ABOUT THE EPISODE
BRAD THOMAS: Hello everyone. This is Brad Thomas with iREIT, and I'm back again with another CEO Roundtable interview. Of course I'm here today with Bill Meaney. Bill is the CEO of Iron Mountain, ticker symbol is (IRM). Bill, thanks for joining us today.
WILLIAM MEANEY: Thanks for having me.
BRAD THOMAS: Well, Bill, I know we were - on back in the first quarter earnings - now we're into the second quarter. Potentially, hopefully, it's just the worst part of the COVID cycle. At a high level, could you update us on what you've seen in the second quarter, and how you see Iron Mountain's business model going forward?
WILLIAM MEANEY: Thanks Brad, I think the last time we spoke, we said that we thought that Q2 would be the low point. I would say even in Q2 - now that we've had the print, is - April was the low point within Q2. And I wouldn't say a bounce back in May and June, but kind of steady, starting off the base. And I don't think it's gonna be a straight-line recovery.
I don't think it's going to be a bounce back recovery. I think medically, we're probably in a COVID environment until this time next year, at least that's our thinking, and then starting to recover from that point, but it is a gradual uptick - as companies, states, municipalities, and countries are starting to come out of what was a severe lockdown, to a gradual reopening.
And then of course, the advantage that we have is because we're a B2B company, and we were considered essential. The worst part of the crisis - that 96% of our facilities were still open, not at the same activity levels that we've seen in the past. And now, 100% of our facilities are up and running, and open for business. So, it's steady as you go, but I think Q2 ended up being a little bit better than we thought before, because we started to see an improvement in May and June.
BRAD THOMAS: Great. Well, I know you announced your Project Summit initiatives - I guess it was 2019. Can you give us an update on how that's playing out, and what do you see right now with regard to the initiatives with the Project Summit?
WILLIAM MEANEY: Yeah. And as said on the Q1 call, we had upsized the Summit - cause like any of these programs - when you go into them - you guide the market to what you know you can get, but a program this size, obviously we did expect to get more – and we did.
So if you look at just 2020, we're well on track to the $150 million in-year benefit that we expect for 2020. And if you look at where we were by Q2: in Q2 we had $65 million of in-year benefits. So, just annualizing, that's $130 million. So there's another $20 million that we expect to get on top of what the run rate improvement from Summit is - at the end of Q2 - which we feel highly confident about.
And then if you look at, overall, the program being $375 million for the full program - again, we have a high level of confidence on that. A number of those programs are - we're laying the foundation now, which we're going to a global business services platform, where we'll have standardized first-rung service centers in key locations across the globe.
We have an executive we just appointed in charge of that - she was running our shred business before - terrific executive and has a lot of experience in process and process management. So we think - we really liked that program. We're also making a lot of IT investments associated with that. So we have pretty good line of sight, what I would call - on the systems improvement, which is the next chunk to come out of Summit.
BRAD THOMAS: Great. And can you talk a little bit about the balance sheet? I did see in the second quarter: you announced a $2.4 billion bond offering. Can you talk about how that potentially enhanced your liquidity profile, and improved your balance sheet?
WILLIAM MEANEY: Yeah. So what I should do is - and since the Q2 announcement, we also refinanced another $1.1 billion, so this was all retiring or refreshing our debt. So it wasn't increasing the leverage - it was all leverage neutral. And between the $2.4 billion that we did in June and the follow-on $1.1 billion, a couple of things: one is we now have all of our bonds lined up at a 7x EBITDA covenant or better.
The newer ones are on a fixed charge basis, so it even calculates better than 7x EBITDA. So first of all, in terms of headroom on the balance sheet, we've actually moved things from 6x and some of them were 6.5x, and we moved them up to 7x.
The other thing is that the latest one, just to give you kind of an appetite is: we did a long 10-year or 10.5-year maturity at 4.5%, which again says the debt markets really get the durability message of Iron Mountain. That was a fantastic result in this environment, to raise $1.1 billion - for 10.5 years at 4.5%. So we were really pleased with that.
