Call Start: 14:00 January 1, 0000 2:33 PM ET
Iron Mountain Incorporated (NYSE:IRM)
RBC Capital Markets Global Communications Infrastructure Conference Call
September 27, 2023 14:00 ET
Company Participants
Barry Hytinen – Executive Vice President & Chief Financial Officer
Conference Call Participants
Jonathan Atkin – RBC Capital Markets
Jonathan Atkin
Welcome to the afternoon fireside chat. If you have any conversations going on, you might want to take it to the hallway. So I’m John Atkin with RBC and I’m pleased to conduct the next 30 minutes of Q&A with Iron Mountain, Chief Financial Officer, Barry Hytinen. Welcome.
Barry Hytinen
Thanks, John. Great to be here.
Jonathan Atkin
And what I’d like to do is maybe give you a little bit of an intro — give you an opportunity to kind of introduce the company. A lot of the people in the audience are familiar with your legacy business and obviously some of your investments in data centers but just kind of bring us up to speed to kind of level set us and then I’ll dive into some operating and strategic and financial questions during the time together.
Barry Hytinen
Okay, sure. Well, again, thanks for having us and appreciate the coverage. Iron Mountain is a business that has a very strong core. It’s a very durable offering. We are the market leader in storage of paper and various other elements of business storage like tapes. We do a tremendous amount of service for those clients. And we have a very large client base. It’s 225,000 client relationships around the world. We operate in about 60 countries around the world. And in our core, in that storage section, we are the, as I said, the undisputed leader but we also have the most reach by far.
Most of the competition that we have is market-driven or in a specific region in a country as opposed to being able to service multinationals. And when we talk to our clients about the reason that they standardized with us it’s around things like chain of custody, trust, making sure there’s a consistent process that the value is there. And fundamentally, that the thing, the assets they entrust to us are going to be there when they need them in the future. On average, in that core, we store boxes for clients that stay on our shelves for between 15 and 20 years.
We have very high retention rates. And what we found over the last few years is we have been, we have started about 6 years ago, testing a revenue management project in which we have been systematically trying to move the average price of our service up for consistent with the value that we deliver to clients. And that has been a very strong project for us over the last several years. And we see a very good horizon going forward on a systematic basis to continue to have revenue management be a nice tailwind to our growth going forward in the core.
There are several businesses within ours that are emerging and growing very rapidly over the last several years. The team started investing in several areas of secular growth, about 5 to 7 years ago depending upon the offering. One of those is digital solutions. And that’s usually, for us, starts with scanning. We scan both inventory that we have been storing for clients for a project or for a specific use case. The vast majority of that then goes back on the shelf for storage after we’ve scanned it. And we ingest that into typically our own content management platform so that clients can use data tools to analyze and get access to information that they’ve never had before because so much of the content that we store for them is in fact, just on our shelves.
And so that makes it a real treasure trove of analysis for them. But we have been doing digitization and content management applications even for inventory that we don’t store which is, I think, speaks to competitiveness [ph] of our offering. And we have a whole host of other digital solutions that we’re building out in that business for us is growing at about 20%-plus [ph] compound rate for the last several years and that’s within our core. Another area that the team started investing in some years ago which I’m sure we’ll spend a lot of time on today is Data Center, where we operate a portfolio that ultimately if we didn’t buy any additional land would be ultimately 800 megawatts but we’ll continue to aggregate more land and power and build that out. And I’ll go into more detail, I’m sure, in the Q&A.
But that is a business that’s growing for us again, on a new bookings basis, like I think, 20% to 30% compounded for some time. We have both a Colo [ph] business which is where we started on the data center side but, the last few years, we’ve got a lot of traction with large cloud hyperscalers who have, we have started with relatively small point, deployment, maybe 500 kW. And now we’re after multiple contracts and testing us out essentially over the last 4 or 5 years, they’ve started making us a strategic partner in this area and we’re signing in the first quarter, as we talked about, we signed a 40-megawatt contract with a client last year.
