The last few weeks have been a busy time for American Tower (AMT):
2/2/12 - The Supreme Court of India cancels all 122 licenses granted since 2008.
2/14/12 - Indian Regulator proposes 74% foreign ownership cap for tower companies.
2/16/12 - American Tower is sued in Texas court by its largest landlord.
2/23/12 - American Tower describes 2012 as back-end-loaded
2/27/12 - Industry tradeshow features non-tower based cellular "underlay" products.
American Tower reported Q4 and full-year 2011 results and filed its annual 10-K this week, as well as providing management's outlook for 2012. Separately, the Mobile World Congress took place this week, with companies showcasing the latest products and innovations. Many of these will impact the value of the traditional cell tower quite substantially. Below are my thoughts and questions after these events.
If the International Growth Story is so great, why is AMT's International Rental and Management revenue declining?
AMT increased its international site count by 29% in Q4, yet it earned less revenue than before acquiring the towers.
What happens when AMT's ground leases expire?... Aggregation.
AMT leases 87% of the land under its towers. When it buys a tower, it generally is referring to the steel structure itself. In the U.S., AMT faces an increasingly difficult situation as these leases come up for renewal. The landowner is under no obligation to AMT beyond the expiry of their lease, an enterprising group of people realized this and has already succeeded in securing control of a large portion of the land under AMT's towers. When a lease expires, a landowner can lease the land to whomever they want. AMT can either walk away from the tower, or pay to have it removed. This is happening right now.
According to a recent court filing in Texas, Tristar Investors has already secured the property interests under 600 of AMT's best towers. So when Tristar takes over the tower, how much is AMT's "Acquired Network Location" intangible or "Customer Relationship" asset worth? Zero, or even less than that if it pays to dismantle the tower. This is a real problem and AMT's management team knows it, but they choose not to talk about it.
"While the landowners and carriers have benefited enormously from TriStar's entry into the market, American Tower has not. Because of the premium financial offers TriStar has made to landowners, revenue is being redirected from the tower company to landowners. American Tower is not at all happy that TriStar is increasing its costs of doing business and shifting dollars from its bottom line to the landowners' bottom lines."
-Tristar Investors v. American Tower, Civil Action 3:12-CV-499 2/16/12
If you read the complaint against AMT, you will see that the alleged behavior is the type of thing that a company does when its very survival is at stake. If in fact it takes the negotiating approach that Tristar alleges, it would indicate to me that the perpetrators recognize the very material threat to their business which the aggregators represent.
The idea that an emerging finish-line to AMT's control of many of its towers raises questions about the relevance of the often touted DCF-based valuation approach, which is so broadly applied to AMT. When AMT is unable to renew the ground leases under many of its towers, that means there is a termination date to the cash flow received from the tower. That makes future cash flows very uncertain.
AMT's balance sheet could be severely impacted by the impairment of its intangibles, as I have discussed in an earlier article. In my opinion it is likely that we will see some substantial impairment charges this quarter for the following reasons:
- Cancellation of major customers' spectrum licenses in India.
- Continued leasehold aggregation activity in the U.S.
- AMT's tenants decreased reliance on particular macrotower locations.
The information is not in what they say, but what they don't say
What I found most interesting about this announcement and conference call is in what management chose not to say. In previous releases, India featured prominently as a primary focus of AMT's international acquisition growth story. Now that India has some bad connotations in the cell industry-- as the former minister of communication sits in jail, the licenses he issued were revoked, and the government is contemplating limiting ownership of cell tower by foreigners-- the whole question of India was broadly swept under the carpet in the conference call.
"Regarding India, earlier this morning, I just spoke to our India leader for an update. And essentially, with the ownership task, that decision has been put on hold, as it's called in India. Which means that higher level government officials have deferred any discussion of this particular topic for sometime in the future. And as a result, I think this is unlikely to ultimately pass and won't be any kind of a near-term issue for American Tower."
-James Taiclet CEO, Q4 Earnings Call
I find this explanation vastly lacking of any specific information and is misleading. My sources in India do not agree with Mr. Taiclet's characterization. The 10-K which AMT filed had a different tone altogether.