And then from a liquidity standpoint, we don't have a liquidity issue in the company, per se, but we used that as an opportunity, not just to take out some of the older bonds that were at 6.5%, but we also recharged the revolver a little bit along the way - I think about $302 million to $300 million. We still have plenty of room on the revolver, but the main thing was, really, just to take advantage of the interest rates, lengthening the maturity, making sure that we had a stair-step that we wanted, in terms of our debt portfolio. And as I say, at 4.5% to do a long 10, we were pretty pleased.
BRAD THOMAS: Great. Well, I know one of the initiatives - and certainly a catalyst that we've written about quite a bit - is the movement into the data business. That seems to be a bigger part of your overall business model. How do you, in terms of your cost of capital today, how do you view this - your cost of capital? I know on the equity side, it’s been challenging - but you’ve done a good job on the debt side.
But in terms of your weighted average cost of capital - and I wanted you to address if you don't mind, the real estate - I know I've written about this quite a bit, recognizing that Iron Mountain has a fairly significant amount of real estate on its balance sheet that potentially could be utilized for sale-leasebacks in a more efficient manner. I'm just curious, how would you address that cost of capital in regards to the owned real estate as well?
WILLIAM MEANEY: Yeah, no, it's a great question. It's probably like three or four questions of points in your overall statement. Let me back up in terms of the need for capital - where we're deploying it - to your point - is on data center - is we continue to be super pleased on data centers.
So if you look at the business - this is absent Summit - obviously Summit's driving a huge spurt in EBITDA growth - but if you look at just what the base business generates, it’s about 4% organic EBITDA growth - a little bit better than 4%.
And before we got into this year - is data center - whilst it's only about 7%, 8% of our revenue was driving just under a third of that organic EBITDA growth. So it's already a big part of the growth story going forward, in terms of Iron Mountain - which we think, longer term, will unleash the equity value. Because not many stocks can grind out 4% organic EBITDA growth.
So then you fast forward: how are we doing this year with data center - to your point - is that we guided the market that we would lease up 15 to 20 megawatts this year. And we came in, in the first half, just under 39: 38 and change. So clearly, we're having a lot of success in data center, even beyond what our expectations were - and there's an opportunity to deploy even more capital.
So then you say, okay, well unfortunately the good Lord hasn't blessed us with a share price that I feel -it's good to go out there and issue equity. But the one thing that I would say is that - even if we did have a share price - is you have to look at - you might be able to issue at 17x, 18x, 19x multiple, but doesn't mean that's what your cost equity is.
So equitizing over the long run - data centers - you do want to look at alternative capital. So the way we think about data center funding going forward, is obviously we have the financial beast, the mature records business that spins off a lot of cash, that not only pays the dividend – we're able to extract money and put it over in data center. So we continue to see the $200 million plus - $200 million to $300 million a year that we can continue to deploy that way.
I think the second aspect about that is assets that are at, or nearing maturity, or I say stabilization, those are a good opportunity to put them into a joint venture, because we would rather put our capital and data center on the ones that have a development profile, because we understand the risk, and obviously the returns are higher on a site that are going through a development spurt.
So we announced that we've actually sold – upfront, during the construction - all of the Frankfurt data center sites. So we continue to stay on track. And our expectation is we will put that to a joint venture because now that's a fully stabilized asset. So we could then take that money and deploy it in higher return data center opportunities down the road.
And then the last aspect which you're raising, which is a great point is - we guided the market that we think that we'll have about $100 million of recycling this year - industrial real estate - which we can do sale-leaseback - in some cases, exit. And what we found right now is you say, "Okay, do we think we're going to do more of that?"
I think that the expectation is we probably will do a bit more, because if you look at where industrial cap rates are trading right now - we're not saying industrial real estate is a bad investment, but it's pretty well-priced right now. And the returns that we can get by putting that into data center is just that much better.
