Iron Mountain is misunderstood.
Investors hear the name Iron Mountain,say "oh, the paper storage business?", scoff and tune out.
Yet 220K customers, including the world's most heavily regulated organizations, trust Iron Mountain with theirmission-critical storage needs. Those services generates $4.3 billion in annual revenue in 2019. Most of that revenue has 75% profit margins.
Who is scoffing now?
Yet, I feel bad for the CEO. He has togo on CNBC and to REIT conferences to try and get people excited about a paper business. He's basically Michael Scott from Dunder Mifflin.
But then I think about all that recurring revenue that comes in rain or shine with zero hassles (the tenants are boxes) and I realize this guy has it made.
This REIT is a great business with downside protection and a secret growth story. If your eyes haven’t glazed over yet, just suspend disbelief for a moment and hear me out.
Unreal Business Metrics
What kind of business does this soundlike?
· Zero competitors
· 75% gross margins on main business
· Near zero ongoing capital requirements– paper boxes don’t complain much
· Sells a service required by law for many businesses (compliance)
· Extreme customer diversification(225,000 worldwide customers)
· Sticky tenants with high switching costs – 98% retention rate (50% of boxes stay for 15+ years!)
· Pricing power with reliable organic growth
Pre COVID, document storage volumes –and revenues - were growing steadily:
If paper records are supposedly dying,why is their volume still growing?
Meanwhile expenses are falling:
IRM’s continued margin expansion is partly due to its recent cost cutting initiative: “Project Summit”. Management is projecting an annual run-rate cost savings of $150mm by 2020 and annualEBITDA benefits of $375mm exiting 2021.
I believe this is proof that IRM’s recent R&D investments are paying off. They have been condensing divisions and reporting, which should help simplify operations and drive savings.
Growing recurring revenue coupled with lower expenses is a pretty good combo. This has translated in 51% growth in FFOfrom 2015 – 2019.
Source- IRM 2019 Annual Report
Iron Mountain vs. Self-Storage and Industrial Buildings
Once downside to having zero competitors is that It’s difficult for the market to understand. There are noREITs to compare or contrast to.
The best proxies are self-storage and industrial.Iron mountain’s core business combines the best characteristics of bothself-storage and industrial buildings. Relative to these asset classes, IronMountain records storage has:
· Dramatically lower tenant turnover -98% retention / 15-year average tenant life
· CBD real estate locations on par withClass A industrial buildings
· No tenant improvements or tenant turnover capital costs (similar to self-storage)
· Optionality – facilities have back upuse options (can easily be converted to industrial use)
COVID Impact To IRM
While not completely unaffected, IronMountain (and it’s recession resistant business lines) is well positioned toweather this crisis.
· 96% of IRM’s facilities are open
· Records management (62% of totalrevenue) – unaffected, 97% collections YTD
· Service business, aka file retrieval(~10% of total revenue) - down 50% as many client’s offices remain closed
· Shredding service (9% of total revenue)- down 25%-30%
· Data Center / Fine Art (8% of totalrevenue) - unaffected
How Long Does This Business Thrive?
Ok – but how long can IRM shake thismoney tree?
Probably for decades.
This isn’t blockbuster video. Thereisn’t new technology that is going to crush this business overnight. In fact,we’ve had the technology to go paperless... for 50 years. It’s called ascanner.
The cloud is no spring chicken either.Dropbox was founded 13 years ago.
The reality is, we live in a highlyregulated world where laws require companies to save physical records.
Of course, eventually the tide willturn, compliance requirements will slowly change, companies will stop beinglazy and will convert paper docs to data. IRM’s 98% customer retention ratewill eventually start trending down; albeit it slowly.
Thankfully, Iron Mountain’s managementis preparing for that day. The percentage of their total revenue stemming fromdocument storage is declining. Currently at 62% today, down from 68% from 2015.
IRM is becoming less dependent onrecords management.
This trend should continue and ideally,speed up. While IRM has added interesting ancillary services such as fine artand film storage, the dominant new focus within the firm is its data centerdivision.
Future ofIRM – Data Centers
IRM has invested over $2 billion in 15data center developments and acquisitions since 2017.
