This Company’s CFO Is Buying on Bad News

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Iron Mountain (NYSE: IRM) plunged 16% on June 7 after the company filed an 8-K related to its discussions with the IRS. First, the records management and data protection services company’s request for a certain Private Letter Ruling (PLR), which would allow it to qualify for conversion to a real estate investment trust (namely, a ruling which would classify Iron Mountain’s racking structures as real estate), has been met with a “tentatively adverse” reaction. This can often mean that the IRS has not made a decision yet, but the 8-K also disclosed that Iron Mountain has learned that the IRS has convened an internal working group to study its definition of real estate for REIT-related purposes. This may well lead to a stricter definition. Bulls had expected that Iron Mountain might have smoother sailing towards REIT status; as a result, the report from the company caused a steep fall in the stock price.

Brian McKeon, the CFO of Iron Mountain, has reacted fairly quickly to the market’s response. On June 7, he directly purchased 3,600 shares of the stock at an average price of $28.61 per share (the stock closed just below $29). This gives him nearly 11,000 shares in total, making it a significant percentage increase in his holdings. Studies show that stocks bought by insiders exhibit a small outperformance effect (read our analysis of studies on insider trading). We think that this is because buying the stock increases an insider’s company-specific risk (since they already earn income from the company), and so insiders should diversify their wealth unless they are fairly confident in the company’s prospects.

The company had reported flat revenue in the first quarter of 2013 versus a year earlier, with a 34% decline in pretax income as operating costs increased--though cash flow from operations was up. Wall Street analysts expect earnings per share to pick up going forward, but even so the stock trades at 21 times expected earnings for 2014. As a result we think that the price actually still includes some option value from a REIT conversion.

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Peers for Iron Mountain include data integration and storage services companies Informatica (NASDAQ: INFA), EMC (NYSE: EMC), and NetApp (NASDAQ: NTAP). Trailing earnings multiples are high at these three peers as well, though the sell-side is optimistic on each company's prospects. EMC and NetApp would actually be value plays if analyst forecasts are proven correct, as those stocks’ forward P/Es both clock in at 12. Last quarter each of those two companies experienced a small decline in earnings, however, with only modest growth in revenue, and so we’d be skeptical of the optimism in these projections. Certainly we won’t be buying either EMC or NetApp without more positive news.

Informatica is in a similar boat: even after a 14% decline in price over the last year, it is valued at over 20 times forward earnings estimates. Again, that figure already assumes that net income will increase significantly from current levels over the next year and a half. While revenue did rise 9% last quarter compared to the first quarter of 2012, earnings fell over 30%. We’d certainly avoid being long, and any of these three companies might actually be worth researching as short targets if anything.

With Iron Mountain looking fairly pricy in terms of forward estimates, then, it’s possible that it is just trading in line with the industry rather than with a continued perception that the company stands a good chance of being approved for REIT conversion. Still, REIT status seems speculative at this point and the valuation is too high for us to recommend Iron Mountain on value terms. Even taking into account the insider purchase, then, we would avoid the stock.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Informatica. The Motley Fool owns shares of EMC. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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