Iron Mountain: How Long Can They Milk This Cash Cow (~10% Yield)
Summary
- Iron Mountain is a highly profitable monopoly.
- The business is largely unaffected by COVID, yet the stock tanked anyways.
- Paper storage not exactly a sexy growth market; but it will last a lot longer than people expect.
- Sky high dividend, even if they choose to trim (which they don't have to).
- Back door data center play with limited near term downside at current price.
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 regulated organizations, trust Iron Mountain with their mission-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 to go on CNBC and try and get people excited about a paper business. Think Michael Scott from Dunder Mifflin.
But then I picture all that sweet recurring revenue with zero hassles (the tenants are boxes) and I realize this guy has it made.
Iron Mountain 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 sound like?
- Zero competitors
- 75% gross margins on main business line
- 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 annual EBITDA 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 to 51% growth in FFO from 2015 – 2019.
Source - IRM 2019 Annual Report
Iron Mountain vs. Self-Storage and Industrial Buildings
One downside to having zero competitors is that makes the company difficult to understand. There are no comparable reits.
The best proxies are self-storage and industrial businesses. Iron mountain’s core business combines the best characteristics of both self-storage and industrial buildings. Relative to these asset classes, Iron Mountain records storage has:
- Dramatically lower tenant turnover - 98% retention / 15-year average tenant life
- CBD real estate locations on par with Class A industrial buildings
- No tenant improvements or tenant turnover capital costs (similar to self-storage)
- Optionality – facilities have back up use options (can easily be converted to industrial use)
COVID Impact To IRM
While not completely unaffected, Iron Mountain (and it’s recession resistant business lines) is well positioned to weather this crisis.
- 96% of IRM’s facilities are open
- Records management (62% of total revenue) – 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 total revenue) - unaffected
How Long Does This Business Thrive?
Ok, okay it sounds like a good business – but how long can IRM shake this money tree?
Probably for decades.
This isn’t blockbuster video. There isn’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 a scanner.
The cloud is no spring chicken either. Dropbox was founded 13 years ago.
The reality is, we live in a highly regulated world where laws require companies to save physical records.
Of course, eventually the tide will turn, compliance requirements will slowly change and companies will convert paper docs to data. IRM’s 98% customer retention rate will eventually start trending down; albeit it slowly.
Thankfully, Iron Mountain’s management is preparing for that day. The percentage of their total revenue stemming from document storage is declining. Currently at 62% today, down from 68% from 2015.
Source: Company Presentation, REIT Dividends
IRM is becoming less dependent on records management.
This trend should continue and ideally, speed up. While IRM has added interesting ancillary services such as fine art and film storage, the dominant new focus within the firm is its data center division.
Future of IRM – Data Centers
IRM has invested over $2 billion in 15 data center developments and acquisitions since 2017.
Having worked in private equity real estate acquisitions most of my career, I find this rapid growth impressive. It's not easy to put $2 Billion to work in ~3 years.
Entering the data center business was a wise move. Well-executed data centers print cash (often double digit cash on cash returns) and Iron mountain is uniquely positioned to excel in this space.
Iron Mountain's Data Center Edge
IRM:
- Excels at real estate acquisitions & development
- Has deed expertise in security first, mission critical facilities operations
- Can leverage existing customer relationships (950 of the Fortune 1000) to drive new data center leases and development projects – 5 of the top 10 global cloud providers are existing Iron Mountain customers.
While IRM’s data centers only counts for 6% of revenues, this segment is growing quickly and responsible for 1/3 of the company’s 4% organic growth (pre-COVID).
Furthermore, the firm’s pipeline of new data center deals and developments (350 Megawatts of total potential) is strong. Construction recently started on new locations in Amsterdam, London Singapore, Northern Virginia and New Jersey.
Safety Net - Downside Mitigation
In real estate it’s best to focus on the downside because the upside takes care of itself.
In addition to $150mm in cash, the firm has access to another $1 billion line of credit. It can also tap the equity and debt markets if needed. The company debt has a weighted average of 5.5 years remaining with no debt maturities this year. At 5.6x debt-to-ebitda, the firm is not overleveraged; it's slightly below the REIT average.
And finally, in an extreme downside situation, the firm can boost liquidity through asset sales.
Unlike self-storage properties, Iron Mountain's buildings can be converted to alternative (and highly coveted) industrial uses. The firm is opportunistic with its real estate holdings and will sell for big profits if they can consolidate document storage with other regional IRM building.
9.45% Monster Dividend – Will They Cut?
IRM’s nearly double-digit dividend would typically be a red flag for most reits. In this case, the yield is artificially high due to the COVID market sell off, vs. structural problems at the company.
IRM’s FFO for Q1 was close, but it did not cover the dividend. I suspect that will be the same for the next 1-2 quarters.
This is not an obvious call though. While they have the cash flow and war chest to continue floating shortfalls this year; we don’t know how long the virus will act as a drag on their services business.
The Summit Project cost savings might offset these temporary losses, but if not – how many times will they go to the well (cash reserves) to support the dividend if the 2nd COVID wave continues to dampen service revenue?
Furthermore, they have compelling growth opportunities in the data center vertical that requires hefty amounts of capital. I’m sure management would rather plow capital into growth investments than supporting an above market dividend.
Finally, the CEO recently mentioned his goal was to get their payout ratio down to the 60% range by 2023. IRM can hit that target with the growth and cost savings they’ve forecasted, or they can trim the dividend if those plans don't materialize quickly.
Unfortunately, there is too much uncertainty to make this prediction with conviction. However, if I was the CEO or CFO, I’d push to trim but not eliminate the dividend. A 25% discount seems appropriate. This is the base case for my investment thesis. That would still amount to a hefty 7% dividend.
Bottom Line
Regardless, I believe the risk / return profile is compelling for this misunderstood company. I like buying monopoly businesses with sticky tenants and high profit margins trading at 12 times FFO (which is cheaper than a 8% cap rate for those real estate investors playing from home).
However, that’s not why we're buying here. We're betting IRM continues to aggressively grow it’s data center business.
The following "hot take" might sound crazy but hear me out. Despite all my glowing compliments about IRM’s business model, I think data centers that power the internet have a brighter 30-year future than warehouses filled with paper (which I think Chinese technology from 100 BC).
It appears I’m not the only one that feels this way (go figure). Data center reits are trading at lofty 24 to 31 times FFO today with paper thin dividend yields (see what I did there?).
So that’s the play. Clip above average dividends (even if IRM trim’s it) at a value entry price and watch the data center portfolio – and FFO multiple – grow.
We have to watch this one though. If data center growth stalls in a couple years, I’ll likely exit taking a modest post COVID capital gain with some big dividend checks along the way.
Analyst's Disclosure: I am/we are long IRM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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