From this week's Barron's:
>>Prison REIT Reworks Agreement
With Its Tenant (No, Not an
Inmate), and the Stock Slides
By Barry Vinocur
It seems as though management at one of the country's more unusual property
companies -- Prison Realty Trust -- hasn't been out of the cross hairs of
critical investors and analysts since before its July 1997 initial public
offering. Among other things, critics then cited potential management
conflicts of interest and the prospect that the real-estate investment trust
would be -- with no pun intended -- a "captive" of its former parent,
Corrections Corp. of America.
Last year, the company found itself under attack again following its proposal
to merge with CCA; the merger went through despite opposition from a number of
shareholders, including two big pension funds. Their argument: CCA was selling
out too cheaply.
More recently, the REIT reaped some negative publicity, including a segment on
the TV newsmagazine 60 Minutes, because of a number of incidents, including a
series of stabbings and a prison break at a facility owned by the REIT and
operated by CCA in Youngstown, Ohio. Youngstown officials say they agreed to
the construction of a private prison in their city -- along with the creation
of 450 jobs -- after being assured that it would house only medium-security
inmates. However, they maintain, Corrections Corp. accepted maximum-security
prisoners, including violent offenders, transferred from overflowing
facilities in Washington, D.C. At least one lawsuit arising from the incidents
has been settled for approximately $1.6 million.
Last week, management of the Nashville-based REIT, the largest owner of
privately operated prisons in the U.S., was under fire again, this time over
the reworking of its agreement with a new private operating company that
Prison Realty had spun out after the CCA merger to oversee the REIT's prisons.
The result has been a sharp drop in the company's stock price, from just north
of 21 to around 14.
Prison Realty Trust started out joined
at the hip to CCA. Founded by Doctor R.
Crants and Thomas W. Beasley, who had
been roommates at West Point, CCA was a
pioneer in the prison-privatization
movement. Crants serves as the REIT's
chairman and CEO; his son, Robert
Crants III, is its president.
To maintain its tax-favored REIT
status, Prison Realty Trust cannot both
own and operate its properties.
Instead, it buys prisons from the
operating company, which then leases
the properties under long-term
agreements. What made Prison Realty
Trust unusual, however, is that CCA was
its sole tenant.
Such a "captive" relationship is
nothing new in the world of REITs. Many
of today's health-care REITs started out as captives, though financial woes at
their "captor" parents led the REITs to diversify their tenant bases. Today
Prison Realty remains closely tied to the private operating company spun out
to a group of shareholders after the CCA merger.
The latest controversy stems from the reworking of several key elements of the
agreement between the REIT and the private operating company. Ownership of the
private company includes a number of the senior executives of the REIT,
including the younger Crants.
The reworked agreement provides, among other things, for an increase in the
tenant incentive fee paid by the REIT to the operating company. In a recent
Securities and Exchange Commission filing, the company states that the REIT
pays the private company the fee to induce it to lease facilities the private
company has developed. Under the reworked agreement, the fee increases to
$4,000 a bed yearly from $840. Analysts and investors estimate the cost of the
increased incentive to be roughly $41 million a year. The reworked agreement
also provides for increases totaling some $40 million annually in a number of
other fees paid by the REIT to the private company.
In a research note last week, Christopher Haley and J. Hall Jones Jr., who
follow Prison Realty Trust for First Union Capital Markets, wrote that the
REIT's accountant, Arthur Andersen, determined the REIT had to pay the private
company the increased incentive fee to have new leases be considered
fair-market leases under the Tax Code and preserve the REIT's tax-favored
status. The analysts found it "discouraging" to learn about the higher fee
from the company's quarterly SEC filing. And they maintained that management's
earlier failure to see the need to raise the fee put its credibility under a
cloud. But they concluded that the increases were necessary to maintain the
private company as a credible tenant.
William Marks, who follows the company at Banc of America Securities in San
Francisco, agrees there's a credibility problem. "We're owed an explanation,"
he told Barron's last week.
The negative news is likely to put a crimp in the REIT's ability to raise
additional capital. Early last week, it began marketing a $300 million
high-yield debt offering. Pricing had been expected in the 9%-9.25% range. But
following a conference call with analysts and investors on May 14, during
which the agreement's reworking was discussed by Doctor Crants, First Union's
Haley said he expected that the required yield on the company's offering would
have to be raised to around 8.75%.
Another question facing investors is the company's dividend. Besides its
regular payout, the company is required to pay a special dividend this year as
a result of the merger. Banc of America's Marks says the company had already
conceded that it would have to borrow to pay the special dividend, but he
believes the REIT won't earn enough this year to cover its regular dividend on
its common stock of $2.20 a share.
How large the shortfall ends up being will depend on a number of factors,
Marks says, including the yield on the debt offering. His estimate is 20 cents
a share, a shortfall he expects will be covered by borrowing; Marks reports
that the REIT's management has told him it won't cut the payout. The analyst
hastens to add that he expects earnings to cover the dividend next year.
"Borrowing to cover the dividend should be a one-time occurrence," Marks
declares.
A number of investors say that as concerned as they are about the reworking of
the agreement and its impact on the REIT's operating results, they are at
least equally concerned about how management has handled the situation.
Comments one portfolio manager who until recently owned Prison Realty Trust:
"There are simply too many unknowns. Not only don't we know how this happened,
but no one has yet accepted responsibility for what happened." Further, he
says, the way management has dealt with the matter raises concern about its
forthrightness: "Everything should have been laid out in the conference call
on May 14. It wasn't. We didn't get the full picture until we reviewed the
company's latest SEC filing."
Analyst Marks fears there are "more shoes still to drop. I don't know that we
have yet to see the end. Is this the final deal? I just don't know."
BARRY VINOCUR is editor-in-chief of Realty Stock Review,
published in Shrewsbury, New Jersey.<< |
