Description

Iron Mountain Incorporated (IRM) is a well-managed company with good long-term growth prospects and a dominant competitive position that is currently selling near its all-time low valuation as a public company.  IRM has grown from a business with limited product offerings and annual revenues of $104M in 1995 into a global company with total revenues in excess of $3B today.  IRM should be able to grow revenues at 7-12%, OIBDA at 10-15% and EPS at high teens to 20%+ rates over the next 5 years.  Moreover, the company is investing at a 15-20% incremental pretax ROIC, well above historical levels during the roll-up phase.  At the current price of $22, the market is giving investors a chance to buy into a defensive, long-term compounder with a recurring revenue base and comparatively low economic sensitivity at a very attractive expected rate of return.  Indeed, today's valuation of 8.2x OIBDA is below its historical trading range of 9-14x forward OIBDA.  If the stock merely returns to its average valuation of 12x OIBDA, the shares would trade for $40.

BACKGROUND

IRM is the global leader in information and storage services.  The company helps its customers reduce the risks and costs associated with information protection and storage by offering records management services (70% of sales), data protection and recovery services (20% of sales) and information destruction services (10% of sales).  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 120,000 corporate clients throughout North America, Europe, Latin America and Asia Pacific.  IRM operates in 39 countries on 5 continents with more than 1,000 facilities worldwide.  The diverse customer base is comprised of commercial, legal, banking, healthcare, accounting, insurance, entertainment and government organizations.  More than 95% of the Fortune 1000 and more than 90% of the FTSE 100 are IRM customers.  IRM employs over 21,000 people.

Since the IPO in February 1996, IRM has executed on a growth plan to build market leadership by extending its strategic position through service line and global expansion.  As the company describes in its 10K, this growth plan can be broken into three phases.  In Phase 1, IRM established leadership and broad market access in the core business of records management and data protection and recovery.  This phase was characterized by many acquisitions.  In Phase 2, IRM invested in building a successful selling organization to access new customers and convert previously unvended demand.  Of course, different parts of the business are in different stages of development, but overall the company has mostly transitioned to the third phase.  In Phase 3, which the company calls the capitalization phase, IRM seeks to expand and deepen its relationships with customers to continue solving their increasingly complex information protection and storage problems.  The company expects that it will run in Phase 3 for many years.

BUSINESS OVERVIEW

IRM's information and protection storage services can be divided into three primary service categories: records management services, data protection & recovery services, and information destruction services.  IRM offers both physical services and technology solutions in each of these categories.  Physical records management services include records management program development and implementation based on best-practices to help customers comply with specific regulatory requirements, implementation of programs that feature secure, cost-effective storage for all media, flexible retrieval access and retention management.  The technology-based records management services are comprised of digital archiving and related services for secure, legally compliant and cost-effective long-term archiving of electronic records.

Storage and core service revenues represent approximately 85% of IRM's total revenues.  The foundation of the company's revenue growth and the underpinning of its customer relationships are outsourced information protection and storage services.  Core services consist of the handling and transportation of stored records and information.  Both storage revenues and core service revenues are highly recurring and therefore quite predictable.  Core storage and service revenues have grown at a HSD or LDD internal rate (i.e., excluding the impact of foreign exchange and acquisition) for many years.

 In addition to core services, IRM offers an array of complementary products and services, including special project work, data restoration projects, fulfillment services, consulting services and product sales (including software licenses, specially designed storage containers and related supplies).  Recycled paper revenues, which have fluctuated recently, are included in complementary services revenue.  These services are intended to serve specific needs and to enhance customers' overall records management programs.  These services, which represent roughly 15% of total revenues, should be viewed as a complement to core services.  They are more episodic and discretionary in nature - and thus they are more economically sensitive.  For example, in the recession year of 2009 complementary revenue growth will be -10% to -15% compared to core storage revenue growth of +6% and core service revenue growth of +3%.

IRM reports results for 3 segments.  The North American Physical Business and the International Physical Business segments offer physical records management services, data protection and recovery services and information destruction services in their respective geographies.  The North American Physical Business accounts for 68% of sales and 78% of profits.  This segment is the company's financial engine and is its most mature business.  NA Physical topline has grown at an HSD rate for the last several years and has segment contribution margins in the 29-30% range.  This segment should grow at 6-9% over the next 5 years.

The International Physical segment accounts for 25% of sales and 18% of profits.  This segment contains IRM's growing business outside of the US and Canada, in the regions of Europe, South America, Mexico and Asia Pacific.  The most established international markets are the UK, Australia and Brazil.  The emerging markets of Continental Europe and Latin America continue to be in what I would call an "investment period" in which the company is building out a real estate presence and forming JV partnerships.  The International Physical business has grown at HSD to LDD rates in the last several years and has contribution margins in the high teens to 20% range.  This segment is expected to grow at 8-12% over the next 5 years.  Management believes that over time it can build a business in the international markets comparable in quality to the core NA franchise.