And the other aspect about it is: is that when we take a lease and we do lease-adjusted leverage, we capitalize that at 6.5 turns. So now the arbitrage between what we can sell industrial real estate - and as you say, we have a couple of billion dollars’ worth of industrial real estate - so the arbitrage of what we can sell that for, and create even more headroom in our debt profile - it seems to me that there is an opportunity to make sense to be putting it to work at things where we're getting, let's say, on a blended basis, 12% cash on cash returns.
So that's how we - I think it's a long way of getting to your point, but we do think - we continue to recycle some of our industrial portfolio. If you've watched the story for a long time - I think last year it was about 150 - this year, we got a market around 100. And I think you could expect where cap rates are now is: we'll do at least that, but we are looking at more, as well.
BRAD THOMAS: Yeah. No, that makes a lot of sense. I mean, obviously I cover Net Lease REITs and I was a net lease developer for a while. And so I know that space really well. And obviously when you look at that sector, and the growth - we actually had two companies listed - well, one company listed last week in the Net Lease space - I think we'll have another one this week. So there's certainly been a tremendous amount of demand of capital entering the Net Lease - especially as I look back over the last 10 years or so. And now with this low, low rate environment, these net lease REITs are really continuing to seek out opportunities. It just seems like a very natural fit.
And of course, the other side of that is, you're right, I cover Industrial as well. And those cap rates are fairly attractive, especially for some of those larger Net Lease REITs. And then you look at the Data Center sector, which obviously - I think what we all want to see: is Iron Mountain begin to trade more like a Data Center REIT, than a Diversified REIT, right?
And so I think by monetizing that real estate, and deploying it strategically and tactically into data centers, I think could really drive this multiple. Can you talk a little bit more about the data center business? I know that's kind of the exciting part of the business model - and how do you see the growth opportunities within the data center business? I mean, I know obviously, you've got such a diversified business model, with global: 1400, almost 1500 facilities, worldwide. Where do you see the best opportunities in the data business?
WILLIAM MEANEY: It's a great question. So I think there's a couple parts to that. So we're really pleased by the traction that we're starting to get. I think a couple of years ago people said, "Oh, Iron Mountain is getting into the Data Center space.
They're not known for that." I think we were just - I wouldn't say fighting to get into the deal flow, but we had to let people know that we were in there - and then now we're firmly established: we've got a pretty good global footprint, actually one of the most globalized footprints, but it's not surprising - because in our legacy business, we're in over 50 countries, and now being in Singapore, Frankfurt, Amsterdam, the U.K. - two sites now in Slough. And then of course our U.S. portfolio.
So we're getting to a good reputation, both with hyperscale, and in the normal retail or co-location environment. And you can see that, given what we did in the first half, I said we basically did 2x what we thought we're going to do in the whole year - in the first half of the year. So we feel really, really good about that.
The returns, still, yeah, hyperscale returns on a cash on cash basis, you're around 8. So those are a bit skinny, but that's all before leverage. It also gives you the ability to stabilize a large campus, much faster, which you can boost the returns on that side. We still look at 12% blended returns on large campuses where we have a combination of hyperscale and co-lo.
So we feel really good about the returns. We feel really good about the pipeline and the opportunity. I think to your point is that the other part is - we do see getting a bigger presence in the data center business - is to get fully valued on the traditional side of the business, as well. Because if you think about it today, we're an 8% dividend yield, pre-Summit. So forgetting about what Summit gives us additional, right - is we've been printing over the last - what, six, eight quarters: 4% organic EBITDA growth or better. Which just from a TSR standpoint, you add an 8% dividend yield - that's the 12% TSR multiple splat. It doesn't make any sense.
So the thing is, I know that people may not think it's sexy storing paper and storing physical things, but I'll tell you it's a hell of a good business. And part of, I think the magic of unlocking the value of Iron Mountain is not data center being bigger than the legacy business, but people fully valuing the traditional side of the business, because they're not worried about it going away. It probably infuriates people that we keep printing 4% organic EBITDA growth, 'cause they say, "How can you do that storing physical stuff?" But it's still a very, very good business.
