"Private Prisons Don't Work"

For-profit facilities face a barrage of criticism--and overbuilding has cut into profits and hurt stock prices

In the spring of 1999 in western Tennessee, a convicted murderer serving a 220-year sentence scaled the wall of the privately run Mason Correctional Facility in broad daylight. He eluded search teams for six days. The incident alarmed nearby residents and whipped media coverage into a frenzy.

The episode is just one of many escapes, murders, and other mishaps that have plagued the private prison industry since it burst on the scene in 1983. Always controversial, for-profit prisons were initially hailed by political conservatives as a cost-effective way to relieve the overcrowded penal system. And for a while private prisons relieved some pressure and initially turned a nice profit for such companies as Prison Realty Trust and Wackenhut Corrections Corp. Indeed, Wackenhut did too well for some. Its South Florida facility was publicly criticized for treating inmates as if they were on vacation, giving them access to televisions and gyms.

But today, the industry is in a rut, and its prospects have been severely trimmed. Overbuilding and ill-fated financial schemes have hammered stock prices. States, once eager to outsource their inmates, are backing out of private prison contracts. News of escapes and violence at private prisons adds to a climate of distrust. Execs at the for-profit prisons insist the concept still works. But the spate of bad news has given longtime critics such as Middle Tennessee State University criminologist Frank Lee a new platform. "Private prisons don't work," he says.

Certainly not as well as some had hoped. While the concept has political and social critics on either side of the discussion, private prisons were allowed to bloom in the first place because of the financial pressures placed on state governments in the 1980s. Then, rising crime rates and huge budget deficits pushed officials in states from Tennessee to California to try for-profit prisons, despite the criticism and political debate they generated.

MIXED RESULTS. But today, private prisons face a classic demand problem. Crime is down. State coffers are flush. Relieved of the pressure, states are taking a more critical look at the private prison option and finding the results so far are, at best, mixed. In Louisiana, for example, a 1996 study by researchers at Louisiana State University's School of Social Work found that Wackenhut's Allen Parish prison housed inmates at just a marginally cheaper rate: an average day cost of $22.93, vs. $26.60 for a nearby government-run facility.

Worse, lurid tales of jailbreaks at privately run facilities have done little to instill confidence in companies such as Prison Realty Inc. To date, more than 80 prisoners have escaped from Prison Realty facilities. The biggest embarrassment occurred in Youngstown, Ohio, where Prison Realty now houses 1,700 inmates. In 1997, the company agreed to take in maximum security prisoners from Washington, D.C. Trouble began immediately, climaxing in two high-profile murders inside the prison in the same year. "The track record remains hazy," says Christopher P. Haley, First Union Securities industry analyst.

Faced with uncertainty, some states are backing off. California scrapped its plans just last year to contract with private outfits to run four 500-bed prisons, and Georgia recently canceled plans to use a 1,500-bed facility that Prison Realty built on speculation in rural south Georgia. "We don't need new beds right now, nor is the state planning to increase funding for more private prisons," says Scott Stallings, spokesman for the Georgia Corrections Dept.

Just as demand is slacking, investors are finding that private prison companies have done a less than spectacular job of guarding the bottom line. No private prison company is more troubled than industry leader Prison Realty, which represents 55% of the market. It lost $265 million last year. An angry board ousted founder Doctor R. Crants this summer and replaced him with former Tennessee finance director John D. Ferguson. But even Ferguson concedes his work is cut out for him. "You can't believe the distrust out there about the company," he says.

That's in part because Crants, who declined to be interviewed by BUSINESS WEEK, brought some ultimately ill-fated real estate tactics to his company, first dubbed Corrections Corp. of America. In the late 1990s, Crants began building prisons on speculation. In 1997 he reorganized his company as a real estate investment trust. Now, construction would be financed through the sale of REIT shares, which would also pay stockholders dividends from operations. Crants' REIT, now called Prison Realty, leased its facilities to a separate CCA subsidiary. Wackenhut also embraced the REIT idea, though it did not build on spec.

Still, both tactics were overly optimistic. Eight years of strong national economic growth sharply lowered crime rates--and the demand for new prisons--while leaving governments flush with windfalls to build correctional facilities of their own. Prison Realty alone has 12,000 empty beds. And when demand slowed, shareholders were hit hard. Prisoner Realty shares fell from a high near 40 in 1998 to around 2 today. And Wackenhut Corrections Corp., the No. 2 player, saw its stock fall to 9 from a high in the upper 30s, even though the company remains profitable.

Still, the private prison industry isn't backing down. Government prison officials may criticize the industry, executives say, but they're not shy about copying innovations introduced by private companies. State legislators in Florida, Oklahoma, and New Mexico have asked Wackenhut, for one, to duplicate its intensive nine-month drug rehabilitation program in their states. "Prison officials from all over the world come to inspect our facilities," notes George C. Zoley, chief executive and vice-chairman of Wackenhut, which operates 30% of the nation's for-profit prisons.

NEW MARKETS. Prison Realty's Ferguson says he has a plan to lead his company out of the quagmire. Directors are expected to approve his plans, which include dismantling the REIT and merging Prison Realty into the old CCA, at a Sept. 12 meeting. The plan will streamline the company's finances and corporate structure, he says. Shareholders won't recoup their losses, but Wall Street watchers say they have little alternative but to try it Ferguson's way. "I'm telling people to approve the [Prison Realty turnaround plans] while holding my nose," says James R. Macdonald, an analyst at First Analysis Corp.

Looking ahead, the companies are seeking out new markets. Prison Realty is targeting federal contracts, a move even critics praise. Wackenhut has had success selling its prisons overseas. Already, the company, which has prisons in South Africa and Australia, has seen its international revenue jump 87%, to $3.9 million, in the first quarter of 2000 from a year earlier.

Will this be enough? Probably enough to stabilize the industry. While a return to the torrid '80s-era growth of 20% a year is unlikely, criminologists and stock analysts believe the private prison industry will survive, albeit in a reduced state. Macdonald predicts Prison Realty will break even this year and return to profitability in 2001. And criminologists concede that privately run prisons, while not a wholesale replacement for public facilities, do serve a valuable need. Taking over the private prisons would be "prohibitively expensive," says University of North Florida criminologist Michael Hallet. So while some will still do time behind for-profit bars, the industry's heyday may already be history.

Before it's here, it's on the Bloomberg Terminal.