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Iron Mountain: Cockroaches In The Kitchen

There is seldom just one cockroach in the kitchen. The old adage rings large at Iron Mountain, the real estate investment trust dedicated to being a “guardian for all things information and data storage related” that has long profited from unabated popularity among yield-hungry investors.

The latter will fade. Although management proved expert at cajoling capital markets and taking advantage of the company’s expensive stock to fund expansion, the billions spent on acquisitions over the years had negligible effect on revenue and EBITDA. In a like manner, they did not prevent a steep decline of cash earnings distributable to shareholders.

Such failure sheds light on CEO William Meaney’s tendencies for unwarranted self-congratulation (“We believe the Recall acquisition [in 2016] accelerates our already successful growth strategy“), and lends color to a comment made by former chairman Mr. Reese in 2012, when he tacitly admitted that trouble was in fact looming for a while (“Although some worry that these secular trends in our core physical storage business will cause the business to decline…”).

The company reports funds from operations (FFO) figures that provide an interesting yet defective benchmark of true levered profitability, for it leaves substantial capital expenditures out of the picture. Skeptics will also dispute the distinction made between “growth” and “maintenance” investments detailed in the annual reports — the former being much larger than advertised — because the build-out of new capacities and services remains by management’s admission imperative to counter stagnation in the legacy storage business.

But there’s worse. The company needs an expensive stock to pursue acquisitions and investments through the sale of new issues at robust valuations. Of course, the surest way to keep the share price momentum boils down to consistently increase the distribution of dividends, if possible with great fanfare.

This is, alas, where serious trouble usually begins — and Iron Mountain is no exception, for current distributions would be unsustainable without capital raises, and acquisitions out of reach. Speaking of which, let us take below the liberty to quote an excerpt from the classic 6th edition of Security Analysis, courtesy of Bruce Berkowitz’s preface to the Theory of Common Stock Investment, The Dividend Factor:

Investors scrutinize companies’ dividend policies as a window into management’s thinking about the durability of free cash flow. In this context, a high dividend level would be a positive factor in equity valuation. […]

The danger here is that management may be tempted to manipulate the dividend to create an inappropriately favorable picture of future cash flow. […]

Companies under stress are almost always late to cut their dividends. In such cases investors who buy stocks with unusually rich dividend yields and deteriorating fundamentals are asking for trouble.

On a per share basis, Iron Mountain’s record of value creation does not support the upbeat tone management customarily employ through their communications — even when assessed upon an unlevered basis. Reported FFO dramatically understates cash outflows (because capital expenditures dwarf depreciation and amortization), while it overstates actual operating performance (because cash-flows aren’t tenable without acquisitions).

It should be reckoned that management is playing a difficult hand in trying to pivot a stagnating legacy business — physical storage — towards new value-added services, such as the ownership of data centers or the handling of fine arts. But at $38, Iron Mountain’s common shares almost trade at 40x cash earnings: since 2018 numbers have yet to show any improvement, fundamentals cannot warrant such a lofty valuation.

As long as the music plays, one has to get up and dance — à la Chuck Prince the week before Citi sunk. Nothing new under the sun here: Iron Mountain’s management have cornered themselves into a high-risk, low-reward situation with no easy way out; a lot of new capital will be required to defend earning power and fund both expansion and distribution, forcing them to address capital markets with a message that considerably alleviates a challenging reality.

Absent a miracle, one foresees trouble and expects a dividend cut. A sharp sell-off would most certainly follow, then spark well-deserved skepticism towards the company.

(No position.)

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