Real estate investment trust (REIT) Iron Mountain (NYSE: IRM) currently offers investors a fat 5.8% dividend yield. That's way more than the 1.3% you'd get from an S&P 500 Index fund and the 2.3% from the average REIT, using Vanguard Real Estate Index ETF as a proxy. But before getting sucked in by the massive dividend, you need to step back and understand that Iron Mountain is making big changes to its business. Here's why it's more important to understand where this REIT will be in 10 years than to know where it stands today.
The Iron Mountain backstory
Iron Mountain converted to a REIT in 2014. Prior to that, it was a regular old company that owned and operated a collection of storage facilities. However, these weren't like the places you see all over for storing personal items. Iron Mountain stored, and still stores, business documents and other unique valuables (think high-end art).
This is a complex business based on trust and accountability. Physical business records may need to be put in storage to save space, but they also need to be safe and accessible if needed. And a system needs to be in place to ensure the proper destruction of records that no longer need to be kept but must be protected: Think old bank records and similar hard-copy documents.
Iron Mountain was, basically, one of the biggest, most trusted names in this unique business. And, given that a large portion of revenue is tied to boxes sitting in storage facilities, turning into a REIT made a great deal of sense.
But there's one big problem today, some seven years later: The world is increasingly shifting away from paper and toward digital records. So while storing physical records is a cash cow operation with a huge 98% retention rate, the business opportunity isn't going to last forever.
Notably, the company highlights that the average box of paper remains in one of its facilities for around 15 years. It's unlikely that the need for physical document storage will be gone in a decade and a half, but it would be shortsighted to think that demand will be as strong as it has historically been, either.
Shifting gears in a big way
Iron Mountain's management isn't blind to what's going on around it, so it's been looking to shift with the times. The big push is to build data centers, using its customer Rolodex and its strong track record of security as a foundation to build out a new data storage operation. It is a solid plan, though in some ways you could also argue it is the only way for the REIT to ensure its long-term survival. So far, Iron Mountain has built or bought 15 data centers.
The problem is that it costs a great deal of money to build and buy data centers. And, as a REIT, Iron Mountain is paying out a lot of its cash to investors. The company has used its balance sheet as a major source of financing, with debt levels that are high relative to other data center players. To put a number on that, Iron Mountain's debt-to-equity ratio is around seven times compared to 1.1 times for Equinix and 0.8 times for Digital Realty, the two largest players in the data center niche. That's a very big difference.
To be fair, Iron Mountain's cash cow physical storage operations can likely support that leverage. But given the need to grow a new business, it is understandable that investors are concerned that the dividend might end up being sacrificed in this vital transition. So far, management has voiced its support for the dividend even as it looks to reduce leverage. But that could mean slower growth in the digital space. All in, this investment is complicated and probably not the best option for conservative income investors, despite a very attractive yield.
For more aggressive types, however, the next 10 years will be an important transition period. Effectively, the company's core operations will likely end up shifting from the physical storage business to the digital one. Part of that will be organic, as physical storage needs lessen in the digital age, and part will be driven by investment in the digital space. In a decade, it's likely that the digital side will grow to be at least half of the company's business, if not more, from around 20% or so today. And it's a transition that investors will need to track very carefully to ensure Iron Mountain is making appropriate progress.
From the leader to...
It looks like Iron Mountain is on the right path, even though it will be a costly, time-consuming business shift. In some ways, it has no choice.
That said, there's another problem that investors need to consider here. Today, Iron Mountain is the leader in physical storage. Data centers are more commoditized and competitive. So as Iron Mountain transitions to a new business, it is also likely to lose the competitive edge it has today. All in, more digital is in the future, but that doesn't mean Iron Mountain will have the same cache with customers.