Iron Mountain Incorporated (IRM) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Alex Hess, a Vice President on Andrew Steinerman's Business and Information Services Equity Research team here at JPMorgan. We're really excited to have with us today, Barry Hytinen from Iron Mountain. Many of you know Barry very well. He's been the EVP and CFO of Iron Mountain for about 6 years now. Barry, it's always great to have you, and we're really excited that you're back with us at Ultimate Services today.

Thank you, Alex. It is a pleasure to be here.

Great. So I want to start with the growth portfolio or the growth businesses. Back in 2021, those are about 15% of revenues. Now they're tracking towards 28% of full year revenues. The exit rate might be 29%, 30%, what have you, it will be a little higher. Walk investors through the history of how you found these growth vectors. Those are digital solutions, data center, Asset Lifecycle Management as areas where you thought were the right places for Iron Mountain to be participating?

Yes. I appreciate that question, Alex, because our growth portfolio is, I think, a very underappreciated element of our story in that we have been growing it quickly, collectively north of 20% for quite a few number of years, and we see that trend continuing for a long time in light of the segments we're operating in. The team started investing in most of those areas over a decade ago. And the concept was having really consolidated records management and developed a massive client list. We operate with over 245,000 clients around the world. The team was looking for natural adjacencies whereby we could serve our clients and in a high-quality way in compelling areas where we could drive value for clients. And so Bill and the team, long before I joined the company, started looking at a variety of areas. Digital solutions was one that kind of came quite naturally because it cross-sells off of our core very easily in light of the fact that much of what we initially started doing was scanning of content that we had on behalf of clients because perhaps they wanted to do a level of analysis on a piece of the inventory, that sort of thing. Where that has naturally now grown to is our digital business unit team members have created a platform initially built off of some Google technology. Some years ago, we were the AI/ML Partner of the Year with Google. And since that time, our internal team has built out the application to be a true Software-as-a-Service platform, which we call DXP. And DXP is a platform that allows us to significantly save customers' cost, drive considerable efficiencies for clients, particularly in areas where there's physical and digital information that needs to go from an unstructured format to a structured format. I'm sure we'll talk about that more. But that was a very logical adjacency and one which we feel has a tremendous amount of incremental growth as we're continuing to find increasingly new applications for DXP, whether it be in our government clients or in our corporate clients. In our data center business, that was really one that started in a very small respect years and years ago, Alex, in the fact that we had clients that were looking for very secure locations where they could have some level of colo. And so we started putting servers in our mines, for example, in our Western Pennsylvania mine, we have a data center now, and we've had one there for some time in which it was specific to client needs where they were looking to Iron Mountain to help them solve problems that they had in their own infrastructure. And over time, as we continue to test and learn as it relates to enterprise colo, we found more and more of our clients, particularly on our data management business, we were shifting load to the cloud and then they had an on-site data center, for example, that was naturally becoming less efficient because it was getting less load, and that was an opportunity for us to come in and help solve another client problem whereby they could colo with us in sites. And over time, that's just been a growing and growing area of our business, which I'm sure we will spend more time on, so I won't belabor further. And then lastly is the Asset Lifecycle Management business. And Bill and the team started investing in that area in 2017, again, as another way of helping our clients. As you know, we go out to see clients and pick up boxes, do other work for them on their sites. And what we found is many clients were looking for a solution to help with obsolete or end-of-life IT gear. So we started helping them by picking that up and having third parties process it. And what that has grown into is a really compelling market opportunity for us. In 2021, our ALM business was $38 million of revenue. And this year, we'll do about $600 million of revenue. And we're continuing to consolidate what is a very large space. And so I would say, Alex, it comes down to the team has been looking for ways to serve our clients. We're very customer-centric, and we are continuing to explore additional adjacencies and vectors for growth that we'll talk to you about at future days.

Great. Yes. So I very fondly remember when the Iron Mountain ALM business was SITAD, and we were shifting the name because you guys had just bought ITRenew and so you have to keep track of all these different names. Now it's just ALM, which is very easy. So on this industry, on ALM, we'll start there. You sized this market, $30 billion. You're clear #1 here. I don't think it's close. I don't think it's 3 or 4x larger than the #2 perhaps. But it's $600 million out of a $30 billion, excuse me, TAM. How do you size this market?