We signed a 72-megawatt deployment. And so we’ve been getting a lot of traction in data center and seeing that become a larger and larger portion of our business. It’s accretive to our total company EBITDA margin as well. And then another area that we’ve been investing in for about 5 or 6 years now is in the IT asset disposition space which we refer to as Asset Life Cycle Management. And in that space, we have in that series of markets which is a very big market, Asset Life Cycle Management is about a $15 billion a year served market, it’s probably $30 million total addressable market.
We think it cross-sells exceptionally well with our core because when you think about our largest clients, large financial services companies, large insurers, healthcare companies, except multinationals, they all have needs for records where they’ve, most of them are standardized with us. And for similar reasons, they have needs for secure and enterprise-level IT asset disposition in the form of privacy concerns about laptops that have been written to or service they have been on to, they want to make sure that the privacy elements of those are addressed appropriately, that they’re sustainably recycled or disposed off. There are concerns with large clients about green washing and alike.
And so we think enterprise IT asset disposition is another major growth opportunity for us over the next few years. And it is a business that for us on the enterprise side that’s been growing at the 20% to 30%-plus [ph] compound rate for several years. Now still a relatively small portion of our business but one that has got a lot of opportunity and within asset life cycle management, we also have a hyperscale data center decommissioning portion of the business. That’s actually the larger of the parts of our ALM business. And while we are seeing good trends with clients as it relates to volume and improving win rates and we’ve got really important client relationships in that space with some of the largest Cloud Hyperscalers, component pricing has been a challenge which I’m sure we’ll talk about but that’s been a challenge for everyone in the industry.
And we anticipate that in the future, it will improve but we haven’t, we haven’t assumed that for this year. So John, we’ve got a business that is growing and we have systematically increased the growth rate of the company. If you look at it over the last, say, 9 or 10 quarters, we’ve been growing much faster than the prior, let’s say, 10 years’ worth of growth on an organic basis. And that’s because we’ve got stable volume in our core. The revenue management activities have been driving good growth digital solutions have been growing fast and complementing that growth in our core. And then in our growth areas of Asset Life Cycle Management, Data Centers growing quite rapidly for some time and becoming more of a meaningful slug of the company. EBITDA has also been growing quite nicely and we generate a lot of profit out of that and a lot of cash out of that core which we’ve been deploying into building out data center development. Data center is our most capital-intense portion of the business. And really, as a practical matter, the rest of the company is not particularly capital intense.
And then from a capital allocation standpoint and then I’ll hand it back to you, a couple of things to note. We have a leverage target range of 4.5 to 5.5x. That’s on a lease-adjusted basis. You go back 3 or 4 years ago, we were cresting about 6x against that metric and been outside the range for some time because we were growing our data center business somewhat through acquisition, among other reasons. But we said intentionally, that we were going to lower the leverage while continuing to grow the business. And as over the last few quarters, we’ve been at 5.1x which is really the lowest leverage level the company has had in years. And we aim to operate inside our leverage range of that 4.5x to 5.5x.
Together with that, we have an AFFO payout ratio target range of low to mid-60% [ph]. I go back to the same time frame about 3 or 4, 5 years ago, we were well above that payout ratio range. And we said as part of our leverage plan to get the leverage down as well as to invest in data center, you should expect us to kind of have the stack closer to the payout range before we raise the dividend again, because we wanted to get back into the range and how we’ve done that.
As you know, we recently entered that target range of low to mid-60% [ph]. We increased, we announced that the Board had authorized us to increase the dividend on our last call for the first time in several years. And now as you think about that range, because we aim to operate inside that range, generally speaking, you should be expecting the dividend to grow pretty much in line with the growth in AFFO. Otherwise, we fall out of the range. And that’s obviously not the aim that we have. We’re deploying more and more of our capital into Data Center development to build out our pipeline. And I think we have a really good balanced approach as it relates to maintaining leverage in this relative level and you’ll see the dividend rise over time.
Jonathan Atkin
So you said more and more data center development CapEx. So as we think about the next couple of years versus where you are on kind of a 2023 run rate, what does that mean in terms of?
