TEXT - Fitch affirms Corrections Corp of America issuer default rating
Jan 31 - 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 refinance indebtedness. 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. FINANCIAL POLICIES 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 growth opportunities. 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 without cause. 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 in 2011. 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 reduction. 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. SENSITIVITY/RATING DRIVERS Considerations for an investment grade IDR include the following: --Further penetration and public acceptance of private correctional facilities; --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 include: --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 below 4.0x.