Iron Mountain sees lower leverage from REIT plan, but may need funding

By Paul Deckelman

New York, June 6 - Iron Mountain Inc. wants to turn that "mountain" into gold.

The Boston-based global information management company doesn't actually store all of the documents and records of its client companies inside a mountain made of iron, of course, but rather, keeps them in nearly 1,000 secure fire-protected buildings on five continents - and on Wednesday, its top executives outlined an ambitious plan to unlock the value of that nearly 64 million square feet of property for its shareholders by converting the company into a real estate investment trust by Jan. 1, 2014.

In doing so, the executives said that Iron Mountain expects to cut its cost of capital and lower its leverage, perhaps eventually to investment-grade levels.

However, while outlining the general plan for the conversion and the potential benefits from that move to its shareholders on a conference call with analysts, the company's chairman and chief executive officer, C. Richard Reese, and its chief financial officer and executive vice president, Brian P. McKeon, gave no specific details on what the company's planned capital structure would look like, assuming the conversion passes muster with the Internal Revenue Service and is also approved by company shareholders.

May tap the capital markets

But McKeon did say on the call that that the conversion to a REIT "will involve significant up-front costs," including needed tax payments, and certain capital expenditures and operating costs, all of which may total as much as $425 million, as well as some ongoing compliance costs of up to $10 million annually.

Iron Mountain would also be required to make certain distributions to its shareholders as part of the process of disgorging accumulated earnings and profits prior to the end of the first year as a REIT, which could cost another $1 billion to $1.5 billion, payable in a combination of at least 20% in cash and up to 80% stock.

McKeon said the bulk of the earnings and profits distributions would be made this year, "prior to potential changes in the dividend tax rates," with an additional smaller distribution in 2013 and other, smaller distributions over time after that.

Adding in other one-time conversion costs, Iron Mountain foresees a total cash cost to support the REIT conversion process of between $800 million and $1 billion, and the CFO said that "given the nature and timing of these outlays, including distribution to stockholders, we may access the capital markets for additional funding in the coming months to support our related cash needs."

McKeon did not specify whether this would take the form of new debt, on top of the $3.39 billion of total long-term debt the company was carrying on its balance sheet at the end of the 2012 first quarter on March 31, or whether it might be an issuance of new equity, or convertible debt.

He said that tapping the capital markets "may result in near-term increases in our leverage prior to transitioning to our longer-term capital allocation strategy and lower leverage over time."

A shift away from debt

In explaining some of the rationale for transformation of the 61-year-old company to a REIT model, Reese said that "we built this business using a highly levered business strategy, relying on the debt markets for the capital we needed to grow the business.

"As we look forward, and if you look at how REITs operate, as we grow the business, there will be a natural shift towards a greater use of equity rather than debt. We're not saying zero debt, we're not saying all-equity and we're not saying high dilution. But what we're doing is signaling a shift in how we'll think about the capital markets, and so forth."

Reese reminisced that over the years, he would sometimes be asked whether he would consider issuing new equity and using the proceeds to pay down debt, "and I would look at them and say 'are you crazy?', given all of the advantages of debt financing, including attractive costs, good covenants and loan terms, and "a great tax shield - so why would I pay it down?"

However, he explained, with conversion to a REIT, "all of that changes," including the loss of the tax advantages, "so it changes the economics - it changes your average cost of capital. And we will over time look at re-jiggering some of those things" to get to the lowest cost of capital that the company can achieve.

Company eyes property deals

Besides expectations that like most REITS, Iron Mountain will turn to sales of equity should it need additional capital, rather than debt, the McKeon also held out the prospect of buying some of the facilities they now lease, figuring that in some cases, their cost could improve by "a couple of hundred basis points of opportunity" versus what they are paying for leases.

He said that the company already considers leasing costs as part of its leverage structure - the $3.39 billion first-quarter long-term debt figure includes some $212 million of real estate mortgages and capital leases.

Of its 64 million of total square feet, Iron Mountain currently owns a little more than one third of that, and leases the rest - but the CFO said that it will explore upping the percentage of its owned real estate by buying some of the properties it currently leases, if the price is right.

"We think we can reduce financing costs by purchasing leased facilities through a combination of debt and equity, resulting in a lower cost of capital than we've achieved through lease financing," he said.

Reese jumped in to reassure investors that such purchases would only involve some of the currently leased facilities, and nowhere near all of them.

An analyst asked for some kind of medium-to-longer-term guidance on the kind of leverage number the company might be aiming for by shifting to more equity funding versus debt when it becomes a REIT, and by, in Reese's phrase "arbitraging" the different costs of capital on its properties, between leasing them or owning them outright.

McKeon said that the company is "not really in a position to make specific estimates at this point," but he added that "over the very long-term, in terms of our leverage structure, we'd like to move towards investment grade."

Reese said that such an achievement "will take a long time."

Moody's Investors Service currently rates Iron Mountain's various tranches of senior subordinated junk bonds at B1 and gives it a Ba3 corporate family rating. Standard & Poor's pegged the bonds at B+ and gave it a BB- corporate credit rating. Fitch Ratings does not rate the company's debt.

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