And yeah, I mean, we get part of that growth by price, in volume growth in the emerging markets, slightly negative in the other markets, and then in building in some consumer - but it's a business that has a long runway that can drive that type of growth. So the data - for our view on the data center business is: it needs to be big enough so that people don't worry about the traditional side of the business, and fully value what it delivers on a cash flow basis - at least that's our view - because the business can trade at a much higher multiple just on what it's performing today.
BRAD THOMAS: Yeah. That leads me to one final point here - and I've covered this quite a bit, and it's amazing whenever I write an article and I'll get a lot of comments just about that core business model, which is really the box - the box model - and the fact that 50% of your boxes stay in your facilities for 15 years on average. So it's a very sticky part of your business model. You've got such a large part of that.
And obviously the real opportunity is unlocking these customers that have been around a long, long time - but can you debunk for me, Bill, the argument I get quite a bit - and I'm sure you get this - that “Paper's dying, and boxes are no longer going to be necessary for storage.” So in a couple sentences or less, can you tell our audience here, why you think the Iron Mountain's core business model is there to stay?
WILLIAM MEANEY: Yeah. No business model's there to stay forever. I think we all understand that - in tech companies we see it all the time, I mean - and even pharmaceutical companies. What's a blockbuster drug today, is a generic tomorrow - and they need another blockbuster. So I wouldn't say we're immune, and that our business models are static. But to your point - is that if you think about, okay, so we're in the midst of COVID, and we were down about 1.8 million cubic feet in the quarter, year over year - that was offset by 2 million growth in terms of consumer, which is an area that we just went in.
So the record storage business was down 3.8 million cubic feet. So, and this is in the depths of COVID. So, let's take even a worse-case scenario. You say, okay, it doesn't get better: we exit COVID and it stays like COVID is you’re minus 12 million cubic feet before you start adding consumer, but this is on a base of 750 million cubic feet, where we're pushing, let's say, on average, 3% price growth every year. So even if the business is in slight decline, first of all on a 750 million cubic feet, that's a fairly slight decline.
On the other side - is that consumer is starting to become a bigger and bigger offsetting portion of it. So the thing is, take a step back. You say, okay, "Over the next 10 years, do I see the profile of the cash generation of this business - and the legacy part of the business - or the traditional side of the business - changing at all? Is there anything in danger of Iron Mountain to be able to continue to hit 4% organic EBITDA growth, even with a small data center business, that's becoming a bigger product?”
Today, it's a third of our 4% organic EBITDA growth. In five years’ time it'll be that much bigger proportion. So, the thing I would say is in the next 10 years, the Iron Mountain financial model is rock solid. In other words, is there a risk to that 4% EBITDA growth? I don't see how, even in the scenario that I gave you, which I don't think anyone thinks that we're going to track, even if people who are bear on Iron Mountain's traditional business model, I don't think any of them going to say, we're going to stay at COVID activity levels forever.
People will debate: will you bounce back to the way you were before or whatever, but let's not even have that debate. Let's just say it stays at that level. Can our financial business model handle that drag, that continues to drive 4% plus organic EBITDA growth? - before you add Summit on top. So my view is that the financial model's rock solid - people might not like what we do. The fact that it's not as sexy as selling phones or IT equipment, but it's pretty good.
And the whole time that financial beast gives us two other things. One is the cross-selling opportunity. So before we got on the call, we were talking about this President and Chief Operating Officer of a large global bank. And we do both data centers for them, and boxes. And at one point, I was speaking to him during the depths of the crisis - this was back in March or April - and he was like, laughing.
He goes, “I see four of your boxes sitting in the corner of my office.” Part of the reason why we have the data center business is because the trust that we built with them over decades on being a reliable partner for things that - we don't know what's in the box, but it's super important to them. Whether it's for litigation or for customer reach.
And then on the other side is the financial aspect. It's a 75% gross margin business. So every morning I get up and put my feet on the floor, there's a pile of quarters there. Because each of these boxes gets about a quarter a month and there's a pile of them sitting there at my feet. And I didn't do anything except snore all night.
