S&P Lowers Iron Mountain (IRM) to 'B+'; Cites Recent Leverage Increase

Standard & Poor's Ratings Services lowered its corporate credit rating on Boston-based storage and information management solutions company Iron Mountain Inc. to 'B+' from 'BB-'. The outlook is stable.

At the same time, we lowered all issue-level ratings by one notch. The recovery ratings remain unchanged.

The downgrade reflects the increase in Iron Mountain's leverage to the mid-5x area, which is above our 5x threshold for the company at the 'BB-' rating, our expectation of several years of negative discretionary cash flow (cash flow from operations minus capital expenditures and dividends) unless the company scales back capital expenditures, and the low likelihood, in our view, that a rapid deleveraging will occur. Leverage has drifted higher as a result of increased shareholder payouts, acquisitions, and costs associated with the REIT conversion. Now that the company has received the positive ruling on its REIT status, we expect the company will use equity financing, which could bring leverage down over the long term, assuming continuous equity market support. However, we do not expect that the equity issuance will be sufficient in the next 12 months to deleverage swiftly below 5x. In addition, the distributions to shareholders required of a REIT, in combination with high capital expenditures and ongoing acquisitions, will likely result in negative discretionary cash flow before the company issues equity or debt. The prospects for ongoing high leverage and reduced financial flexibility are significant rating considerations.

We view Iron Mountain's business risk profile as "fair." The company is a global market leader in the records management business, which benefits from low customer attrition, high switching costs, and long-term storage contracts that provide stable and recurring revenue. The company maintains an EBITDA margin in the mid-30% area in its North American business, and has achieved significant EBITDA margin improvement in its international business as the segment has matured, and as storage capacity utilization has gradually increased.

At the same time, the company's business is exposed to the threat of digital storage, as well as to disasters such as fires. Over the last eight quarters from 2012 through 2013, the company's net organic volume growth in its North American records management business declined (on average) about 0.3%. The company has been able to mitigate organic volume declines via acquisitions, but we believe the increasing adoption of digital storage alternatives could lower volumes going forward. Aside from the company's storage business, its consolidated services segment, which includes secure shredding, retrieval access, and other outsourcing services, accounted for 41% of total revenue and declined 2.4% in 2013 (after declining 4.5% in 2012), because of reduced retrieval/re-file activity and lower shredding revenues.

We view Iron Mountain's financial risk profile as "aggressive," given its high leverage, relative capital intensity, and increasingly shareholder-favoring policies. We expect the company to increase its use of equity financing and to use proceeds for deleveraging transactions. However, an unfavorable shift in equity market views of REITs could hamper progress. We do not expect leverage to decline based on debt repayment from cash flow.

Our initial rating outcome ("anchor") is 'bb-', and the risks surrounding high shareholder distributions, negative discretionary cash flow, and persistent high leverage, support our use of a negative financial policy modifier, which has a one-notch negative effect on the rating.

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