American Tower Corp. (NYSE:AMT) announced another acquisition, this time expanding its tower empire in Brazil. The deal is small, yet underscores the company's ambitions to grow the business at a rapid pace across the globe.
That being said, the valuation has become too excessive for me, driven by lower rates and historic growth. The high valuation and leverage makes shares too risky, in my opinion.
American Tower announced that it has entered into an agreement with GPCP V to acquire 100% of the equity interest of BR Towers S.A.
American Tower will pay 2.18 billion Brazilian Reals, which comes down to $978 million, to acquire the Brazilian telecommunications real estate business. GPCP owns 2,530 towers, and has the exclusive rights for another 2,110 towers in the country.
The deal is expected to close in the fourth quarter of this year.
Financing of the deal will be arranged through a combination of equity and debt.
The activities are anticipated to generate $131 million in annual run rate revenues and roughly $81 million in gross margins. This values activities at 7.5 times annual revenues and nearly 14 times gross margins. The deal is expected to be immediately accretive to adjusted funds from operations.
At the end of the first quarter, American Tower reported a 5.5 times net leverage ratio, which was higher than its targeted 3-5 times target ratio. The company is expected to return to this target range later this year, which seems unlikely given the latest deal.
A Growth Story
American Tower has been growing rapidly in recent times, posting a 22.6% increase in first-quarter revenues to $984 million. Adjusted EBITDA was up by 22.1% to $640 million, as net earnings improved to $202 million.
For the year 2014, American Tower now anticipates revenues of $3.93 billion. Adjusted EBITDA is seen at $2.58 billion, with adjusted funds from operations pegged at $1.74 billion. Note that this update does not incorporate the impact of the latest deal.
Long-Term Growth Dynamics
American Tower owns, operates and develops wireless and broadcast towers and real estate. In total, it operates some 68,000 sites across the globe. The company has long-term lease contracts, which typically cannot be cancelled.
Total churn rates are very low, at 1-2% per annum, driven by 5-10 year contract durations with five-year renewal periods in a typical fashion. The company has a protection for inflation, having built in escalators in its contracts.
Maintenance capital expenditures are just $75 million in total per annum in 2012, while expansion capital investments are typically low as well. The large upfront investments and greater operational cash flows in the years following are very important to consider. This is the reason why traditional earnings valuation falls severely short when considering the prospects for the firm.
The Importance Of Accounting
American Tower's business model is rather simple. It costs the company an average of $225,000 to build a US tower. If it finds a carrier to use the tower, it generates perhaps $20,000 in revenues, while incurring $12,000 in operating costs.
As such, the company incurs huge upfront investments, while posting relatively low net earnings following, as it reports relatively high operating cash flows. If American Tower finds a second tenant for that tower, revenues double to $40,000, while operating costs increase toward just $13,000.
The great operating leverage in the case of multiple customers drives the appeal of the business model, and is the reason why carriers tend to divest those assets themselves.
Valuing American Tower
American Tower held roughly $368 million in cash, equivalents and short-term investments at the end of the first quarter. Total debt stands at $14.3 billion, resulting in a very sizable $14 billion debt position.
With shares trading at $88 per share, equity is valued at $35 billion. This values the company at roughly 42 times earnings, based on an outlook for earnings of $820 to $850 million.
Note that operational cash flows are much higher. Depreciation and amortization charges are seen around $975 million, which is far above maintenance capital investments seen around roughly $200 million. Adjusting for this, shares trade at a roughly 22-23 times earnings.
Note that operational cash flows are actually seen lower, as American Tower expects to spend $850 million to $950 million in order to boost its operations going forward. The vast majority of these investments are aimed at growing the business, rather than maintaining current operations.
The company's quarterly dividend of $0.34 per share provides investors with a 1.5% dividend yield.
Long-Term Success Story
Shares of the company fell to lows of just $1 in 2002 in the aftermath of the dot.com-bubble. Ever since, shares have seen a gradual recovery, increasing to highs of $45 in 2008, before the recession pulled shares back toward $20 per share.
From that moment on, the recovery has been pretty much a straight line upwards to current levels approaching $90 per share. This has been fueled by the strong growth, as well as the fact that the company acts as a bond substitute, being very sensitive to lower interest rates.
The near-monopoly status which the company is achieving in some areas and the conversion to a REIT have attracted investors as well. That being said, the valuation is a bit steep given the very low interest rates currently, the debt load and the huge run-up in its shares in recent years.
The latest deal is just another modest addition to American Tower's growing empire, yet I remain cautious on valuation concerns.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.