Barry Hytinen
So if you look back over the last couple of years, we’ve been systematically rising our data center development, I think $100 million to $200 million a year. And in fact, on the last call, I raised our total CapEx for the company this year by about $200 million. So we’ll spend about $1.2 billion all in on CapEx in the year with the majority of that, the vast majority of that going into Data Center on the growth side. You should expect that to continue to rise at probably about $100 million to $200 million kind of level. We gave some view at our last Investor Day last year that over the next few years, we’d spend increasing levels of capital on data center.
And the reason that we’re doing that, frankly and this is a little bit of, I think, a little unique as it relates to our story, is we’re very pre-leased. And if you think about our data center portfolio, as I said earlier, if we didn’t buy any additional land and that’s not a reasonable assumption but just to kind of freeze us today, we would be operating after we build it all out, about 800 megawatts worth of power. That’s what our total land and power portfolio could support. Today, against that 800, we’re operating a little over 200 megawatts and we’re about 95% leased in our operating capacity. So we don’t have a lot to lease right now in terms of what’s operational and constructive.
But we’re also under construction currently on about 200 megawatts. So 200 operating, 200 under construction. The interesting thing about what we have under construction is we’re about 93%, 94% pre-leased on all of that. So we’re increasing our spend on development, John, simply because we need to stay ahead of the demand. Our pipeline has been growing very fast. Our pipeline is, for Data Center is larger than it’s ever been. It also has the more large deals than it’s ever had in the past. So both our Colo [ph] business is growing nicely and our hyperscale business is growing quite fast. And we will be allocating more capital just to construct.
So we’re not in a situation where we’re like building to spec. We know what returns we’ve written to and we’re going to continue to escalate the investment in data center because we’re seeing such good traction with our clients.
Jonathan Atkin
What has been cash generative in your core business imply in terms of how you underwrite your, some of your hyperscale contracts around yield and pricing?
Barry Hytinen
So ours is, I think that’s another part of that question alluded to another part of our unique story which is that in our core which is, as you said and as I said earlier, very cash generative. It is not particularly capital intense. It is growing largely off of revenue management activities. We’ve got very strong margins. So think in our core box business, the incremental margins are like 80%-plus [ph] or more. And while that’s not a particularly fast-growing volume business, we’ve been keeping the volume quite steady to slightly up and that’s our forward expectations for volume to continue to grow at slightly up on an annual basis.
And then have revenue management of at least, say, mid-single digit, something of that nature. We’ve been running a little bit ahead of that app. And while I don’t see much of any elasticity in that business, we don’t intend to significantly go beyond that level of revenue management each year principally because we have such a much larger now book of business that we can cross-sell our clients into. So we want to both have a very robust durable business on the core storage and sell those clients, enterprise IT asset disposition, information governance, digital solutions, the various offerings we’ve been investing in over years as well as data center that we’ve been investing in to get more share of wallet from our existing clients where we already have those trusted relationships.
What that affords us is the ability to take that cash that, that business is generating, where it’s a really strong margin business and then deploy it into data center and supplement our growth through that cash flow as well as through maintaining our leverage ratio of around this level and with growth continuing to escalate debt some year-to-year. So we are not, we have not been one to use equity financing to finance our growth and you shouldn’t. I never say never but you shouldn’t anticipate that at all. We have done some just a couple of site level joint ventures on the data center side where we’ve seen the opportunity to get a really nice return and not have to invest incremental capital to build out a specific building, for example, when we got a relatively long duration contract with a major hyperscaler that is clearly a market that’s very attractive to certain would be equity partners.
And so that on the margin is something that we’ve used to finance but principally, our growth is right out of the core, having that really strong cash generation that helps us fuel incremental data center development.
Jonathan Atkin
So you gave us, you probably answered the question but as we think about 9% revenue growth at the midpoint for your guidance, how much would that be Revenue Management? How much would that be Services which is maybe a little more of a headwind. How much of that is volume growth. But maybe the piece parts that underlie the revenue guide for this year?