And that gives us money, if you think about from a data center standpoint, where we have an advantage, versus some of our peers that are more, longer-established in the data center - is we have that customer relationship. And we have a mature business that throws off quarters like a laundromat - that I can then actually not only pay the dividend, but redeploy in the data center business, because the data center business is a capital hungry business. So to me, look - I'm vested in the business. I'm not a big shareholder, but I'm as big as I can afford to be. And my kids and my wife are counting on me. But there's a lot of value to be unleashed, just executing what we have in front of us.
BRAD THOMAS: Well I'm a shareholder too - not huge, but my kids and my wife are also counting on you as well, Bill.
And last question: we've seen a lot of interesting things going on in the Mall sector. Specifically, in the Mall REIT space. A number of these companies - and actually in the Prison sector, more recently, where CoreCivic (CXW) is moving back - they went from C Corp to REIT - now they're going back to C Corp. Now Iron Mountain started out as a C Corp, and then converted to a REIT with the private letter ruling allowing the business model to really be the racking system - is really what I'm referring to, to be a REIT.
So you've been a REIT for a number of years. We, of course, have been following the company since Iron Mountain converted to a REIT. You just announced, I believe, a modest dividend increase. So you’ve - certainly - have been utilizing this REIT model, which is, for those listening: REITs are required to pay out at least 90% of their taxable income in the form of dividends.
So Iron Mountain has been able to successfully grow this dividend. You had a modest dividend increase. Can you talk about how you feel about the safety of that dividend today? And looking back at the company – obviously, certain investors haven't really appreciated Iron Mountain from an equity multiple perspective - hopefully, that's going to change. But could you address the dividend safety, and your business model as a REIT?
WILLIAM MEANEY: Okay. So let me deal with talking about the REIT aspect, and then - cause it's linked to the dividend. So we feel really happy about being a REIT, because before we became a REIT, we were an income-oriented stock. And we think that the REIT construct, besides the tax advantage, obviously the tax advantage isn't as big since the latest round of tax reform - but it's still important to us.
But we think in terms of the investor outreach, and the people who like to hold and understand a company like Iron Mountain - it gives us a broader audience. And it's consistent to our capital allocation model. The REIT capital allocation model - or the income-oriented capital allocation model - to us, has a lot of reinforcement. So we see that makes a lot of sense for a number of reasons.
So then you come to the dividend. So, you're right: last year we increased, coming into this year, the dividend, slightly. This year, we've said we're keeping it flat, as we glide down to the low to mid 60%s of AFFO. We're at about 80% of AFFO, which from an Industrial REIT is probably okay. But if you look at where we're allocating more of our capital, it's more in the data center. And if you look at the Data Center REITs, they're usually, as a percentage of AFFO, in the 60%s. So we think that's probably where we should glide.
But that being said, is we're absolutely committed to the dividend. In other words, we made a firm statement in the depths of COVID, back in May, that we're keeping the dividend. And we just announced in our Q2, again, declaring the dividend, and we gave guidance to the market that we expect - as we bring on Summit - that we'll naturally glide down to the 60%s, and then start growing dividend in line with that kind of payout ratio.
So I think what people can expect is a flattish dividend - not a cut - flat dividend going forward, as we glide into the 60% sweet spot as we're allocating more capital - more similarly as you would expect from a Data Center REIT. But we feel pretty good about that. And of course we get there pretty fast on the back of Summit. So where Summit does - it changes markedly that slope, coming from, roughly, an 80% payout ratio, down into the 60%s.
BRAD THOMAS: Great. Well, Bill, I want to thank you for your time today. It's been very helpful to me, and I'm sure our audience, as well.
And I want to wish you the best. We'll be in touch with you soon, I guess, in the third quarter. And thank you again for your time today.
WILLIAM MEANEY: Thanks for the support and stay well, everyone.
BRAD THOMAS: Thank you.