"our foreign operations may be affected if a country's regulatory authority restricts or revokes spectrum licenses of certain wireless service providers." This has now happened, see my earlier note.
"Telecom Regulatory Authority of India has recently recommended to the Department of Telecommunications changes in annual licensing fees for tower companies based on revenues generated, as well as the potential implementation of restrictions or limitations on foreign ownership." This has not been put on hold as Mr. Taiclet says.
Situation in India is Dire
Last year AMT listed Idea Cellular as its largest tenant in India. Idea Cellular lost 13 licenses when it was caught up in the corruption scandal involving the former Telecommunications minister. This year, AMT has chosen its words carefully. In the current 10K, AMT has lumped India together with Ghana and South Africa. When measuring top clients, notice how Idea Cellular has disappeared and the more palatable Vodafone (NASDAQ:VOD) jumps to the top of the list.
"Our top domestic and international tenants by revenue are as follows:
• Domestic: AT&T Mobility, Sprint Nextel, Verizon Wireless and T−Mobile USA accounted for approximately 74% of domestic rental and management segment revenue for the year ended December 31, 2011.
• International: Iusacell (Mexico), Nextel International (through its operating subsidiaries in Brazil, Chile and Mexico), Telefónica (through its operating subsidiaries in Brazil, Chile, Colombia, Mexico and Peru), MTN Group Limited (in Ghana and South Africa) and Vodafone (in India, Ghana and South Africa) accounted for approximately 53% of international rental and management segment revenue for the year ended December 31, 2011." -AMT 2011 10-K
CEO James Taiclet also chose his words very carefully in the Q4 earnings call with this masterful simile :
"In India, where approximately 90% of our revenue is generated from the large incumbent providers, such as Vodafone, IDEA and Bharti…" -AMT Q4 Earnings Call
He would like you to think that Vodafone is a large customer in India, but in fact it is not. Idea is a large customer and much coverage will go dark in June.
In my opinion, AMT simply did not do its homework before investing nearly a billion dollars into Indian towers. There is enormous consolidation, and huge speculative overbuild of towers. The best towers are owned by Indus Towers, which happens to be the world's largest tower company, with 109,000 towers. It is owned by Bharti Airtel,(42%) Vodafone (42%) and Idea Cellular (16%). Furthermore, Indus has shareholder agreements in place which effectively locks AMT from playing in any meaningful way.
"Shareholder agreements between Indus's promoters and Indus provide for exclusive tenancy arrangements with Indus for all the 16 circles in which it offers its services. This provides ready captive tenancy for Indus's sites, enabling Indus to achieve a tenancy ratio of 1.85 times and tenancy mark of 200,000 tenancies at the end of 2010-11."
I intend to travel to India to uncover the reality AMT's situation there. Details of my trip are available on www.analyticfirepower.com. There are many things I expect to learn on the trip. I will assess tenancy by visiting a sampling of towers and objectively look at how much equipment is present. I will meet with local regulators and municipal authorities to assess the various forms of local taxation and other cost. I will attempt to understand if it is possible to operate a single tower in India without falling afoul of the Foreign Corrupt Practices Act.
Operating towers in India presents many challenges, which are presented in this excerpt from the India Times:
"Experts say local authorities impose a host of taxes on the premises and equipment, further hurting cash flow. "We pay between 40,000 and 70,000 per tower over the value-added tax on every tower to the municipality, local and state governments," said a senior executive at one of the largest tower companies on condition of anonymity. "There are some horror stories, particularly in the North," said Deloitte's Joshi, adding that people renting sites for telecom towers factor gains from diesel theft as revenue.
The industry loses around 46 crore a year in pilferage from the machine rooms of towers, according to an industry survey by Godrej Locks.
Officials monitoring towers estimate around 15-20% of total diesel consumption is pilfered. Energy costs for towers in the North range between 30,000 and 50,000 a month instead of the budgeted 15,000 because of theft, the executive quoted earlier said."