Yes. So we looked at a variety of different ways, and we've also utilized third parties that have done primary level research as well as secondary research on the sizing of it. And what we find is that the total market is, as you say, $30 billion, let's call it, 3/4 of that is what I would consider as enterprise ALM segment, Alex, and 25% is hyperscale. And when I talk about enterprise, what I mean there is our classic corporate clients who have that IT gear that they need to deal with as they generally are kind of consistently having a flow of IT gear that obsoletes, whether that be laptops, on-site data center servers, screens, printers, what have you, all sorts of IT gear. And that is a business -- and that is a market, I should say, that is a market that is growing kind of mid- to high single digits on a consistent basis. And one of the compelling needs there, if you talk to clients is that they are naturally concerned about confidential information, PII, other things that have been written to devices and making sure that they are very securely wiped and disposed of appropriately in a sustainable way. And that is an area where there is a distinct need for more consolidation. The market in enterprise ALM is highly fragmented. As you know, we're already the largest player in that portion of our ALM business, about 60% of the revenue of the $600 million will do in ALM this year, so call it, $360-ish million. And I estimate that puts us at 2 or 3x the next largest player. And we're continuing to grow on an organic and inorganic basis because there's a real compelling need. And what we find is that large -- medium to large businesses that have operations in multiple regions, multiple states, multiple countries, they have to string together a network of many small IT asset disposal companies to service themselves. And that's really because there's nobody that has brought together the power of a consolidated go-to-market approach where a consistent chain of custody, very secure and very capable of dealing with privacy and other safeguards that need to be done in that area as well as, of course, sustainably dealing with the material. And that is what we aim to do, Alex, in the enterprise side. We are in the early innings of consolidating that market -- and if it sounds familiar, you know our story very well, it's a strategy that we did really in the record side earlier on. If you go back 30 or 40 years ago, records management was a very fragmented market without a single player that could provide the service around the world to clients. And over time, the team here consolidated that market and brought together what is a really compelling offering, especially for multinationals, and we think we can do the same thing on the enterprise side. In the hyperscale section of the market, that's, call it, 25% of that $30 billion total TAM. That is a more concentrated space from a customer standpoint. Think about the major cloud hyperscalers because what we're doing there and other participants in that part of the market are doing is helping clients with retrofitting their data centers with gear. So as they -- as a major hyperscaler may have a fleet of data centers that they've opened and continue to open over the last many years, they tend to retrofit the servers in there about every 5 years on average. So they're not taking the gear to obsolescence. They're renewing and refreshing the gear for reasons related to getting better compute, maybe better power efficiency, et cetera. And so that gear still has a considerable amount of value inherent in it, unlike on the enterprise side where gear tends to be taken more to obsolescence. So that's -- on the enterprise side, it tends to be a service-oriented revenue model. And in the hyperscale side, it tends to be more of a revenue share model where we are sharing what we can garner for the assets. So what happens is we take the servers out of their sites, we wipe them. And in some cases, we destroy elements that have been written to. And then we will physically disassemble the servers and sell off the components, CPUs, DRAM, what have you, whereby we will take a 20% on average take of whatever we're selling that gear for. That part of the market is growing high single, low double-digit growth from a market standpoint, Alex, because as you would appreciate, there's so much more data center capacity each and every year. And what we're really doing as an industry is retrofitting on that 5-year kind of horizon that I mentioned. And so it just tends to be a market that has a tremendous amount of volume. It is subject to a little bit more component pricing volatility on that side of the business. And it tends to be a little thinner margin than the enterprise side. But I will tell you that we love the ALM business. We think the market is going to grow for a long period of time. It's an underserved market, as I was describing earlier, and it's one that I think plays very well to our strengths.

Yes. We'll have to check in with you in 5 years when we find out what all these Blackwell and Hopper chips resell for. I think that will be -- if you could answer that now, you can all go home today.

Well, I won't do my [ karmic ] impression today. But I will say that it does appear that it would generally bode well for the ALM market, what you're pointing to, because I think there is a fairly significant correlation in terms of the value of the gear going into the data center is fairly correlated with the value coming out, obviously, with a depreciation schedule. So while none of us necessarily know what that's going to look like in the future, I think indications would be that since that gear is relatively more expensive on the way in, it will probably be at a better value on the way out. And therefore, with a revenue share, we're likely to see some, if you will, mix benefit to headline revenue in the future from that. But you're right, that's a few years off.