Having worked in private equity realestate acquisitions most of my career, I find this rapid growth impressive.
Source- Iron Mountain
Entering the data center business was awise move.
Well-executed data centers are moneytrees and Iron mountain uniquely positioned to excel in this space.
Iron Mountain'sData Center Edge
· Excels at real estate acquisitions& development
· Has deed expertise in security first,mission critical facilities operations
· Can leverage existing customerrelationships (950 of the Fortune 1000) to drive new data center leases anddevelopment projects – 5 of the top 10 global cloud providers are existing IronMountain customers.
While IRM’s data centers only countsfor 6% of revenues, this segment is growing quickly and responsible for 1/3 ofthe company’s 4% organic growth (pre-COVID).
Furthermore, the firm’s pipeline of newdata center deals and developments (350 Megawatts of total potential) isstrong. construction recently started on new locations in Amsterdam, LondonSingapore, Norther Virginia and New Jersey.
Safety Net - Downside Mitigation
In real estate it’s best to focus onthe downside because the upside takes care of itself.
In addition to $150mm in cash, the firmhas access to another $1 billion line of credit. It can also tap the equity anddebt markets if needed. The company debt has a weighted average of 5.5 yearsremaining with no debt maturities this year. At 5.6x debt-to-ebitda, the firmis not overleveraged; it's slightly below the REIT average.
And finally, in an extreme downsidesituation, the firm can boost liquidity through asset sales.
Unlike self-storage properties, IronMountain's buildings can be converted to alternative (and highly coveted)industrial uses. The firm is opportunistic with its real estate holdings andwill sell for big profits if they can consolidate document storage with otherregional IRM building.
9.45% Monster Dividend – Will They Cut?
IRM’s nearly double-digit dividendwould typically be a red flag for most reits. In this case, the yield isartificially high due to the COVID market sell off, vs. structural problems atthe company.
IRM’s FFO for Q1 was close, but it didnot cover the dividend. I suspect that will be the same for the next 1-2quarters.
This is not an obvious call though.While they have the cash flow and war chest to continue floating shortfallsthis year; we don’t know how long the virus will act as a drag on their ancillaryservices.
The Summit Project cost savings mightoffset these temporary losses, but if not – how many times will they go to thewell (cash reserves) to support the dividend if the 2nd COVID wave continues to dampenservice revenue?
Furthermore, they have compellinggrowth opportunities in the data center vertical that requires hefty amounts ofcapital. I’m sure management would rather plow capital into growth investmentsthan supporting an above market dividend.
Finally, the CEO recently mentioned hisgoal was to get their payout ratio down to the 60% range by 2023. IRM canhit that target with the growth and cost savings they’ve forecasted, or theycan trim the dividend if those plans don't materialize quickly.
Unfortunately, there is too muchuncertainty to make this prediction with conviction. However, if I was the CEOor CFO, I’d push to trim but not eliminate the dividend. A 25% discount seemsappropriate. This is the base case for our investment thesis. That wouldstill amount to a hefty 7% dividend.
Regardless, I believe the risk / returnprofile is compelling for this misunderstood company. I like buyingmonopoly businesses with sticky tenants and high profit margins trading at 12times FFO (which is cheaper than a 8% cap rate for those real estate investorsplaying from home).
However, that’s not why I’m buyinghere. I’m betting IRM continues to aggressively grow it’s data centerbusiness.
The following "hot take"might sound crazy but hear me out. Despite all my glowing compliments aboutIRM’s business model, I think data centers that power the internet have abrighter 30-year future than warehouses filled with paper (which I thinkChinese technology from 100 BC).
It appears I’m not the only one thatfeels this way (go figure). Data center reits are trading at lofty 24 to 31times FFO today with paper thin dividend yields(see what I did there?).
So that’s the play. Clip above averagedividends (even if IRM trim’s it) at a value entry price and watch the datacenter portfolio – and FFO multiple – grow.
We have to watch this one though. Ifdata center growth stalls in a couple years, I’ll likely exit taking a modestpost COVID capital gain with some big dividend checks along the way.