Wednesday, April 30, 2014

Speculating on Iron Mountain's REIT Conversion

Many investors are well aware of record storage operator Iron Mountain's efforts to convert the company from a C-Corp to a REIT.  As a REIT, Iron Mountain (IRM) would be taxed only at the individual shareholder level and would likely reduce their cost of capital, both of which would cause the shares to be re-rated higher inline with storage/industrial REIT peers.  Iron Mountain's primary business is building large storage centers and "leasing" out space on their racking structures to store paper records.  In this business line they have over 67 million square feet of storage space across over 1,000 locations, so there's a good case to be made that Iron Mountain is indeed a real estate driven company.

However, last summer, the IRS initially pushed back on Iron Mountain stating they were "tentatively adverse" to classifying the racking structures as real estate.  The basic question is how permanent are they?  Are the racking structures more similar to walls in a house or removable display shelves in a grocery store?  The market reacted quickly selling off IRM shares from around $40 per share before the announcement.

Iron Mountain hosted an analyst day presentation in March (shares are trading in a similar $27-29 range since) where one of the main topics was the REIT conversion, listen to the whole call if you can, but the key REIT valuation slide is below:

It's fairly clear by these measures that Iron Mountain would be significantly undervalued as a REIT.  If approved, the stock should recapture much of the ground it has lost since the IRS's "tentatively adverse" push-back in the near term, and maybe more upside above $40 over the longer term. 

Management seems fairly confident in a positive outcome, they have been operating the company as a REIT since the beginning of the year in preparation of approval so they could file next year as a REIT.  The board initially announced plans to evaluate REIT status in April 2011 (after some activist pressure), and formally announced the desire to pursue the strategy in June 2012, if plans fail the board and management would face real credibility issues.  Additionally, the IRS recently has been approving non-traditional REITs in sectors such as outdoor advertising, cell phone towers, data storage centers, and casino properties.  There is some time pressure to get approval sooner than later, in order to qualify as a REIT, Iron Mountain would have to make a special dividend within the calendar year to distribute their accumulated earnings and profit (E&P) to investors.  In order to get this done, the company believes they need to initiate the process in October, if the IRS doesn't rule in their favor before, the REIT conversion gets pushed back to 2015.

I'm writing this on Wednesday (4/30) afternoon, earnings come out tomorrow (5/1) morning, if any negative REIT related news is released tomorrow I could end up with egg on my face pretty quickly.  But I couldn't resist a little special situation call option strategy, I bought some call option contracts, nothing big, basically just free rolling the small profit I made on BioFuel Energy earlier this month.

Disclosure: I own IRM calls

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