Barry Hytinen
Sure. So the algorithm for this year in our core on the box side is really to have our total volume to be flattish to slightly up. So I think something like 0.5% to 1%. And then our revenue management, all in revenue has been growing in the core business on the storage side, like high single, low double. And so most of that is revenue management but and there’s a little bit of mix in there that interplays as well. On the Services side in our core, we’ve been growing quite appreciably and that’s due to both services that go along with our core offerings but also the digital solutions that I mentioned which is now a several hundred million dollar business and it’s growing pretty quickly. And I think from a, when you look at what clients need and the desire for more information and more analysis and the amount of competitive projects that we’re winning, we are likely to see that business continue to grow for a long period of time at above average rate.
And then when you click down into other segments, take Data Center, it’s growing over 20% on a revenue basis. New bookings are growing even faster. But as I described earlier, we need to construct the data center some, so we’re very pre-leased. And so that’s a business where I have very high visibility on the data center side for additional growth over the next few years because as you would see in our supplemental report, we show you what’s been pre-leased and when we anticipate the construction going into service and we had a healthy amount of megawatts coming into service over the course of the next several quarters and even into 2025.
And as I mentioned and I’ll just reiterate the pipeline is really strong on the Data Center side.
Jonathan Atkin
So 24 and 25 in your supplemental, it does mention a step-up in lease expirations for data centers? And what is your sense around renewal spreads and where is the market headed?
Barry Hytinen
Yes. So when you look at our lease expiration table because we’ve got a Colo [ph] business — you would see that, there’s, every year, we’ve got some book of business that renews. We’ve had very low churn, relatively speaking. In fact, it’s been trending down and our expectation is for it to be pretty low at, for this year based on looking at the book of business that’s there. On the hyperscale side, what you would see if you looked at my exploration table over the last few years and compared it is our lease expiration is becoming more weighted to many years out, because the hyperscale contracts tend to be more like in the vicinity of 10-year to 15-year type deployments. But on the Colo [ph] business; it’s 1-year to 3-year kind of renewals. Pricing trends are really good on data center at this point, at least in the markets that we operate in.
Obviously, I can’t speak to markets where we aren’t but in places like Phoenix and Northern Virginia, Frankfurt, London, some of those other key markets that we operate in, I’m seeing pricing to be very favorable. You would have seen in my mark-to-market, most recent quarter, mark-to-market was up 7%. Of course, that’s a lagging indicator and it’s been trending up for about 7 quarters now in a row. And when I look at, let’s say, triple net leasing and just compare that over the last, say, 12 to 18 months, like-for-like, you’re probably talking 20% to 40% increases, John. So it’s big increases. And so the pricing environment is strong. But I will say, as everyone would, that’s following data center would know, costs have also been up. Supply chain has been challenging over the last few years. So there is an element of supply and demand there.
Jonathan Atkin
EBITDA growth, 7% at the midpoint, as we think about what that implies for incremental margins, you talked about high proof of margins in some of your business segments. But, is it expansion drag around your data center development pipeline? Or what is it that’s adding to your cost base the most?
Barry Hytinen
Sure. So there’s a couple of things at work. First of all, we’re investing in the company to grow the business, that much faster. So we are, as we would have talked about before at some of the other conferences in our Investor Day, we have been reorienting the operating model of our company. So historically, this business was very general manager-oriented where, let’s say, in a given market, let’s take the U.K., for example. There would have been a General Manager of the U.K. That person would have been responsible for sales, customer support, services, everything back functions, what have you.
And in light of the much bigger opportunity we have in terms of products and solutions to offer to clients and after testing some iterations of this, we have very recently put in place a new operating model that includes, for the first time a commercial dedicated global commercial team which is essentially a Sales Force. That organization is being designed to be implemented in terms of for our largest accounts, I think 300, 400 accounts, on a vertical basis and we have been adjusting new talent into that area from major sellers of software and very large ticket price deployments, to bring in expertise of how to sell at a more solution level within those dedicated verticals, because we’ve got so much more product and solution to sell going forward.
And then the rest of our Commercial Organization is serving the other 200-plus thousand clients and that is more geographically represented. Similarly, we have created a global operations function and we’re building out a global shared services function. So there’s a level of investment we’re making in the business which is part of that. And then secondly, John, is in some of our growth areas, naturally, the margin is a little bit lower.