Yes. So just staying maybe in the data center world, right? And we're going to talk about all the assets you have to energize. But a point that you've made repeatedly over the last years is that Iron Mountain don't build on spec. But you do have right now a notably high percentage of construction in progress that isn't pre-leased. Now maybe not notably high relative to the industry, notably high relative to your history. How should investors think about that unleased construction in progress? Are you building to indications of demand based on the stated needs of your recurring tenants? Like how do you decide, hey, look, we don't have a person yet leasing this facility, but like this is not a spec project?

Yes. So -- and it's a good question because our strategy, generally, Alex, as you know, is to not build on spec. We -- one of the things that we really like about our hyperscale data center business is we're dealing with very large AAA kind of credit counterparties in which we're signing leases of 10-, 15-year duration with multiple renewal options and at a very good return, I think 10% to 11% cash-on-cash unlevered returns. And in light of the build schedule and the pre-leasing elements of that, frequently, we can sign a lease before we put the shovel in the ground to start the construction. In the case that you're pointing out right now where we have a slightly elevated level of not yet leased construction-oriented development, I would say there's a couple of very specific things going on there. if -- as you know, we signed our Chicago asset, we totally leased that building post the last quarter end. So it's not in our current schedule as [indiscernible]. And that's with a shift from London, as we talked about on the call. So it's a net additional 11 megawatts for the year. However, we have been working with the client on that potential move for some time. So as you saw, we have been doing construction in that asset, and there's a considerable amount of spend against it as we're prepping because that's going to go -- a portion of that will go live for the client even next year. And so there's that element. But then there's a couple of other assets in there that are under development that are clearly very, very highly sought-after locations. When you look at the assets that we have energizing over, say, the next 12 to 18 months, Alex, you -- we've got 28 megawatts in Northern Virginia. We've got megawatts in Madrid and Amsterdam. All 3 of those would clearly be significant hyperscale locations for. And then we have 25 megawatts in London. And I would tell you that if you look at the energization schedule there, those should be very, very good leases for us as we get closer to energy.

So -- but I do want to just step back on this for one second, which is -- you clearly don't build this spec. You clearly build with some sense of tenants in mind, but you're also selective. You don't -- you work with a very select number of tenants and you build and you develop conservatively. So when investors understand those 2 facts, the stylistic third factor that falls out is, hey, when we decide to go and start building something before it's pre-leased, we have a reasonable indication of a small handful of tenants that will probably be interested. Is that a fair characterization?

I think that's generally fair, Alex. I mean the market for the type of leasing that we're doing on the hyperscale side is you're talking about the top 10 hyperscalers. Really, there's probably 4 or 5 for us that are really meaningful as it relates to our client base in that sector of our business. And when we talk about like Northern Virginia, London, Amsterdam, we have a very active pipeline of discussion there. And while the deals tend to be a little bit lumpy in the sense of it's hard to predict precisely which week or which month a deal is going to sign because there's always elements of technical due diligence and the design can change slightly, which naturally affects the underwriting and the contract terms. And as you would appreciate, there's a lot that goes into those sorts of deals because you're talking about a 15-year initial lease with perhaps the likelihood of with renewal options to go 30, 40 years. And so the details matter. And so when we get into a detailed discussion with clients and something changes, we need a little bit more time to get the contract done. But I will tell you that when I look at the Tier 1 assets that we have, I feel -- and I know our team feels extraordinarily good about the ability to lease over the next 18-plus months as we look at the assets we have coming for energization.

Perfect. I want to turn to the treasury contract that you guys just signed. This is in Global RIM, but it is part of the growth portfolio as well. It's a digital service that you're providing them. As we understand it, you're going to help the treasury reduce their reliance on tax-based paper-based tax filings. There's sort of a long-running digitization revenue stream. It appears based on what's sort of in the public domain to have a revenue stream that coincides with tax season. Can you elaborate a bit more on sort of the scope of the contract, like specifically, what are you doing? And like how -- what's going to govern volumes in that business and what the revenue mechanism is?

