012. CCA was able to adjust cost items in contracts to compensate for
reduced revenue levels such that the contracted profit did not deteriorate,
and the reconfiguration worked in their favor in the most recent request for
assistance in 2012. As a result, the company had strong relative financial
performance through the recent recession.
Another lingering concern remains the concentration of the company's
customers. Federal correctional and detention authorities made up 43% of
revenues in 2011 and primarily includes the Bureau of Prisons (BOP; 12%), the
United States Marshals Service (USMS; 20%), and the U.S. Immigration and
Customs Enforcement (ICE; 12%). State customers accounted for 50% of revenues
The California Department of Corrections and Rehabilitation (CDCR) made up 13%
of total revenue for 2011, though this will decline in the coming years, where
the pace of which will depend on the successful implementation of changes
proposed in California's corrections realignment program and whether or not
federal judges uphold their prior rulings centered on CDCR prison population
Our base case assumes that the population target is upheld and that California
will continue to utilize CCA beds out of state until additional CDCR capacity
comes on line, translating to a deactivation of a few thousand beds through
the end of 2015. Without additional inmate offsets coming on line in this time
frame (excluding recently announced contracts with Idaho and Arizona) this can
drive growth slightly negative in 2013 and the following couple of years.
Whether the withdrawals and offsets proceed according to our conservative base
case or California's proposed corrections realignment program, both scenarios
- considered in isolation - will be manageable within the 'BB+' IDR.
LIMITED REAL ESTATE VALUE:
Based on a cost of $60,000 per bed, the replacement cost of the company's 47
facilities is around $4 billion, which compares to roughly $1.1 billion of
debt and a current enterprise value of $4.8 billion.
The company's real estate holdings provide only modest credit support in
Fitch's view. There are limited alternative uses of prisons, the properties
are often in rural areas, and there is no established mortgage market as a
contingent liquidity source. However, the facilities do provide essential
governmental services, so there is inherent value in the properties.
Additionally, prisons have a long depreciable life (50 years) with a practical
useful life greater than that (equivalent to 75 years), and CCA has a young
owned portfolio (median age of 16 years).
STRONG FINANCIAL PROFILE:
At Sept. 30, 2012, Fitch calculated FFO less maintenance capex of roughly $240
million for CCA and expects this to increase sizably for 2013 by roughly $50
million, reflecting tax savings from the REIT conversion, partially offset by
a slight decline in EBITDA.
This strong and stable stream of cash flow will be used to support the large
recurring dividend commitments, which Fitch estimates to be roughly $215
million in 2013 excluding the one-time E&P distribution, as well as
fluctuations in accounts receivable, prison construction, share repurchases,
additional dividends, and/or paying down the balance on the revolver ($635
million at Sept. 30, 2012).
CCA's debt maturity profile is attractive. In 2012, the company paid down $375
million of 6.25% notes due 2013, and $150 million of 6.75% notes due 2014
primarily by borrowing on the revolver, which matures December 2016. There are
$465 million of 7.75% unsecured notes due 2017 that remain outstanding.
The secured credit facility is rated 'BBB-', one notch above the IDR. CCA's
accounts receivables are pledged as collateral, which totaled $239 million as
of Sept. 30, 2012. Equity in the company's domestic operating subsidiaries and
65% of international subs are also pledged as collateral, but long-term fixed
assets are not pledged.
As of LTM Sept. 30, 2012, leverage through the secured credit facility was
roughly 1.4x, and 1.8x on a fully drawn basis.
Considerations for an investment grade IDR include the following:
--Further penetration and public acceptance of private correctional
--An acceleration of market share gains and/or contract wins;
--Adherence to more conservative financial policies (2.0x leverage target;
4.0x minimum fixed charge coverage and $150 million minimum liquidity);
--Increased mortgage lending activity in the private prisons sector.
Considerations for downward pressure on the 'BB+' IDR and/or Stable Outlook
--Increased pressure on per diem rates from customers;
--Decreasing market share gains and/or notable contract losses;
--Material political decisions related to long-term dynamics of the private
correctional facilities industry;
--Leverage sustaining above 4.0x and FFO fixed charge coverage sustaining
Additional information is available at 'www.fitchratings.com'. The ratings
above were solicited by, or on behalf of, the issuer, and therefore, Fitch has
been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
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