Iron Mountain REIT Conversion Returns Value
On April 19, 2011, Iron Mountain Inc. (IRM), a global leader in information and storage services, announced plans to evaluate and pursue a conversion into a Real Estate Investment Trust (REIT) to maximize value creation through financing, capital and tax strategies. On June 5, 2012, the board approved a plan for the company to pursue conversion to a REIT no sooner than January 1, 2014.
For those unfamiliar to the REIT concept, a REIT is a company that derives most of its income from real estate mortgages or real property. If a corporation qualifies and elects to be treated as a REIT, it generally will not be subject to U.S. federal corporate income taxes on income that it currently distributes to its stockholders. The company’s qualification as a REIT depends on its ability to meet on a continuing basis various tests under the Code relating to, among other things, the sources of its gross income, the composition and value of its assets, its distribution levels to its stockholders and the diversity of ownership of its stock. I have much confidence in IRM’s ability to convert into a REIT given the new board and management changes which have extensive knowledge and experience in real estate.
IRM is the global leader in information and storage services. They help customers reduce the risks and costs associated with information protection and storage by offering records management services, data protection and recovery services and information destruction services. In addition, the company brings expertise and experience in addressing complex recovery.
IRM was founded in an underground facility near Hudson, New York in 1951. Today the company has 155,000 corporate clients of more than 94% of the Fortune 1000 throughout North America, Europe, Latin America and Asia Pacific. IRM operates in 39 countries on 5 continents with more than 1,000 facilities worldwide. IRM employs over 21,000 people.
At about $31 per share, IRM common stock is being undervalued on an annualized basis adjusted for the relative certainty of return of shareholder value (to some this company certainly would be considered a myth due to its attempt at putting shareholders first) in comparison to Treasury rates. IRM represents an opportunity to buy a $9 billion global leader in a consolidating industry which will be able to construct great deals given a REIT structure. Even though the company has evolved into their more mature phase transition of growth, the new structure will allow complementary acquisitions growth for IRM with increased optionality in future deals and relieved obligations of corporate taxes. I see an upside of at least 40% in two years largely dependent on IRM’s ability to achieve regulatory approval to convert into a REIT ultimately affecting their ability to increase their dividend distributions.
At the time of IRM’s board approval into a REIT, the company has paid an average of roughly 78% of proceeds from net income of 2010 and 2011. The current dividend stands at an annual rate of $1.08 a share with a 3.45% yield on the company’s share price of $31.30. The REIT still remains an uncertainty until approval is given. The company has projected that should there be no hiccups, their 2014 tax status should reflect the new structure.
In order to qualify as a REIT for U.S. federal income tax purposes, IRM will have to make quarterly distributions of either cash, common stock or a combination of both, commencing in the first quarter of 2014, to holders of its common stock equal to at least 90% of its taxable income on an annual basis (excluding net capital gains), as defined in the Code. Given a resultant conversion to a REIT, particular stock market pricing dynamics for IRM should begin taking place around year end 2013 and the first half of 2014. With the past three year pre-tax earnings averaging $344.13 million/$1.72 per share and average after tax net earnings of $214.89 million/$1.08 per share, I would anticipate for the period ending March 31, 2014, the first quarterly distribution to equal approximately $0.47 per share of the new IRM REIT structure or $1.88 annually. Though, the actual amount of the distribution will depend on IRM’s actual funds from operations for such period.
With 171 million shares outstanding, and trading at about $31, the company’s market cap is at $5.3 billion. The company has $3.4 billion in debt and has $300 to 400 million in positive cash flow. Backing out goodwill the company is able to generate returns largely on the backs of interest bearing capital not considering the large returns to shareholders over the past two years. Current tangible assets are back by PPE at depreciated historical cost and is very solid. The company reported $220 million in adjusted OIBDA the first three months of the year with full year expected OIBDA ranging between $890-$930 million and full year EBITDA of $916 million
IRM’s stock trades at a P/E of 15.9 and a multiple of 15.4 times enterprise value to operating cash flow. Historically, these multiples represent a discount to their averages. By applying the averages for P/E or enterprise value to operating cash flow, I arrive at a fair value of $40 to $44. On a conservative dividend yield of 3.80% on the new distribution in 2014, I get $49. These valuations averaged out indicate an upside of 42% based upon an equity acquisition price of $31.30 per share. My downside analysis generated a price of $24 per share based on the M&A value I utilized on a multiple of EBITDA implying potential risk of 23% in relation to acquisition price. With a historical price trends giving us a similar analysis for the downside average $24.
The more specific risks associated the company appear to be more macro based. The global environment has been thrown into highly uncertain terms. Interest rates are closely tied to the my dividend yield valuation given rates remains low or unchanged. Another risk continues to remain with the real estate environment where it will affect how the company’s property assets are valued if things are worse than expected.
What I have calculated based on associated risks with my trading style as well as other macro and micro issues is an initial entry allocation of 8% and a fully weighted Kelly calculation of 34%. This will be different for others given their own business/investment acumen (the two are highly correlated).