Pound Pup Legacy

The booming security business now employs as many as one-fourth of American workers. Here are four companies poised to make a bundle from our penchant for protection.

By Jon Markman

In the midst of a six-year war on terrorism, widening income inequality and a growing fear of immigrants, America has become something of a police state, according to a new study, with as much as 25% of our entire labor force focused on protection rather than production.

The evidence is all around us, from the 47% increase in U.S. workers classified as security guards since 2002 to the sharp advance in the number of men and women under arms in Iraq, Afghanistan and elsewhere.

And it's not just public police forces and shopping-mall rent-a-cops. During the raging brush fires in Southern California last month, it was revealed that many wealthy homeowners now hire private firefighters through their insurance companies.

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The study by noted Santa Fe Institute and University of Massachusetts economists Samuel Bowles and Arjun Jayadev, called "Garrison America," suggests that one in four Americans are now engaged in "guard labor," which means they either provide security for people and property or impose work discipline at factories, farms and retailers.

Similar calculations of guard labor for 18 other countries suggest that the United States is pretty much the leader in this category, slightly trailing Greece, a former military dictatorship, but well ahead of Western democracies such as Switzerland, which has just a 10th of its labor force devoted to guard labor.

Note: Police personnel are not included due to lack of comparable data.

The increasing focus on protecting the existing economic pie rather than making more pie has important implications going forward, especially as we head into a year in which something like $1 trillion in adjustable-rate-mortgage adjustments will hit low-income and middle-class homeowners like a pie in the face.

You don't need a Ph.D. in behavioral science to realize that a material number of household heads, faced with the loss of their homes and cars to foreclosure and repo men, will turn to theft, drugs and violence amid a sense of frustration with their deteriorating status, just as they have in past periods of economic dislocation.

In this scenario, the world of protection and corrections is likely to enter boom times just as the economy slips sideways toward a slowdown or recession. Indeed, the guard biz is probably the most countercyclical play you can consider as an investor -- right up there with public companies focused on bankruptcy software, business restructuring and Pentagon contracting.

Welcome, downwardly mobile yuppies, to the dawn of the Age of Nefarious.

Guarded optimism

There are ways for cynical investors to make a buck off the new world disorder, and that is by considering investments in companies that supply security guards, build and staff prisons, and run psychiatric hospitals.  

It is an unsavory business, to be sure, that has had run-ins with the law, politicians and common sense. Yet the industry is also more professional now than in past eras, run by a new breed of executives more sensitive to public perceptions and moral norms -- rather than the brutes who ruled by guts, grease and intimidation in years past.

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Key names in the industry that we need to focus on are prison titan Corrections Corp. of America (CXW, news, msgs), which sports a $3.3 billion stock-market capitalization; Geo Group (GEO, news, msgs), which has a $1.1 billion market cap; Cornel (CRN, news, msgs), which has a $340 million cap; and Brink's (BCO, news, msgs) at $3 billion. You could probably throw in the major drug companies that make antidepressants Prozac, Paxil and Zoloft, too, but we don't really need to go there. Let's look at the three in detail.

Of the bunch, Geo looks in many ways the most attractive. The second-largest operator of private correctional facilities in the United States and provider of rehab, educational and mental-health services to boot, Geo operates numerous maximum- and minimum-security prisons domestically and in Scotland, South Africa and Canada.

Continued: A rising demand and a stagnant supply 

The company is poised to benefit from rising demand from states and federal immigration agencies that are overwhelmed by their rising criminal and detainee populations and see an outsourced solution provider as an ideal partner. Governments hate being in the business of building prisons and dealing with bad guys, so per diem fees are steadily marching higher for Geo and its peers because of a real lack of capacity.

In a nutshell, when rising demand meets stagnant supply, companies can raise prices and profitability soars. Figure that the company can earn $1.70 a share in 2009 on revenues of about $1.1 billion. With a price-to-earnings multiple of 23 -- reasonable for a company growing at better than 20% -- shares could get to $39, a 34% move from here. It won't be a straight shot, though, as bad things happen at prisons from time to time that can temporarily pressure a stock like this -- and facility populations can vary from quarter to quarter, making earnings somewhat unpredictable.

Meanwhile, Corrections Corp. operates around 65 correctional, detention and juvenile facilities in the United States with a total capacity of more than 72,000 beds in 19 states. It also provides prisoner-transportation services through a subsidiary. The company has been racking up contract wins in the past few months, with a 7,772-bed deal from the California Department of Corrections in October probably the most emblematic since it replaced a 5,670-bed contract with the same agency.

The company also recently announced it would now begin building a new 3,060-bed correctional facility in Eloy, Ariz., to house its overflow of California inmates starting around this time next year. Some of its other California inmates will go to its Tennessee and Florida operations. I figure the company can earn $1.71 a share in 2009, which with a price-earnings multiple of 23 would put the stock at around $39, up 40% from the current quote.

Backing up the truck

And finally Brink's offers a whole different take on the idea as it provides home-security systems and services, armored-car transportation, airport security and guard services. The company reported strong earnings last week with all segments hitting their marks. 

The company's international business, such as armored transportation in Latin America, was a standout, while the residential-housing crunch did put a bit of a damper on the home-security business, which was up just 1.6%. Fortunately that was offset by commercial-security results, which rocked. I figure the company can protect itself and shareholders by earning as much as $3.52 a share in 2009, which would put the stock at $81, up 26% from today's price, on a P/E of 23.

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I'm not crazy about the state of affairs that has led to prisons being a growth industry, but investors need to play the hand they're dealt. Lock 'n' load.

Fine print

Click here to visit the Santa Fe Institute think tank's site. . . . Click here to visit the Justice Department Web site or here to go straight to the 2006 crime statistics. . . .  

Click here to visit the GEO Web site. . . . Click here to visit Brink's. . . . Click here to visit Corrections Corp. or here to see their recruitment video for military veterans.

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At the time of publication, Jon Markman did not own or control shares of any of the companies in this column.