The prison business looks ready to stage a breakout.

Tougher mandatory sentences were already straining the nation's jails. Now, the Department of Homeland Security's Border Initiative and its detention of undocumented immigrants has further burdened the system. Federal prisons already have 33% more inmates than they were designed to house and state prisons are similarly overcrowded.

The upshot? A severe shortage of prison space -- and a robust outlook for the three biggest private jailers.

A Need to Outsource

The vast majority of prisons are still owned and operated by federal or state governments; less than 8% of prisons are outsourced to private operators. But the private market -- dominated by Corrections Corp. of America, Geo Group and Cornell -- is expected to grow substantially over the next five years.

A February report from the Pew Charitable Trusts, a nonprofit research foundation, forecasts a 13% increase in the inmate population by 2011 -- in line with past growth rates, but further compounding the overcapacity problem. That amounts to as much as $27.5 billion in new prison construction and operation.

That kind of burden leaves states and the federal government with little choice but to outsource incarceration to private companies.

Corrections, Geo and Cornell are "far and away the biggest beneficiaries of that trend," says Patrick Swindle, an analyst with boutique investment bank Avondale Partners in Nashville, Tenn.

Higher Profit Margins

Take Corrections, the biggest of the bunch with about a 50% market share and expected earnings growth of some 22% a year over the next five years. The company recently amended a contract with California to house an additional 4,700 inmates, with more expected to come from the state's desperately overcrowded system. Occupancy rates of 90%-plus and better contract terms are boosting profit margins.

Geo, with 30% of the market, is enjoying new contracts, better terms and sky-high occupancy rates as well. As a result, analysts, on average, expect earnings growth of 16% a year for the next five years.

Another plus is the company's emerging Geo Care business, which takes over crumbling state mental institutions. "These are very old state facilities, many of which need to be replaced," Mr. Swindle says. "Geo Care is a first mover in the space, and that business is really beginning to get its legs." Geo Care contributed $70 million to Geo's 2006 revenue of $861 million, almost double its contribution the year earlier.

Small but Growing

With just 8% of the private prison market, Cornell is the smallest player. But the company is expanding its Folkston, Ga., prison in response to demand from the U.S. Marshals Service. And in January, it renewed a long-term contract with the Federal Bureau of Prisons to add housing at its facility in Big Spring, Texas.

Cornell's long-term earnings-growth rate is projected at 11% a year for the next five years.

There's another bright side to this somewhat dark industry: These stocks have a defensive aspect. Jamie Cuellar, portfolio manager at Brazos Capital Management, which owns shares in all three companies, says the sector is almost countercyclical.

"When times are bad, more people tend to go to jail," Mr. Cuellar says. "It's awful, but it's true."

Write to Dan Burrows at dan.burrows@dowjones.com

http://online.wsj.com/article/SB118022826756215918.html?mod=googlenews_wsj