The new administration in Washington, D.C., has led to a material shift in the dialogue around for-profit prison operators like GEO Group (NYSE: GEO). It's not yet clear how the industry is going to react and change, but there are already hints that the future for GEO Group will look very different than the recent past. Here's what you need to know as we look three years into GEO Group's future.
1. Business non grata
GEO Group owns and operates prisons on behalf of various levels of the U.S. government. That includes local governments and federal agencies. There are a lot of people in prison in the United States, so while this is a niche area, it's still a pretty big business.
Governments have outsourced the task of running prisons in an effort to save money. But as the new Biden administration started its four-year term, there was a quick presidential announcement that federal agencies should stop working with for-profit prison operators.
That sounds dire, but it really only impacts a couple of customers at GEO Group (specifically the Federal Bureau of Prisons and U.S. Marshals Service). So this is hardly a death knell for the real estate investment trust (REIT). However, the pronouncement could set a broader tone in the sector and lead to more material headwinds.
GEO Group is already losing business because of the directional shift. In other words, the next three years with the current administration heading things up in Washington, D.C., could be difficult.
2. What are we going to be?
That is, perhaps, part of the reason why GEO Group has begun reconsidering its status as a real estate investment trust. A REIT is a very specific business structure designed to pass income on to investors. However, because REITs must distribute at least 90% of their taxable earnings to shareholders, there's little left over for other purposes.
Facing the above-noted headwinds, GEO Group is clearly thinking that it may transition away from being a REIT. The final decision is expected by the end of this year.
So, in three years' time, GEO Group might no longer be a REIT. There are likely to be material tax considerations that go with that for investors.
3. Fixing the leverage situation
In light of all of this, GEO Group decided to suspend its dividend earlier this year. A key piece of that decision, however, had to do with the company's balance sheet, with management noting "the goal of maximizing the use of cash flows to repay debt, deleverage, and internally fund growth."
While the goal of deleveraging is laudable, the dividend suspension suggests that this is an urgent undertaking. On that front, the REIT's debt-to-equity ratio was close to 3 at the end of the second quarter. For comparison, some of the most prominent names in other REIT niches are far less leveraged, many with debt-to-equity ratios below 1. Leverage reduces flexibility and, given points one and two above, GEO Group appears to be at a point in time when it needs to have more options, not less.
Where will it be?
With so much up in the air right now, it's hard to tell what is going to happen to GEO Group over the next three years. That uncertainty should probably scare off most long-term investors. And without a dividend, income-focused types shouldn't be interested here, either. The only thing that is pretty clear is that GEO Group's future is likely to look very different from its recent past. Until there's more clarity, it's probably best to watch this company from the sidelines.
Adding even more complexity to the story, GEO Group's stock has gotten caught up in the Reddit message board madness. So the stock price has been subject to irrational trading swings based in no way on business fundamentals. If all the above wasn't enough to scare you away, the involvement of Reddit traders should be.