Sure thing. So it may be counterintuitive, but to most folks who might be using electronic means to file their tax returns, but the U.S. government is still processing a tremendous amount of inbound paper tax returns and various other tax correspondents, Alex. And historically, up until present day, the government has generally been processing that largely through a labor-based solution of personnel at the Internal Revenue Service. And what we are offering the Department of Treasury is a digital transformation effort, whereby we showed them a proof of concept of where we had built large language models to process the various tax forms and correspondences in a highly -- high-quality, consistent and rapid way such that we would meet the naturally exacting standards they have. And naturally, as you would imagine, the government does not want a lot of errors in processing of tax reform and tax forms. And so when we pitched this opportunity, and it's been in the public ether now for several quarters, but what has manifested itself here recently in this win is a 5-year contract in which the Department of Treasury has awarded us a $714 million contract for the estimated value over the next 5 years. They did award to 3 other, what I think is fair to say, much smaller players than us in this area. And while we are not exactly certain yet, but there are mechanisms by which the government will use to disperse the volume, we're the only one processing forms at this time. It's not a huge amount of revenue. As I mentioned on the most recent call, I expect we'll do probably $4 million of revenue in the fourth quarter with the IRS. But you are right, we expect it to ramp into tax season. And in light of our ability to process, our ability to be ready to process the inbound rapidly and across a variety of forms and the fact that we've already become FedRAMP and we have a tremendous number of people that are now cleared, as you can imagine, there are quite a lot of hurdles to get over to doing this kind of processing. And I think we're in a very, very advantaged position vis-a-vis that. And so if you want to think about it from a standpoint of if we got 100% of the volume, and I'm not saying we would, but just to kind of frame the opportunity, we estimate it would be about $140 million a year, Alex, based on the volume that the government is currently seeing. And the way that was brought together was that the government put out a bid form that said this number of 1040s, for example, this number of other forms and various correspondences and then had anyone that wanted to bid that was a qualified bidder come in and say what they would process each form on a per form basis. And naturally, more complex is more expensive, less complex, less expensive. And then when you mix effect that under our bidding, it came out to about $140 million a year. And the opportunity here is, I think, quite immense because if you kind of factor that against the size of our existing digital business, our digital business unit is now at a run rate of about $550 million of revenue on an annualized basis. And so even if we got the majority of this, this is a big move in terms of our -- for our digital team. And furthermore, I think it becomes a huge case study for us to go and talk to both corporate clients as well as other government agencies as we show the massive value creation we're going to have for the U.S. government because published reports would suggest, in fact, some from the government suggest that the United States spends, I think, in the vicinity of $600-plus million a year doing paper processing of tax returns. And so when you think about it, our cost to do that to the government of $140 million is a huge savings. And I think speaks to the opportunity for digital transformation and what our team has built in DXP. And this isn't the first large contract we've won using DXP, Alex. We've been doing mortgage processing for a couple of major financial institutions. We're doing a variety of other similar exercises, but this is a very meaningful one and I think can be a great case study for demonstrating value.

Excellent. Well, that's the growth portfolio. Now we are 24 minutes in, we still haven't talked about box volumes. So my view...

I thought you'd get there.

Might be a record for you guys. So just again, let's just go through box volumes. And specifically, you've had an uptick -- I'm not talking sea change, but a modest uptick in retention rates for the core global room storage rental business. And that's been despite continued mid-single-digit price increases. driving that increased retention? And what might it suggest about your customers' elasticity of demand going forward?

Yes. I will say this, Alex, it's really a wobble. It's an improvement. I'm just trying to be balanced. Even when the retention rate was coming -- wobbling down slightly coming out of COVID and through a couple of projects that we were doing for very specific small pieces of inventory, but it can move the retention 1/10 or so. I told people a year or so ago and, hey, in about a year, it's going to start moving back up because we'll get through that project. And fundamentally, the underlying health of our client base is really good. Our customer retention rates are extremely high. And most of the clients who we do business with in the record side, they've been doing business with us literally for decades all around the world. In most cases, they've nearly standardized with us if they haven't totally standardized with us for this as we deliver tremendous value to those clients that need a partner in this area across their enterprise. And so look, the retention rate will kind of continue to be in this vicinity, I believe, it kind of also factors into the concept that the average box stays with us for about 14.5 years, and that's been kind of steady for a long time. There are some boxes that end of life much sooner than that. There are some that stay much longer, but the underlying health of our records business is strong.

