Hedge funds recently released their latest 13F filings, and one of the most headlined transactions was that of Michael Burry doubling down on his GEO Group (NYSE: GEO) position. He also added five other stocks to Scion Asset Management’s portfolio, but GEO is by far the largest holding, occupying just under 38% of the fund’s public-equity holdings. Up until the prior quarter, GEO was actually the fund’s sole equity holding. Thus, considering how selective Mr. Burry is with his stock picking, this has made me and other investors wonder if the upside Mr. Burry sees is indeed as big as his conviction of the stock appears to be.
In any case, let’s go over what’s the deal with GEO stock and why Michael Burry’s shareholding is a solid stamp of approval, given the concerns surrounding the company. However, let me first disclose that for ethical reasons (see below), I am neutral on the stock.
GEO is Navigating Its Challenges Well
GEO stock has been under heavy pressure over the past few years. It may have recovered over the past year, but shares are still trading roughly 70% below their 2017 levels. This is due to several challenges the company is undergoing. Nevertheless, the company has navigated these challenges quite skillfully, which in my view, is the biggest reason Mr. Burry has been increasingly bullish on the stock. Let’s examine.
The main hardship that GEO is facing surrounds its very business model and the public backlash as a result of it. The company makes its money by providing secure facilities, processing centers, and prison space to government agencies. It’s not the most ethical way to build shareholder value; nevertheless, that’s what GEO does.
Challenge #1: Lack of Bank Financing
With public backlash growing in recent years, all major banks had decided to cut ties with private prison companies by the end of 2019. Now, keep in mind that as a Real Estate Investment Trust, access to bank financing makes for a critical component of GEO’s growth prospects. In response, GEO, which at the time was known among investors for its massive dividend yield, decided to suspend its dividend.
As shown above, no dividends have been paid since Q1 2021, and while the suspension caused a massive sell-off at the time, it has been proven to be the right decision. This is because, besides allowing the company to deleverage faster, it also means that GEO will now be able to self-fund its growth, compensating for the lack of bank financing.
Challenge #2: Biden’s Order to Stop Private Prison Contract Renewals
The second challenge that GEO got to face was last year’s executive order signed by President Biden, in which he directed the Justice Department to refuse to renew contracts with privately-operated, for-profit prisons. Of course, this news spooked GEO investors.
However, GEO appears to be somewhat ducking this executive order thus far. Firstly, this order does not affect facilities GEO manages on behalf of U.S. Immigration and Customs Enforcement. Additionally, GEO has started to evade the order by engaging in intergovernmental service agreements with counties which then contract directly with the federal government for detention services.
Thus, so far, renewals have been quite strong. In Q3, for instance, GEO successfully renewed two managed-only contracts in its Secure Services segment. In Florida, its contract for the 1,948-bed South Bay Correctional and Rehabilitation Facility was renewed for a two-year term, while in Arizona, GEO renewed its contract for the Phoenix West correctional and rehabilitation facility, which features around 500 beds. The contract has a five-year term.
Is GEO Stock a Buy, According to Analysts?
Although The GEO Group is a relatively popular stock, it lacks complete institutional ownership and analyst coverage due to its business model, as mentioned earlier. Nevertheless, based on a single buy rating, the stock has earned a Moderate Buy rating, with a $15.00 price target, which suggests around 43% upside potential from the stock’s current levels.
Michael Burry’s Stamp of Approval on GEO Stock
The two major challenges we just went over pose an existential threat to GEO. However, given that management has handled the situation with sustenance, combined with the fact that shares appear quite cheap, it’s easy to see why Mr. Burry has doubled down to the stock.
Since the dividend cut, GEO has reduced its long-term debt by more than 33% to $1.96 billion. Is the company still heavily indebted? Yes, but considering that management expects GEO to generate adjusted EBITDA between $527.0 million and $533.5 million, that means two things.
Firstly, deleveraging will continue to be swift, and secondly, the stock trades at around 2.5x its forward adjusted EBITDA, which makes it a deep value play. Once long-term debt starts falling below $1 billion, you will have a very profitable company able to return to massive dividend payments and, thus, dividend yields if the stock doesn’t appreciate.
It is in that “eventual” stock price appreciation that Mr. Burry is most likely betting on, and his latest increase in his GEO positions precisely the vote of confidence the stock has been in need of for quite some time now.
