Bloomberg News

Drug War Lures Mexico Firms to Jails as Foreign Rivals Stay Away

August 02, 2012

Mexico Drug War Has Home Builders Cashing In on Private Prisons

A relative of an inmate observes policemen behind the security fence after a riot inside Apodaca prison, near Monterrey, state of Nuevo Leon, Mexico. Photographer: Julio Cesar Aguilar/AFP via Getty Images

Two Mexican homebuilding companies are embracing the government’s turn to private enterprises to help run violence-plagued prisons that has been shunned by international jail-management firms.

The country will open its first private prisons this year as the U.S.-backed war against drug gangs fills cells past capacity. In Central America, where a fire at an overcrowded Honduras jail killed 366 inmates in February, business groups are also pushing governments to build and run facilities.

It’s an opportunity that global prison operators such as G4S Plc (GFS) and Corrections Corp. of America are passing up in the face of the disorder and corruption that plagues Latin American jails. That’s left untested firms like Mexican builders Desarrolladora Homex SAB (HOMEX*) and Empresas ICA SAB (ICA*) with the task of bringing order to facilities the United Nations says lack basic sanitation and are plagued by “alarming” levels of violence.

“It’s hard to say that things could get worse because the jails are so bad,” said Mark Ungar, a professor at the City University of New York in Brooklyn who studies Latin American prisons. “But I can’t imagine many international companies wanting to jump into this.”

Outgoing Mexican President Felipe Calderon’s administration has said farming out prison construction to private companies would cut costs for such projects by 29 percent and the new jails would increase capacity for inmates by as much as 30 percent. Enrique Pena Nieto, who will succeed him in December, says he also supports private investment to expand facilities that hold 22 percent more inmates than the 180,000 they were designed to accommodate, according to a May 2011 government report.

Honduras Blaze

Improving security at penitentiaries took on renewed urgency following the Feb. 14 blaze in Honduras, the world’s deadliest prison fire in a century. Less than a week later, 37 inmates conspired with guards to sneak out of a Mexican jail by provoking one of the nation’s bloodiest prison riots, in which 44 died.

Calderon has said that a dozen new prisons under construction, some of them private, will be completed before his term ends, helping to relieve overcrowding in 429 federal and state facilities.

While Calderon’s drug crackdown has led to a surge in killings -- more than 47,500 since he took office in 2006 -- Latin America’s second biggest economy has proven resilient in the face of the worsening violence. Gross domestic product grew 4.6 percent in the first three months of 2012 from a year earlier, the fastest pace in six quarters and compared with Brazil’s 0.8 percent expansion.

Criminal Hotbed

Crowded jails that serve as a hotbed for criminal activity have hampered the drug fight in Mexico and Central America. Only $24 million of a $1.6 billion U.S. anti-narcotics aid package for the region is devoted to equipment and training for the prison system. With resources already stretched, private investors are being asked to fill the void.

Culiacan-based Homex, Mexico’s biggest homebuilder by sales, said July 25 it will buy out a partner in its prison projects for 1.1 billion pesos ($80 million) after second- quarter home sales tumbled. The company plans to build two correctional facilities this year and manage services such as food, laundry and building maintenance, the company said on conference calls with investors.

“I’m confident there will be more” to build, said Homex’s Chief Executive Officer Gerardo de Nicolas Gutierrez in an interview in New York on March 8. “The prison population will grow as the judicial system is improved.”

Revenue Contribution

Mexico City-based ICA, Mexico’s largest construction company, said in a July 27 earnings report that two prison projects due for completion before October were its single- largest contributor to second quarter revenue.

The penitentiary projects have the potential to produce a 35 percent profit margin for companies thanks to the government’s annual payment for services of 1 billion pesos per prison, Carlos Hermosillo, a Mexico City-based analyst with Grupo Financiero Banorte SAB, said in a phone interview. In return, the government gains immediate access to capital to build prisons faster than if it had to seek budget approval from congress, he said.

This year, shares of Homex have fallen 31 percent to 27 pesos, while ICA has risen 34 percent to 23 pesos per share.