That's great. And I appreciate the -- you flagging a positive changes in the wobbles, it's good to be balanced on that side. I want to just touch briefly on capital allocation from here. You've got all these businesses, some of which have -- I'd say most of which actually have very impressive incremental margin profiles you're not throwing losses after this revenue growth, it all comes with incremental EBITDA dollars, which is lovely. But you have taken on more capital as you've grown your top line, you've grown your capital base. In a juncture where, let's say, we go into a recession or there's a slowdown or one of your businesses wobbles more significantly for a year, like which of these metrics are you going to allow to downshift first? Would you take down your CapEx? Would you moderate the pace of dividend growth? Just trying to think how -- it's a balancing act. So there's a lot of work that goes into this, right?

Yes, for sure. There is. It's -- our team gets up every day and creating value for our clients, and it's hard work. I would tell you this, Alex, if you look at the increase in capital that we've been deploying, it's been disproportionately to data center over the last 5 years. I think my first year with the company, we might have spent $300 million on data center. This year, we'll do closer to $2 billion. And why is that? And coming back to your earlier point, it's to support the pre-leases we've already signed. And so if you look at our data center business, this year, we're going to do just under $800 million of revenue, call it, a low 50s EBITDA margin, super strong business, writing very strong returns on deals. And if you look out to next year, I've kind of said a few times that in light of the backlog of deals that we are constructing and that will commence between now and earlier this year and anniversary next year and through next year, we will be over $1 billion of revenue with no additional leasing and obviously, run a lease. And then we -- on top of that, we have another $250 million of revenue that will come out of backlog over the next few years after next year. And that's all booked business with clients that are AAA-type credit and with very long lease terms. So in your hypothetical, I will say this, we're a very cost-conscious company. We are very focused on driving margins in each one of our business, and you didn't ask, but I'll just tell you, I think that there's opportunity for incremental margin in each of our businesses. Now the total enterprise margin will depend on where you grow your revenue. But there's self-help, so to speak, an opportunity, and our team is working hard on driving profitability in every single one of our businesses. And -- but we'd be very focused on driving capital returns in such a scenario. I'll tell you this, you mentioned the dividend. For us, the dividend is almost formulaic. We have a payout ratio target of low 60s percent as a percentage of AFFO. And some years back, we were well higher than that. So we said, look, we're going to pause. We're not going to raise the dividend until we get down into the payout ratio. At the same time, our leverage was a little bit higher than we wanted. It was around 6, and we said we want to get it down into our target range of 4.5 to 5.5x. What's happened during the next 5-plus years since then? We got the leverage down to 5x right at the center of our target range. We've been there for quite a while now. And we got the dividend payout ratio into -- we got the dividend into the right payout ratio range. And we just raised the dividend 10% for the third time in a row -- third year in a row. And why 10%? Well, that's in line with our AFFO growth. And so what you should anticipate is that the dividend will continue to rise in line with AFFO because we expect to continue to maintain that payout ratio. I'll say this, Alex, in a -- if the macro -- and you're hypothetical, if the macro is a little more challenged, there's always opportunity for us to kind of belt tighten, but it won't be on pre-leased data center because we have clients waiting for us to open up those and those will then convert to revenue.

No, that makes a lot of sense. That makes a lot of sense. We've got about 10 seconds left. So maybe a little word association. What's something that's not on investors' radar that you think they should be paying attention to with respect to the Iron Mountain stock?

Yes. I guess I'd point out 2 things. And it's not that they're not on the radar, but I'd just underscore. Our core business is really durable, Alex. I mean we've been doing a level of revenue management year in and year out. Our volume on an organic basis has been flat to slightly up, I think 30 basis points, and we've driven a lot of margin in there. And that business is very capital light. It can continue to grow in a way that requires relatively very little capital to grow. And that is one of the secrets of our success because unlike a lot of other data centers, we've got inherent free cash flow coming out of that business, which we can then drive into growth in data center. And then the other one I would point out is, look, I mentioned it earlier, our ALM business is growing strength to strength, right? 36% organic growth last quarter. That was 70%, I believe, total growth. Margins are expanding in that business. And it is a secularly growing portion of the economy and one that we think is ripe for consolidation. And frankly, we're going to ultimately build a business that serves clients in a way that they want to be served, which is that we offer the same consistent process, chain of custody, privacy and value all the way around the world, which is something clients are looking for.

Thank you so much for your time today, Barry.

Thanks, Alex.

Really appreciate it.

Appreciate it.