Climbing The Mountain
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I don't think I'm making a mountain out of a mole hill, when I say investors have a huge opportunity coming up. Iron Mountain (NYSE: IRM) is moving to convert into a REIT. This came to my attention through a series of articles by fellow Fool Rick Munarriz. He periodically writes about companies that are increasing their dividend payouts. I always read these articles, and it helps me keep up with the yield of the many companies I follow. His little blurb about Iron Mountain converting to a REIT jumped off the page though because of its implications.
When most people think of REITs, they tend to think of companies like Annaly Capital (NYSE: NLY) and its indicated 13% current yield. Investors might also think of a personal favorite of mine in this space Invesco Mortgage Capital (NYSE: IVR) and its over 14% indicated yield. There is a huge difference between real-estate related REITs, and what Iron Mountain is doing. Annaly and Invesco are real-estate REITs, that essentially use the difference between long-term mortgage rates and short-term borrowing rates to make their money. They borrow heavily using leverage to increase their returns. Since they are required to distribute 90% of their profits to maintain their REIT status, they also issue new shares on a regular basis. The difference is while Annaly and Invesco rely on the difference in interest rates to make their money, Iron Mountain runs a business of document management and disposal.
Iron Mountain's business is pretty simple to understand. If a business has a record they want to protect or destroy, the company can help them. At my previous employer, we had an Iron Mountain shred bin for all of the sensitive documents we were required to shred. Let me tell you the cost savings of not having to stand at a shredder feeding pages and pages of documents in was huge. It was such a nice change to be able to save up a stack of things to shred and then just drop them in the bin. Iron Mountain came to the business twice a week, picked up the bin, securely shredded the documents, and gave us back the empty bin to refill with more papers. On the other side of the business, Iron Mountain offers secure document storage to help companies with meeting regulatory or policy based storage practices. The company complements these paper services with off-site data backup, and online backup and recovery solutions. The company's services are in demand too, with earnings growth expected of over 14% in the next few years. What gets me really excited though is with this conversion to a REIT, the company's dividend is about to change dramatically.
Just to give you an idea of what this change would mean, let's look at the company's full year 2011 numbers. For the year, Iron Mountain generated about $406 million in free cash flow. In order for a REIT to maintain its tax-advantaged status, the company must distribute 90% of its earnings. This would mean Iron Mountain would have been required to pay out at least $365.6 million in dividends last year. With about 171 million shares outstanding, this would indicate an annual dividend rate of $2.13 per share. Based on today's prices, that would mean a yield of about 6.6% versus the current yield of 3.34%. If the stock is worth $32.32 with a 3.34% yield and 14% growth, what should it be worth with a 6.6% yield and the same 14% growth? In theory, the shares should be valued at a higher amount.
The challenge for investors to understand is, as with any REIT dividends are not going to be a static amount that is steadily increased. REITs pay out 90% of their income. This means Iron Mountain might pay out $0.30 one quarter, then $0.60 the next quarter. This change in the dividend will likely give intelligent investors the opportunity to pick up Iron Mountain at lower prices. If you understand this concept, you'll know when the shares are being knocked down unfairly. I will be keeping a close watch on Iron Mountain for when this conversion is going to take place. It's rare to find a company expected to grow at over 14% that also pays a dividend over 6%. The combined over 20% expected return is what most investors dream about. If the company can execute, and this REIT conversion goes through, the company's stock price will be climbing a mountain of its own.
MHenage owns shares of Invesco Mortgage Capital and Annaly Capital Management. The Motley Fool owns shares of Annaly Capital Management. 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.If you have questions about this post or the Fool’s blog network, click here for information.