Natural Fit

While companies that build and operate resorts and toll roads may consider it a natural fit to turn to prison construction, their lack of experience running such facilities could prove detrimental to their bottom line, said Ramon Ortiz, an analyst with Mexico City-based brokerage Corp. Actinver SAB.

“They face a very steep learning curve,” Ortiz said.

Press officials at both ICA and Homex didn’t return e-mails requesting comment.

While Mexico’s government will remain in charge of guarding the prisons, that’s not enough to inspire confidence for London- based G4S, which runs nine jails in the U.K., Australia and South Africa.

“The level of influence of some of the criminal gangs is extreme,” Fiona Walters, a G4S Americas spokeswoman, said in a phone interview from Jupiter, Florida. “To be able to run a safe and secure prison also speaks to broader issues and some of the challenges you’ve got with the cartels in some of those countries.”

G4S’s shares have dropped 7.7 percent to 250 pounds this year.

Drug Lord

Mexico’s prisons are legendary for their lawlessness. Joaquin “El Chapo” Guzman, the nation’s most-wanted drug lord, bribed guards so he could continue his extravagant lifestyle behind bars, including parties with prostitutes. He escaped in 2001 from his maximum security jail in a laundry bin.

Nashville-based Corrections Corp. (CXW:US) of America, the largest U.S. prison contractor, as well as its competitors Boca Raton- based Geo Group Inc. (GEO:US) and closely held Management & Training Corp., based in Centerville, Utah, have no plans to pursue business in Mexico or Central America, spokesmen for each company told Bloomberg.

This year, Corrections Corp. has risen 49 percent to $30 per share and Geo Group has climbed 39 percent to $23.

Investing outside of safer, developed markets would “pose a lot of risks for the G4S’s of this world,” said Alex Magni, an equity analyst at HSBC Holdings Plc. (HSBA)

Investors ‘Nervous’

“Investors would probably get quite nervous since there’s a world of opportunity where they don’t have to take that sort of risk,” Magni said in an interview from London.

In the U.S., which has the world’s highest incarceration rate, about 16 percent of federal prisoners and 7 percent of state prisoners are held in private jails, the Department of Justice said in a December report.

More recently, sentiment has turned against private prisons as cash-strapped state governments in the U.S. question whether handing inmates over to private facilities generates the cost- savings touted by the industry.

In April, California said it would reclaim almost 10,000 inmates held at private facilities. Shares in Corrections Corp tumbled 8.9 percent, their biggest drop in 11 months, the day after the plan was announced by Governor Jerry Brown. In February, Florida’s Senate blocked a plan to create the largest private-prison system in the U.S.

Rights Groups

In Mexico, some human rights groups have complained that the government is shirking its responsibility to clean up jails by turning to private companies.

“It’s a way to wash their hands and blame someone else for human rights violations that can take place at these jails,” Jose Luis Gutierrez, director of Mexico City-based Legal Assistance for Human Rights, said in a phone interview.

The Public Security Ministry, which oversees Mexico’s prisons, did not return calls seeking comment.

Central America may also follow Mexico’s lead in turning its prisons over to private hands. Business groups in Honduras and El Salvador, whose prisons are the most overcrowded in the region, have each lobbied their governments to open the prison system to investment.

Both countries are major transit zones for U.S.-bound cocaine from South America, and have seen incarceration rates surge over the past decade.

While Chile and Brazil have succeeded in turning over some basic prison services such as building maintenance to private companies, Central American prisons racked by violent gangs are easily corrupted and nearly impossible to manage, said Ungar, who has advised the Inter-American Development Bank.

“Governments have abdicated their responsibility in managing prisons,” Jose Miguel Vivanco, the Americas director for Washington-based Human Rights Watch, said in a phone interview from Washington. “Internally, these prisons are run by the prisoners themselves.”

To contact the reporters on this story: Nacha Cattan in Mexico City at ncattan@bloomberg.net; Eric Sabo in Washington at esabo1@bloomberg.net

To contact the editor responsible for this story: Joshua Goodman at jgoodman19@bloomberg.net


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Companies Mentioned

  • CXW
    (Corrections Corp of America)
    • $37.9 USD
    • -0.04
    • -0.11%
  • GEO
    (Geo Group Inc/The)
    • $40.44 USD
    • 0.04
    • 0.1%
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