The Worldwide Digital Business segment includes IRM's online backup and recovery solutions for server data and personal computers, digital archiving services, eDiscovery services, intellectual property management services and electronic information destruction services and is not limited to any particular geography.  Digital has grown at rates in the teens in the last several years and has contribution margins on pace for 19% this year.  The long-term target is for Digital revenues to grow at 10-20%.

INDUSTRY CONSOLIDATION

The information protection and storage services industry was historically a very fragmented one.  Even today, most information protection and storage services companies serve a single local market.  Such companies tend to be either owner-operated or ancillary to another business, such as a storage or moving company.  However, from 1995-2000 there has been significant consolidation within the industry in North America.  This consolidation has continued in recent years, albeit at a slower pace.  Today IRM has roughly 15% of the North American market and 5% of the $40B+ global market.  IRM is 4x the size of the next largest competitor, Recall (a subsidiary of Brambles).

IRM under former CEO Richard Reese led the consolidation in the industry.  Reese recognized early that there was an opportunity for large information protection and storage services providers to achieve economies of scale due to the industry's capital requirements for growth and customer demands for more sophisticated technology-based solutions.  Large organizations prefer to contract with one vendor in multiple cities and countries for multiple services.  IRM's success over the years is proof that larger customers increasingly demand a single, sophisticated company to handle their important physical and electronic records needs.  Large national and multinational companies are better able to satisfy these customer demands than are smaller competitors.  For these reasons, the consolidation trend in North America and other regions is likely to continue.

GROWTH DRIVERS

Skeptics of the IRM story have questioned whether there will be an ongoing need for physical storage services in an increasingly electronic world.  IRM believes that the volume of stored physical and electronic records will continue to increase for the following reasons: (1) regulatory requirements, (2) concerns over possible future litigation and the resulting increases in volume and holding periods of records, (3) continued proliferation of data processing technologies such as PCs and networks, (4) inexpensive document producing technologies such as fax, desktop publishing software and desktop printing, (5) the high cost of reviewing records and deciding whether to retain or destroy them, (6) failure of many entities to adopt or follow policies on records destruction and (7) requirements to keep backup copies of certain records in off-site locations. 

IRM's experience has been that paper-based information will continue to grow, not in spite of, but because of, "paperless" technologies such as email and the Internet.  In fact, these technologies have prompted the creation of hard copies of such electronic information and have also led to increased demand for electronic records services, such as the storage and offsite rotation of backup copies of magnetic media.  IRM believes that the proliferation of digital information technologies and distributed data networks has created a growing need for efficient, cost-effective, high quality technology solutions for electronic data protection, digital archiving and the management of electronic documents.

FINANCIAL CHARACTERISTICS

One of the most attractive features of IRM's business is its base of recurring revenues.  IRM derives the majority of its revenues from fixed periodic, usually monthly, fees charged to customers based on volume of records stored.  IRM receives recurring payments for storage fees without incurring additional labor or marketing expenses or significant capital costs once a customer places physical records in storage and until those records are destroyed or permanently removed.  Moreover, IRM typically receives a service fee when records are removed or destroyed, thereby raising switching costs.  Contracts for the storage of electronic backup media also consist of fixed monthly payments.  These stable storage revenues have always accounted for more than 50% of total revenues and represented 54% last year.

 Another positive characteristic of the storage business is its non-cyclicality.  Companies that have outsourced records management services are less likely during economic downturns to incur the move-out costs and other expenses associated with switching vendors of moving programs in-house.  As a result, IRM has not experienced meaningful reductions in its storage business during past economic downturns.  However, the rate at which some customers added new cartons to their inventory has declined in past economic slowdowns, including the current recession.  Total net volumes have remained positive even during the current recession.

 IRM's business enjoys a natural growth tailwind.  Physical records customers have generated additional cartons at a faster rate than stored cartons have been destroyed or removed.  This inherent growth from existing physical records customers comprises roughly ½ of total net volume growth, excluding acquisitions, in North America.  This growth is due to several factors, including the trend toward increased records retention, customer satisfaction with IRM service, the costs and inconvenience of moving storage operations in-house or to another provider and positive pricing actions.

 As mentioned above, IRM enjoys a stable and diversified customer base.  Customer verticals include commercial, legal, banking, healthcare, accounting, insurance, entertainment and government organizations.  More than 95% of the Fortune 1000 and more than 90% of the FTSE 100 are IRM customers.  No customer accounts for as much as 2% of revenues.  The average volume reduction due to customers terminating their relationship with IRM is less than 2%.

 Finally, the company's capital expenditures are mostly related to growth.  The company maintains that only 15% of aggregate capital expenditures are for maintenance and that 85% of spending is for growth-related investments, primarily in storage systems, which include racking, building and leasehold improvements, computer systems hardware and software, and buildings.  Moreover, management has indicated in many forums - most recently at their annual Investor Day in October - that capital expenditures as a % of sales will decline appreciably going forward.

