Anyone who has dumped some old "stuff" into a self-storage facility knows how useful it can be to find a new long-term home for things you just can't get rid of yet. That's the basic business model that Iron Mountain (IRM -0.70%) has long followed, only on the business side of things. While most investors are focused on the real estate investment trust's (REIT's) digital makeover, it's important to keep an eye on its past, too. Here's one thing that way too many people overlook.
Putting paper away
While you might put some old tchotchke from high school into long-term storage, the main thing that businesses dumped into Iron Mountain's storage facilities was paper. The REIT offers other types of storage, like for high-end art, but it deals in paper by and large. Paper storage was a wonderful and reliable business for years, thanks to regulations regarding how long important legal and financial documents have to be retained.
To give a slight hint at how stable this business was, Iron Mountain claims to have a 98% customer retention rate. And the average box it takes on remains in its facilities for 15 years. The problem, of course, is that the world is going digital, so paper records aren't quite as important as they once were.
To Iron Mountain's credit, it has been building a digital storage business. Essentially, it competes in the data center space, building off its Rolodex to get customers on board. Being that it serves around 95% of the Fortune 1000, it has a pretty good list of potential customers -- the fact most investors focus on when they look at Iron Mountain. And to be fair, that makes a lot of sense. While expensive and time-consuming, building data centers is the future of storage.
Time is of the essence
The basic idea is that Iron Mountain can use revenues from its reliable legacy business to support the building of its replacement. With such high retention rates, that's a logical path forward. But there's one often-overlooked fact you need to watch out for here.
Roughly 65% of Iron Mountain's revenues, or around $2.86 billion, come from its storage business. Of that number, 73% is related to records management, the legacy physical storage business. That's a big number that's slowly going to shrink over time as a percentage of the top line. However, there's a wrinkle here.
Iron Mountain has been expanding this business via acquisition (largely in foreign markets), but it only expects organic volume growth to be flat to slightly higher in 2021. Consolidating the industry may be a good game plan in the near term to boost performance, but it doesn't alter the long-term trend toward digital records. Eventually, the physical storage business is likely to start shrinking on an absolute basis, as well, even as the company increases its prices. However, the 35% of its top line that's tied to services, around $1.54 billion, is what investors need to think more about.
Of that $1.54 billion, or 35% of total sales, roughly 24% is tied to shredding and 42% to records management (basically, moving boxes around, to keep things simple). Together, that's two-thirds of the services business or a touch over $1 billion in revenues. That's a huge number at around 23% of total revenues. Only this revenue is tied directly to the physical storage of paper records. If the company handles fewer boxes in the future, this number will decline, too. It's worth noting that third quarter 2021 services revenues were 4% below pre-pandemic levels, according to management. That was attributed to the coronavirus, but don't overlook this issue.
In 2020, when Iron Mountain was able to grow its storage revenues (physical and digital) by roughly 3%, services revenue fell 12%. That led to an overall revenue decline of 3%. Services is an important and clearly sensitive business line. Given that organic volume in physical storage is basically flat, the REIT can only buy growth in physical storage for so long before the larger digital trends start to take hold. That, in turn, could exacerbate the pain as the legacy services business goes away, as well. Looking at 2020, it's reasonable be concerned that a services revenue drop-off might happens faster than investors expect. It's worth noting that the digital business is still a pretty small piece of the overall pie, so the timing of the transition between these two businesses is quite important to monitor.
And then there's the cost involved in building out the digital business, which is reliant on the revenues of the paper-storage operations. This delicate dance must go smoothly, or Iron Mountain could find itself short of its transformation goals.
The right moves
This focus on the services side of Iron Mountain's business is in no way meant to disparage the REIT. It does what it does well, including operating data centers. It's more of a reality check for investors focusing too much on the future without paying enough attention to the past.
As it looks to transition its business, there are hard-to-quantify risks at Iron Mountain that low-risk dividend investors might be better off avoiding. The path it is taking looks like the right one, but getting from today to the digital future could be lumpier than some on Wall Street hope. Indeed, there's a reason why Iron Mountain's dividend yield, at around 5.4%, is dramatically higher than the average REIT and peers exclusively in the data center space.