Geo Group (NYSE-GEO) – Updated Thesis: Stock trades at $8.20, but is worth $27, $37 and $42 based on various valuation metrics. And the reasons why this deep undervaluation won’t last.

1. Worth $27 based on earnings. Worth $37 based on FFO. Some investors consider Geo Group to be a REIT, others do not. Either way, the stock is very inexpensive. If considering Geo Group as a regular company, one should value it on an earnings basis. On an earnings basis, Geo Group trades at 5.8x 2021E earnings of $1.40 per share. However, the average company in the Russell 2000 trades at 19.5x earnings, indicating a fair value of $27 for Geo Group shares. (19.5 x $1.40 = $27.30). And if considering Geo Group as a REIT, one should value it on a P/FFO basis. Geo Group trades at 4.3x 2021E funds from operations (FFO) of $1.90 per share. However, the average ‘other/ diversified’ REIT in the United States trades at 19.8x FFO, indicating a fair value of $37 for Geo Group shares. (19.8 x $1.90 = $37.62). (See Figure 1 below).

2. Worth $42 based on replacement cost. As an alternative way to determine the fair value of Geo Group shares, we can look at the replacement cost of Geo Group's assets minus liabilities. To calculate the replacement cost of Geo Group's assets, I researched the construction cost of 25 recently built prisons in the United States. However, because prisons are different sizes, I looked at their construction cost on a per bed basis. The cost was $220,061 per bed. Given Geo Group owns prisons with 55,951 beds, that implies a $12.3 billion total replacement cost. Now that we know the replacement cost of GEO’s facilities, we can calculate the replacement cost of the rest of the company. To do that, we take the value of the company’s facilities, plus the value of the company’s cash and receivables of $1.1 billion, less all liabilities of $3.4 billion. $12.3 + $1.1 – $3.4 = $10.0 billion. Divide $10.0 billion by 122.4 million of shares outstanding = $81.57 per share. But aren’t new facilities worth more than older ones? Yes. GEO’s Secure Services facilities were built, on average, in 1998. Rule of thumb is that industrial building values decline at 2.5% per year. That means $81.57 per share for buildings built in 2020 = $38.64 per share for buildings built in 1998. But also importantly, all of the facilities have been renovated. The renovations would add back at least 10% to the value of the facilities. And $38.64 x 1.10 leaves us with a replacement cost of $42.50 per Geo Group share. (See Figure 1 below).

Sources: Google searches, internal calculations.

3. Reddit users often read the above paragraphs, then they state the following: “Okay I agree with you, GEO is undervalued. But why is it undervalued? And when will it move back to fair value?” Well, for the past 1.5 years, news headlines constantly stated Geo Group’s earnings are at risk of decline due to the U.S. federal government’s new negative stance towards private prisons. As a result, shares fell 50%. However, news reporters (and in turn some investors) are overlooking the fact that federal facilities only hold 7% of prisoners in the United States. The other 93% of prisoners are held at the state or local levels. So the federal government's stance on private prisons is largely irrelevant, because it only applies to 7% of prisoners. Furthermore, as seen in the picture below, due to: (a) soaring crime rates; (b) soaring police retirements (up 45% yoy for the 12 months ended April 2021); and (c) prison overcrowding, the current federal government’s political aspiration, in addition to being largely irrelevant, is completely unrealistic. This reality – that the federal government’s stance on private prisons is irrelevant – is already positively impacting Geo Group's bottom line. On August 4, 2021, the company reported a significant beat on its Q2 earnings results and raised its full-year earnings guidance from $1.20 to $1.40 per share. And subsequent to the reporting of Q2 results, the company announced it would be re-opening a previously closed facility called Moshannon Correctional. The stock is already up 22% from August 4 to today. **Update: The federal government, despite its bold statements advocating against private prisons for the past year, has quietly admitted it will allow Geo Group to bid on the renewal of the very contracts which the government previously said would no longer be given to the private sector**. It's just a matter of time before the entire market realizes Geo Group's earnings will not decline, but are in fact sustainable. (More likely earnings will increase, at least at the rate of inflation). And companies with sustainable earnings trade at 15-20x earnings, not 5x earnings. This re-rating from 5x P/E to 15-20x P/E supports a 200%-300% increase in Geo Group’s share price from $8.15 per share to between $21 and $28 per share.

Sources: Statista, The New York Times, U.S. Bureau of Justice, Progress News

4. Don’t wait because momentum is building. First, we have legendary investment guru, Dr. Michael Burry, buying $20 million of shares of Geo Group between April and June 2021. He also tweeted about the stock in June: Second, we have large scale insider buying from CEO Zoley who purchased $1.1 million worth of shares at $6.75 per share in June. Third, a whale investor just bought $1 million worth of Geo Group options with a strike price of $12 and March 2022 expiry date. This $1 million investment goes to $0 if GEO shares don’t rise to $12 by March. Typically, whale investors don’t make those big bets unless they are almost certain of something. And fourth, Geo Group has its own Reddit group of 1,200 members, up from 200 in June. One posted a billboard in New York, promoting the stock. (see it below and here: However, Geo hasn't even been mentioned in the most important Reddit group (Wall Street Bets) yet, because its market cap of $1.05 billion falls just below the forum's $1.25 billion requirement. What happens when the only meme stock with strong fundamentals makes its way onto this aggressive short squeeze subreddit?

Source: Twitter, Reddit

5. If the above isn’t reason enough to buy, consider this question: Is Geo Group the single best short squeeze candidate out of all meme stocks? As seen in the scatter plot below, because of Geo Group's relatively small market capitalization ($1.0 billion) and high short interest (22%), it is as likely as any other meme stock to get squeezed. However, there is an additional factor that needs to be considered, not displayed by the chart. That factor is Geo Group's deep undervaluation. I believe this undervaluation has two important implications:

a) Geo Group could triple based on fundamentals alone, trapping shorts. In other words, a massive squeeze could happen, independent of Reddit/Wall Street Bets.

b) Reddit users can risk far more capital on Geo Group vs other meme stocks. Only 3 of the 25 most talked about meme stocks/short squeeze candidates have earnings. Because Geo Group trades far below its fair value (while every other meme stock trades far above their fair values), Reddit users can risk far more capital investing in Geo Group. Looking at the chart below, which meme stock are you more comfortable owning? I know I’d be as comfortable investing $15,000 into a stock that trades at 5.8x earnings as I would be investing $5,000 in a stock with no earnings. Bottom line: APES have triple the ammo.


6. How high could shares go on a short squeeze? + Conclusion. GameStop’s market capitalization reached a high of $35 billion when the stock peaked at $483 per share. AMC reached a similar level. That level translates into a $292 share price for Geo Group (see Moonshot Potential column in Figure #1 above). Under normal market conditions, the probability of a short squeeze is low. However, in the past six months of the ongoing speculative mania, short squeezes have been common (ie. GME, AMC, CARV, CLOV). As discussed in paragraph #5 above, Geo Group’s potential to squeeze may be the highest among all meme stocks. And importantly, as proven by the deep due diligence valuation work completed in this post, instead of losing 50-70% of your capital while waiting for the squeeze (like with AMC, GME etc), you could very well be making a 100%-200% return while waiting.

*This post does not constitute investment advice.

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