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.
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 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
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.
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 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
--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