AMT is now painfully aware of these challenges and has taken the time to lay them out in the company's most recent 10-K:
"Our international business operations may be subject to increased licensing fees or ownership restrictions. For example, the Telecom Regulatory Authority of India has recently recommended to the Department of Telecommunications changes in annual licensing fees for tower companies based on revenues generated, as well as the potential implementation of restrictions or limitations on foreign ownership. Certain municipalities in Brazil and India have sought to impose certain permit fees based upon structural or operational requirements of towers. In addition, our foreign operations may be affected if a country's regulatory authority restricts or revokes spectrum licenses of certain wireless service providers....
..expropriation or governmental regulation restricting foreign ownership;
• restricting or revoking spectrum licenses;
• possible failure to comply with anti−bribery laws such as the Foreign Corrupt Practices Act and similar local anti−bribery laws; and
• uncertainties regarding legal or judicial systems, including inconsistencies between and within laws, regulations and decrees, and judicial application thereof, which may be enforced retroactively, and delays in the judicial process.
-AMT 2011 10-K
Q4 Results and 2012 Outlook - Not Conservative
There has been lots of rationalization by Wall St. analysts that the reason AMT's guidance was below their expectations was because AMT was being "conservative." A reason for this rationalization is because AMT excluded the impact of acquisitions which have not yet closed. As the CFO explained:
"we've excluded from our current outlook the impact of our pending acquisitions of about 2,300 sites for an aggregate purchase price of just under $350 million. We expect these acquisitions to close during the first half of 2012. The pro forma run rate impact from these sites would be approximately $75 million of rental and management revenue on a full year basis, which includes approximately $40 million of pass-through revenue, and $25 million of gross margin."
A less complimentary way of saying the same thing is:
AMT has signed up to pay $152k each for 2,300 Towers, 1,000 of which are in Uganda, a new market where it will need to replicate SG&A to effectively operate, the rest are in Columbia and Mexico. After borrowing money to pay for them, we hope to receive almost $11,000 of gross margin per tower during the first year we own them. That works out to a return of 7.15% which is below our cost of capital.
Gross Margin is a funny thing (a Non-GAAP measure), according to the fine print in the earnings release, AMT seems to have a hard time figuring out too.
"The Company defines Gross Margin as revenues less operating expenses, excluding stock-based compensation expense…. For reporting purposes, the international rental and management segment Operating Profit and Gross Margin also include interest income, TV Azteca, net. These measures of Gross Margin and Operating Profit are also before interest income, interest expense, loss on retirement of long-term obligations, other income (expense), net income attributable to non-controlling interest, income (loss) on equity method investments, income taxes and discontinued operations."
Huh? It seems that the $25 million of Gross Margin that CFO Tom Bartlett was referring to during the call was the amount of revenue expected from the 2,300 towers less the cost of operating them, which works out to $10 million.
Fair enough, but since this whole operation is going to require $350 million to undertake, it might not be so conservative after all, since the capital has to come from somewhere. The towers they are buying are resting on land which AMT controls for "Generally 10 year terms" in these countries.
Therefore, if Wall St is going to base a target price upon a model of perpetual cash flows, they must make changes to the cost of capital for the additional capital expenditure necessary to extend the cash flows beyond the 10 year ground lease. For this reason it is absolutely relevant to include some form of capex/depreciation driven change in the capital structure into the analysis. Unless the tooth fairy shows up and puts an equivalent asset under the pillow in 10 years, the revenue is not going to be there in the 11th year and the towers will have no residual value to AMT, so to ignore this issue is fundamentally inaccurate.
The 2,300 towers in question are in Colombia (750), Mexico (500) and Uganda (1000). These are the first towers that AMT will have in Uganda, and if Ghana is any proxy, there will be substantial SG&A expense required before any of the associated revenue materializes.
What happens when the credit spigot shuts off?
A quick look at the rapid accumulation of debt naturally makes one wonder, what happens when capital gets a bit more expensive? One thing about debt is the more you have, the more expensive the next dollar becomes. I agree that borrowing lots of money at low interest rates is a good thing, but it is difficult to make a long-term growth story contingent upon cheap debt being infinitely available-- because it is not. AMT finished up the year with $7.2 Billion of debt
Source: AMT 2011 10-K and Analytic Firepower
I am short AMT.
Additional disclosure: I have negative delta options positions in AMT