Four Reasons Why SBA Communications Is Ripe for a Price Correction

Unbelievably, there are still real estate businesses yielding 5% cap rates, and investors gullible enough to accept this.

SBA Communications (SBAC) owns and leases cell tower sites to cellular operators with multi-year long term (often 10 or more) triple net leases. Its business is effectively industrial real estate with predictable cash-flows. SBAC and its competitors allow cellular operators to keep these assets and its financing off balance sheets, and in some cases share the cost among different carriers. The separation of the real estate and the cellular service operation business should, in theory, allow catering the businesses to different types of investors and therefore reduce overall cost of capital.

Like everything else in capital markets in recent years, (structured finance comes to mind), this essentially sound concept has been stretched beyond the limits of imagination. SBAC stock is ripe for a major price correction of 60-70% (form $19 to $5-7 range) for the following four reasons:

• The company today is trading at 10 times revenue and 19 times EBITDA (or in real estate parlance a cap rate of 5%). At these multiples, its current price incorporates substantial growth expectations. The Cellular business is a mature business with not much further prospects of rapid penetration growth; carriers are starting to feel the pinch from users more careful about their bills and therefore are likely to postpone or scrap network expansion plans including 3G roll-out. Most cellular carriers are trading at 4X EBITDA and although one can make the case for cell-tower companies to trade at a premium, given the higher predictability of cash-flows, a difference in such an order of magnitude is very hard to justify. Likewise it is hard to justify such a lofty valuation when SBAC’s bonds maturing in 2010 are trading under 80 cents on the dollar (and commanding a spread of 11 points to treasuries). Even its larger and less levered competitor American Tower (AMT) is trading a more modest (but still eye popping) 16 times EBITDA.

• The Company has benefitted from extremely low financing costs using the CMBS market, but that party is over and CMBS issuances have completely dried out. American Tower has recently refinanced its debt at twice its previous costs. As SBAC raises more debt and refinances the existing one, starting in 2010 its financial costs will increase and its profitability will deteriorate further. If SBAC was paying current market yields on its debt, its financing cost would likely be multiplied by two to three times (this is what recently happened to the recent refinancing of American Tower) adding another $80 to 160 million in costs. This is a very significant increase as the company’s TTM EBITDA is about $240 million. The average cost of its debt currently is under 4%, while the yield on its 2010 bonds is over 13%.

• The Company is very leveraged with debt to equity of almost 9 to 1. It has substantial debts maturing in 2010. In all certainty, the company will have to raise additional equity before or shortly after refinancing this debt, to bring its debt to equity in more conservative ranges, this dilutive equity overhang is not good news for existing shareholders.

• In its ten years of existence, the company has never produced a profit - how long are investors going to put up with this? In the current environment, investors are growing more skeptical about (i) unprofitable, (ii) non-dividend paying, (iii) negative net tangible assets, (iv) highly leveraged, (v) real estate businesses. So at the first hint of trouble, expect a stampede.

DISCLOSURE: Short SBAC

Comments

[Sreeni Meka:]

Charlie,
Appreciate your comments. If cash flow simply depends on depreciation rather than income, ( in my opinion ) it is a sure sign of trouble. It takes long time to realize the emperor is naked until some one from big investment firm down grades the equity.

Feb 18 04:15 PM

[Charlie Bottle:]

Absolutelly, althoug I think the stock will fall on its own weight big investment firm analysts are completelly beholden to these guys and will not bite the hand that feeds them.

How low do you think AMT will go?

Feb 18 09:01 PM