So there’s a little bit of mix shift in terms of the business. So in our core storage business which is growing nicely as we discussed but it is growing a little bit. It’s growing fast but not as fast as, let’s say, digital solutions or some of the enterprise IT asset disposition business. And so those are a little bit lower margin. But frankly, we take dollars to the bank and they’re not, those parts of our business are not in any way cannibalistic to our core. So we feel very good about the ability to serve our clients with a more robust offering. And generate very, very good returns.
Jonathan Atkin
So for ITAD, is the growth coming from new logos? Are you displacing other ITAD vendors as you grow? Or is it the fact that the opportunity is growing and you’re kind of taking advantage of new shots on goal as opposed to displacing your peers?
Barry Hytinen
Yes, it is definitely sum of all of those. And so when we think about our asset life cycle management, you’re asking about the enterprise side which is where does the distinct very substantial cross-sell opportunity into our existing client base. And so first and foremost, we kind of start with a lead because we know we have those trusted relationships with so many of them. And especially on the larger side of our client base, they really do have a compelling need for a partner that they can standardize with on IT asset disposition because as we would have all seen so many times in the news but major companies getting tagged with issues related to IT gear getting out there and having privacy concerns or things falling into the wrong hands or frankly being recycled in the wrong ways.
So that, so having a consistency of process and having those client relationships is one; we are definitely expanding new logos within that book of business, John but that’s more of a cross-sell because, you would appreciate in light of the size of the number of client relationships we have, it’s mostly like winning more share of wallet with clients as opposed to truly new clients in our total company. And then we are definitely seeing a rising tide because lifting us and others in the asset life cycle management space as this is a secular growing portion of the economy, there’s more IT here to be disposed off and recycled and reused and we benefit from that.
On the Hyperscale side, that is where we have very distinct relationships. The vast majority of the business is with large cloud hyperscalers where we are decommissioning their data centers for them. The nice, really nice part of that business is we’ve got strong long-standing relationships. In some cases, they’re multiyear contracts. In some cases, they’re exclusive or semi-exclusive relationships and there’s high visibility in that market from a standpoint of the gear that needs to be refreshed, because when you think about the cloud players that are operating very large data centers, generally speaking, on average, they will be renewing the gear in those data centers about every 5 years, some as quickly as 3, 4 years, some might be as long as 6 or 7. But average is about 5.
And so they’ll put up a data center. They might expect to be in that data center for decades but they’ll renew the gear about every 5 years. And they’re renewing for reasons of they want better efficiency on power draw, they want more, maybe they’re converting from CPU to GPU, what have you. But they’re not usually renewing because the gear has gone obsolete because there’s still inherent benefit and value in the gear at the 5-year time frame.
That’s where we come in. We provide a service of wiping gear that’s been written to making sure that’s very handled appropriately. And then we literally disassemble those servers or other gear and sell it in a revenue share model, whereby we get a percentage of the sell-through, we don’t take possession of the inventory. So I don’t have like inventory markdown risk in that business but we do have exposure to what is the selling price. And that has been a real challenge for the whole industry because as folks in this conference, particularly probably would know.
A lot of new and used technology gear has seen prices come way down last year and early this year, we’ve seen a floor in component pricing as of since February and there are a lot of industry prognosticators that say that pricing will start to rise later this year and certainly, there are some that are calling for really significant increases next year like 50% to 70% increases year-on-year.
We have not assumed in our guidance any change in pricing. We assume that would stay at this really low level just from a prudent standpoint and the reason that they are calling for those increases in prices, first and foremost, most people are expecting a level of demand to improve. And but secondly, a lot of the original OEMs suppliers of new gear production of [midyear] kind of started really reducing their production levels early this year as they saw the pricing come in so significantly. And the pricing for used gear that we our selling for our clients generally follows in a very tight correlation with the newer generation gear in terms of where is its pricing.
Jonathan Atkin
Audience questions?
Unidentified Analyst
So historically, regulation has or been, is it not a tailwind at least a big demand factor to their volumes. But to your perspective on any possible changes in either the regulatory landscape for your customer’s willingness to sort of no paper and go straight to digital [indiscernible]?