 RISKS

In my view, the biggest risk to IRM is that growing the business continues to require significant capital expenditures.  This company is not going to be mistaken for See's Candies.  During Phases 1 and 2 of the company's growth, cash flow from operations less capex was negative in some years as the company built out its platform.  In the last few years as the company has entered Phase 3, FCF generation has improved.  Still, however, capex investment for capacity, real estate, and infrastructure has been substantial.  If IRM were to turn off the growth spigot completely, it would lose relative market position as even existing customers demand capacity additions in a positive volume world. 

 I have followed IRM for years and have spent considerable time with management.  The good news is that management is acutely aware of this issue.  CEO Bob Brennan, who had been CEO of Connected Corporation (which IRM acquired in 2004) and who became CEO of IRM in 2008 and CFO Brian McKeon (an HBS graduate who joined the company in 2007 after 7 years with Timberland) have made it a central mission to improve the company's ROIC performance.  During the high-growth and acquisition periods under the leadership of Richard Reese and John Kenny, the company understood the importance of ROI and preached the philosophy.  But the reality is that growth and customer retention were critical in that phase of the company's lifecycle, and those areas were prioritized.  In the current phase, management is willing and able to price more rationally as the platform in North America is largely built out.  Indeed, any prospective investor who has been frustrated in the past by lack of disclosure around capital intensity should revisit the story - you will find improved disclosure at the segment level.  For example, in the NA Physical segment, capex ex-real estate as a % of revenues is projected to fall to under 6% in 2014 from north of 11% in 2006 and 7% in 2009.  There is no reason why the International Physical segment should not behave similarly as it matures.

 Another concern is that IRM has a material amount of debt on its balance sheet.  IRM is levered at 3.5x Net Debt/OIBDA and covers interest 3.7x on a trailing twelve month basis.  I would argue that IRM can comfortably support this level of debt given the stability and predictability of its cash flows.  In 2000, following the acquisition of Pearce Leahy, IRM was levered north of 5x.  IRM had been quite comfortable with leverage above 4x prior to the financial crisis.  The debt load is also supported by extensive real estate holdings.  IRM owns approximately 35% of the 65M square feet that it operates globally.  In my view, management has been smart about structuring the debt portfolio to benefit shareholders while preserving financial flexibility.  The portfolio is 83% fixed-rate debt, has a weighted average interest rate of 6.9% and a weighted average maturity of 8.4 years.  One could make the case that this debt portfolio would be especially valuable in a period of higher inflation.

 Other risks include the potential for a decrease in volumes of physically stored records in the future (which for reasons stated above I believe to be overblown) as well as the concern that IRM's competitive advantage in digital is not nearly as strong as in physical.  To be sure, there are many competing offerings in digital - and neither IRM nor any other vendor is nearly as dominant in digital as IRM is in physical.  However, the important point is that IRM's customers generally view their choice of provider for digital storage services as ancillary to their needs for physical storage.  Customers are likely to continue to use the same provider for their physical and digital records.

 CONCLUSION

In sum, IRM stock today is as cheap as it has ever been.  The company has a market value of $4.9B and a total enterprise value of $7.9B.  The midpoint of OIBDA guidance for 2010 is $918M, so the company sells for only 8.2x compared to a historical range of 9-14x.  Finally, as an additional indication of value for people who are (rightfully) skeptical of EBITDA-based valuation approaches, IRM stock implies a 12% FCF yield on a maintenance capex basis.  While we can debate how much of this capex is truly discretionary, it is clear that IRM's spending has created real economic value in the past and that returns are trending higher. 

 One reason for the depressed share price may be that internal growth has temporarily slowed to 3% in 2009 and is expected to be 3-6% next year.  With 32% of sales coming from outside the US, FX will have a negative 4-5% impact on revenues this year, leading to total reported revenue growth of -1%.  Needless to say, negative reported sales growth is an aberration for IRM. 

 For some potential long-term investors now sitting on the sidelines, the slowing growth has caused old concerns about the possibility for structurally slowing volumes to resurface.  Nevertheless, management has been direct in reiterating that it views the current slowdown as short-term rather than structural.  As mentioned above, I have gotten to know the senior executives and believe that they are being honest in their communications.  For those with a shorter time horizon, it is a familiar story: the fast-money crowd sees a situation where growth will be light for the next 6-12 months, so they have moved on to what they perceive as brighter near-term opportunities.

Catalyst

This investment idea is for long-term investors looking to buy into a good business at an attractive price.  It is not an event-driven situation based on "catalysts."  However, potential catalysts include:

(1) Reacceleration of volume growth as the economy improves

(2) Improved margin performance driven by the more rational approach to pricing that is currently underway

(3) Rotation back into more "defensive" positions if the global economy stagnates or deteriorates