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This is the fifth in an ongoing series about American Tower Corporation (AMT).

These are the hard questions investors should be asking before buying American Tower:

  1. Is Adjusted Funds From Operation a relevant metric for valuing AMT?

I think it is a very inaccurate measure to use. The reason is that a very large portion of AMT's expenses are non-cash. Specifically Stock Based Compensation Expense (approximately $50 million), Depreciation and Amortization ($550 million), and foreign currency translations ($150 million and still counting). See my earlier notes here and here for details.

It is far too convenient to add these expenses back to net income and come up with a Funds From Operation (FFO) number or an even more egregious Adjusted Funds From Operation metric (AFFO), a.k.a. Astonishingly Far From Objective.

Measuring a company that owns less than 20% of the land under its towers using a metric which was designed to measure the cash flow from land and real asset ownership is simply misguided. AMT's tower assets do depreciate; it is a real expense and should not be added back to net income for analysis.

Source: Consensus Estimate and Analytic Firepower research.

Using this metric is very convenient however if you are unable to earn enough money as GAAP measures it to support such a lofty P/E multiple.

Source: Consensus estimates, and Analytic Firepower

So as long as we are making up new ways to measure AMT, let's ponder the valuation pickup associated with all the adjustments that go in to AFFO. If we can add back $817 million worth of expense in 2011, and someone will pay 21x this new made up number - why not - heck, that makes $45/share of "value" that we just invented. Not bad as long as you can fool some of the people.

2. Does it walk like a duck and quack like a duck?

As the old adage goes, if it quacks like a duck, it's a duck-no matter what you call it. Calling itself a REIT does not mean that we can miraculously ignore over $700 million in expenses every year, no matter what they tell you. The point is that any investor needs to assess the economic substance of the enterprise they are investing in. It is critical to interpret financial statements correctly to accurately measure the economic reality. In the case of AMT, they have spent $7 billion worth of borrowed money to buy assets all over the world. In return for that $7 billion, they have received approximately 40,000 towers and $4.8 billion worth of intangible assets. (customer relationships, network locations and goodwill).

Therefore, one has to ask the relevant question of what those intangibles are worth. If they are worth less than what the company says they are, either by amortization or impairment, then that must be factored into any analysis or measurement of value. Pretending those expenses are not there is misguided, as is any measurement such as FFO or AFFO in relation to AMT. The directly comparable companies are non REITs like Crown Castle (CCI) and SBA Communications (SBAC).

3. Do you really believe that the government investigation is just going to go away?

I believe that the dismissive way that the company and Wall St. are interpreting the ongoing SEC investigation into AMT will eventually prove to be wrong. While the government agencies involved in this investigation move at a glacial pace, they are moving.

A formal SEC investigation is not something to be taken lightly. I feel that AMT is disingenuous when it says that it is "cooperating fully with the investigation." This is because obviously the SEC would not have gone to the trouble of getting the subpoena if AMT were cooperating with them when the investigation was still informal.

4. Is it just a coincidence that during the period covered by the investigation, and all within the first half of 2008:

  • The CFO quits abruptly.
  • AMT starts actively building assets in India.
  • AMT mysteriously drops a lawsuit against an Indian company.
  • AMT decides to extend the useful life of their tower assets from 15 to 20 years, resulting in over $30 million per quarter of "extra" earnings.

5. Is it possible to operate 8,000 towers all over India without violating the Foreign Corrupt Practices Act (FCPA)?

In my opinion, operating in India and other emerging countries is quite straightforward if you have the ability to conform to local business customs. AMT does not have the ability to conform to many of the commercial procedures in these countries. As Ed DiSanto the general counsel outlines in his presentation a month after he CFO quit, in Foreign Jurisdictions: FCPA = Familiar Commercial Procedures Allowed

Under the control of Brad Singer, the former CFO, AMT displayed a cautious tone when it came to investing in India. This jittery approach to India was evident in Jim Taiclet's explanation of AMT's strategy in India in early 2008:

After an in-depth assessment of the Indian market for example, we've chosen for the time being to establish our presence by build-to-suit agreements with key customers and are pleased to announce the first of these today. This approach enabled us to enter the market on a construction cost basis versus the currently higher entry cost routes of large acquisition or joint venture alternatives available today in that country.

AMT Q1 2008 conference call May 2nd, 2008

The jitters were gone almost as quickly as the CFO Brad Singer left the building, just 10 months later on March 17, 2009, AMT announced the first of several large Indian acquisitions (via Mauritius). By February of 2010 they had made 3 substantial purchases, including Xcel, Transcend and Essar.

6. Is it possible to compete fairly in India with dominant local players in the market?

AMT has discovered the hard way that India is not Boston. Government policies towards foreign investment are vastly different and attitudes towards monopolies and antitrust are different. India's tower market is very saturated, with 337,000 towers already up as of 3/31/2010. Many of these towers were built as speculative investments without having a single tenant. There are large numbers of empty towers in India still today.

This saturation was worthy of mention in GTL Infrastructure's annual report:

Source: GTL Infrastructure annual report

Indian tower market is dominated by and extremely well connected and capitalized business called Indus Towers that has over 110,000 towers throughout India. In second place is Reliance Capital with a cool 54,000 towers, third is GTL infrastructure with over 30,000 towers. That makes over 180,000 towers in India which are owned by powerful local groups who can make deals with carriers that AMT simply cannot legally accomplish. From the performance of GTL's shares it is clear that even those who can operate freely in the local tradition are having a difficult time adding any value.

An Excerpt from GTL Infrastructure's recent annual report:

From the performance of GTL's shares it is clear that even those who can operate freely in the local tradition are having a difficult time adding any value.

GTL Infrastructure: Share Price Performance over past 12 Months:
GTL Infrastructure

Source: Bombay Stock Exchange

In India the towers that come up for sale tend to be the non-critical/redundant/low tenancy ones. There was an enormous speculative boom in "Indian Infrastructure" investment over the past few years, which resulted in a pretty spectacular overbuild. In India, an area about 1/3 the size of the US already has 350,000 towers, this compares with 300-400K (depending whom you ask) here in the USA. Many were built on spec, and many are still empty. I suspect the towers AMT has paid so dearly for in India might have a high proportion of lemons. To know for sure I may travel over there soon to check them out. I am contemplating forming a "Send Analytic Firepower to India" fund to pay the cost of driving around India for a week taking pictures of AMT's towers there. Let me know if you want to contribute to this assignment, I'll send real-time updates.

India is a difficult place to operate, especially when your competition is either the government or your customer. AMT has pinned much of their future growth on India, and it does not look good. They are the smallest fish in the pond, and the dominant player has 11x the number of towers that AMT does. There are 7 big local players who are much larger than them, (and the competition does not need to comply with the US Foreign Corrupt Practices Act).

In India, there are not less than 12 cellular network operators. Clearly this will thin out over time with a corresponding rationalization of each consolidators network. It is difficult to see how these acquisitions could work out given the current overbuilt state.

I'm quite confident that AMT did not underpay for any tower in India; also, the underlying lease terms are labyrinthine, providing any of the local parties easy-outs, as well as the Indian government's ability to nationalize any communication asset if they need it, (Indian Telegraph Act of 1885) etc.

I'm ready to go to India and get some answers - how about it?

Source: American Tower: The Hard Questions Management Doesn't Want To Talk About Part V

Additional disclosure: I have negative delta options positions in AMT.