Jonathan Atkin
So the question was impact of regulation on paper volumes or perhaps digitization?
Barry Hytinen
Sure. So First of all, I think the, actually, the vast majority of our clients are not storing for specific regulatory reasons. They may have something that might be akin to that like litigation holds at a client or various elements. But the vast majority of what we’re storing is not specifically related to a regulatory. There are clients that — are patent work with us that would be in that sort of zone that you’re asking about. There are trademark elements. But the vast majority of it is because they need it for some potential future use, whether it be in litigation or as I described, trademark work or, we do a lot with pharmaceutical and healthcare providers, et cetera.
I don’t, we have not seen any significant change. And for those clients where regulatory is a reason, we haven’t seen that be a — anything on the horizon that we’re aware of that would change those impetus. And as it relates to the second part of your question on digitization, we certainly have seen over — and we’ve been seeing this for decades, the level of digital transformation evolve with our client base. And we’ve often talked about some verticals, the one that comes to mind right now for me is the Legal Vertical. If you go back 30, 40 years ago, most contracts were born on paper with a pen and a piece of paper that a partner would be writing out the original elements of a contract. And then that would be, were processed or put into a computer to then spit out contracts to be signed.
Today and what that results in is they would have been sending us boxes of contracts and various other paper years ago at a higher level than they send them to us today. And what that resulted in is if you think about the duration of boxes that stay with us on average, 1 box stays with us for about 5 years, you get a situation where if 30 years ago, they were sending us 1 level of volume.
And then fast forward 20 years later, they’re sending us less. It can be a situation where we are destroying more boxes than we’re in taking from that specific vertical. But once we get through that, if you will, second derivative effect, we start to grow again with a vertical. And in fact, that’s what we’ve seen and we talked about before with the legal vertical where it went through a digital transformation, we’re actually starting to see growth.
Fundamentally and if I broaden this out, we have a very solid and favorable view for our volume. We expect our volume in total to be slightly up and that’s our algorithm. If you look at the performance of the company over the last several years, we’ve been achieving that level even during COVID. The trends on volume have improved over the years as we become more commercially focused on winning new volume. And we win new volume a few different ways.
One, by getting a bigger share of wallet from our existing clients. Helping them with across the world and winning competitively within those client bases. We do still have some markets where we’re particularly competitive and winning. We also have some pretty large markets emerging where the market has not yet outsourced to the level of other markets. Like in the U.S., it’s a fairly robust outsourced record management volume. In India which is a market that is big and very fast growing for us.
There’s a lot of volume that’s still held by the clients or by the government. And so in generally, every market we operate in, we’re continuing to see opportunities to aggregate new volume to offset the level of digitization that may be affecting. But I would say our model is more borne off of continuing to monetize the existing inventory, drive revenue management and then drive more compelling offerings that we can cross-sell into clients.
Jonathan Atkin
We’re in stoppage time. So maybe just a quick question. High pre-commit, percentage for Hyperscale on the Data Center side. How much of that would be directly attributable to AI? Versus conventional Cloud or SaaS or Social Networking or what not? Anyway to get an estimate at?
Barry Hytinen
I’m certainly getting that question a lot lately. I would say if we look at the 200-or-so megawatts that I mentioned that were already 95% or so pre-leased on that were under construction, relatively very small amount of that, John, is AI-driven because most of that volume we signed over let’s say, the last 6 to 12 months as we are constructing it to build it out. We do see in our pipeline, as we said on the last call, of some incremental AI but I will just note that the vast majority of the growth in the pipeline that we’ve been talking about is from us becoming a much more dedicated vendor and key partner to major hyperscalers, whereas you go back 2, 3, 4 years ago, we weren’t nearly on the scene, so to speak.
We were still doing relatively small deployments with those key hyperscalers. And we delivered on our commitments. We’ve given them, I think, a very quality product and on time, on budget. And that has yielded us the benefit of working in a deeper way with them. And I expect that that’s going to be the primary driver of our growth in data center for the next few years.
Jonathan Atkin
We are out of time. Appreciate your comments.
Barry Hytinen
Yes. Thanks, John. Appreciate you having us.
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