Don't Let the IRS Scare You

Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Iron Mountain (NYSE: IRM) tumbled some 15% last week after the IRS scared investors out of the stock. The paper and online records company announced just over a year ago that it planned to change to Real Estate Investment Trust (REIT) status, and with the recent pullback the stock is now essentially flat since the announcement from a year ago. 

The IRS is assessing if it will revise the definition of REITs; currently, REITs must invest at least 75% of their assets in real estate and derive at least 75% of their gross income from the rents, interest on mortgages, financing property or sale of real estate. 

Investment firm Stifel Nichols puts the probability of the Iron Mountain getting approval for REIT conversion at 50/50. The REIT conversion for Iron Mountain is enticing, considering the low growth of the business. Even still, the absence of the ongoing costs of a REIT conversion could be a positive of Iron Mountain.

Company tailwinds 

Despite the sell-off at Iron Mountain, the stock has some long-term positives, one of which is the fact that analysts expect Iron Mountain to grow EPS at an annualized 13.3% over the next five years. 

This should come from the company's ability to tap the storage market overseas, where a transition away from conventional paper records should be a long-term positive. As well, the company's focus on higher-margin storage revenue versus services is another positive. Iron Mountain also has a solid recurring revenue stream, getting the majority of revenue from fixed periodic storage-rental fees. 

This recurring revenue should drive higher returns for investors and support the company's dividend. The company pays a 3.7% dividend yield. In 2012, Iron Mountain hiked its dividend by 8% and bought back some $1.1 billion in shares.

Iron Mountain has a diversified revenue base, serving some 155,000 clients across various industries, with over 90% of the Fortune 1,000 companies as its clients. The story gets even better; no single customer accounts for more than 2% of its revenue.

Other notable REIT pressures

Other stocks that took a tumble on the IRS-REIT news includes Lamar Advertising (NASDAQ: LAMR) and CBS, both of which are hoping to transform their outdoor advertising and billboard businesses into a REIT structure.

It would appear that Lamar and CBS, based on prior cases, should be able to build the case that billboards constitute real estate. Lamar believes that it's still on pace to meet its 2014 REIT conversion target. 

Lamar has shifted from a growth business to managing mature cash-generating operations. Revenue is expected to grow 5% in 2013, on the back of the introduction of higher revenue-generating digital billboards. Digital billboards now account for over 15% of revenue. 

As well, the company doesn't currently pay a dividend yield. But the company is a solid cash-flow generator. Cash flow from operations has grown 27% over the last three years and the company is currently generating some $375 million a year, which is nearly $4 per share. 

Equinix (NASDAQ: EQIX) is a provider of network-neutral data centers and Internet exchange services; specifically being the world's largest data center provider, operating data centers for the likes of AT&T and Amazon. 

Just like the other major companies looking to convert to REIT status, earlier this month the IRS informed the company that it was reconsidering what constitutes "real estate" for purposes of the REIT provisions. Equinix is hoping to gain REIT status for 2015. Also, one of the other major data center operators is also a REIT, Digital Realty. 

Equinix managed to post EPS of $0.71 compared to $0.66 for the same period last year as revenue was up 17% year-over-year. Much like Iron Mountain, Equinix has a solid base of recurring revenue, which accounted for some 95% of 2012 revenue. 

Equinix is still a high-growth story thanks to the growing demand for big data exchanges. Equinix is expanding its IBX data-center footprint globally and is popular among tech companies looking for data management. 

Equinix customers can place their equipment in one of the company's shared or private cabinets or customize their space. One of Equinix's long-term sustainable competitive advantages includes the high cost associated with changing infrastructure providers.

Hedgie trade

As far as hedge fund interest, there were a total of 24 hedge funds long Iron Mountain going into the second quarter, which includes Highfields Capital, managed by Jonathon Jacobson, with the most valuable position at $353 million.  And the stock is one of billionaire Israel Englander's newest picks (check out Englander's new picks).

For Lamar, there were a total of 47 hedge funds long the stock, a 24% increase from one quarter earlier. John Scully's SPO Advisory has the largest position in the stock, worth some $404 million, making up 5.5% of its 13F portfolio (check out SPO's top stocks).

Equinix had 71 hedge funds long the stock going into 2013, with Philippe Laffont's Coatue Management holding the most valuable position in the stock, close to $950 million and accounting for 12% of its portfolio (check out Coatue's top stocks).

Bottom line

A number of companies that are looking to convert to REIT status saw their stocks pressured as SEC filings revealed possible IRS changes to REIT conversion requirements. It appears that Iron Mountain's REIT status might be "up in the air." but I believe the cash flow generating capabilities of the company are still intact. As for Equinix and Lamar, both appear to be more likely to see their REIT conversions approved.  

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Equinix. 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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