Seeking Alpha
Long/short equity, value, hedge fund analyst, REITs
Profile| Send Message|
( followers)  

Those of us from the REIT world best know American tower (NYSE:AMT) for its recent conversion to a REIT. The big news was announced in May of 2011, and finalized by the end of the year. This new structure provides it with incredible tax benefits not shared by its competitors. Investors were very intrigued by the introduction of wireless and broadcast towers to the REIT space, and its share price rose over 26% since the start of the year. Was such a gain justified? We will examine its operations, outlook and competition to find out.

Operations

American Tower can be thought of as a triple-net lease REIT as the tenant takes care of virtually everything. Equipment, shelters, cables, antennae and almost everything else are both provided and maintained by the tenant, leaving only the tower itself and the land under AMT's care. Galvanized steel and a very small plot of land are cheap to maintain, leaving American tower with incredible profit margins.

(click to enlarge) (click to enlarge)

Much of American Tower's income stream is locked in through long leasing contracts and even longer rental of the land upon which the towers are built.

This highly profitable business comes at the cost of major capital investment. Construction of a single tower costs in the ballpark of $225,000, so AMT's international portfolio of nearly 50,000 towers required high leverage to put together. As of September 30, 2012, AMT has a debt to equity ratio around 2.51. Such borrowing partially offsets the otherwise phenomenal earnings. According to their 3Q12:

"Interest expense for the nine months ended September 30, 2012 increased 31% to $297.6 million. The increase was primarily attributable to an increase in our average debt outstanding of approximately $1.7 billion, primarily used to fund our recent acquisitions, and an increase in our annualized weighted average cost of borrowing from 5.34% to 5.45%."

Overall, their 3rd quarter earnings were strong. AFFO increased 10.2% from 3Q11 to $284.1mm and AFFO per share increased 9.2% to $0.71.

Outlook

American Tower Corporation is quite optimistic about the outlook of both the tower industry and its position within. In a presentation it suggests the following as demand drivers:

• Wireless subscribers continue to upgrade their traditional handsets to smartphones while also acquiring incremental connected devices such as tablets and wireless data cards.

• Wireless service providers continue to invest in their third generation (3G) networks by adding new cell sites as well as additional equipment to their existing cell sites.

• Wireless service providers continue to pursue new avenues for growth, such as deploying fourth generation (4G) technology based wireless networks to provide higher speed data services and enable fixed broadband substitution.

Most of this is factually verifiable so it is clear that demand for data services is strong and increasing, but I am less certain that it will translate to business for AMT. We must be aware that technological improvement could allow wireless providers to transmit more data without needing to purchase extra space on a tower. Wireless technology is still in its infancy and as demand for it grows incentives to innovate its transmittance increase. If such technology were to come into use it would increase the output capacity of a given amount of tower space and effectively kill the need for more tower space. I have no expertise in technology, so I cannot even begin to assess the probability of such an occurrence, but investors of AMT should be aware of the possibility of technology inhibiting demand for tower space or in the extreme case, making towers obsolete.

Aside from my lengthy warning, I believe the tower industry has excellent growth prospects. Acquisitions remain quite lucrative and plentiful both domestically and globally.

Competitors:

With a market cap of $19.4B and over 23,000 towers, Crown Castle International (NYSE:CCI) is arguably AMT's primary competitor. On an earnings and value basis, it has a slight edge on American Tower.

Company

3Q AFFO

3Q AFFO/share

Recent Market Price $

Price/AFFO extrapolated*

American Tower

$284.1mm

$0.71

$74.35

26.2

Crown Castle

$230mm

$0.79

$66.66

21.1

*Both companies have rent escalators and acquisition growth, so extrapolated AFFO may significantly underestimate their true value.

CCI is also a competitor of AMT in the true economic sense of the word. It will obtain huge market share upon completion of the deal with T-Mobile detailed below in an excerpt from their press release.

T-MOBILE USA TOWER TRANSACTION

Crown Castle will acquire rights to approximately 7,200 T-Mobile towers for $2.4 billion in cash at closing (subject to certain adjustments). Under the definitive agreements, Crown Castle will have the exclusive right to lease and operate the T-Mobile towers for a weighted average term of approximately 28 years. In addition, Crown Castle will have the option to purchase such towers at the end of the respective lease terms for aggregate option payments of approximately $2.4 billion, which payments, if exercised, would be primarily between 2025 and 2048. The transaction is expected to close in fourth quarter 2012.

American Tower answers back with acquisitions of its own - a deal to get approximately 2,000 tower sites in Germany from E E-Plus, for approximately $500 million. This deal is to close during the fourth quarter of 2012, subject to customary closing conditions.

Additional competitors of AMT are the tenants themselves. Many of these phone companies build towers of their own. While zoning and permitting can create a delay, there is a rather small barrier to entry, so the ability of phone companies to produce their own towers puts a functional limit on the amount AMT can charge. Rates necessarily stay in a sweet-spot in which the phone companies are better off using their money through other avenues, and American Tower remains profitable. Oddly enough, a decrease in the cost of producing a tower, whether it be through cheaper materials or eased up zoning, would be detrimental to AMT's profits.

American Tower as an investment

As a participant in one of the world's most rapidly growing business sectors, AMT is very well positioned to succeed. Through leverage and intelligent business practices, it gleans an absurd magnitude of profit out of its $3.68B of equity. These profits remain respectable even when measured as a cap-rate on their nearly $13B of assets. However, the cost of AMT's profits to us as investors, at its market cap of over $29B makes it far weaker. American Tower is a phenomenal company in a burgeoning industry, but it is just too expensive. In my opinion, wait for a price dip under $63 for an entrance point.

Disclosure: This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.

Source: Will American Tower's REIT Conversion Propel It To Wireless Dominance?