Dividends Don't Power This Tower REIT

Summary

• American Tower has sold off along with the broader market and is now trading at 14% below its all-time high.
• With the recent earnings beat, we reiterate our positive view on the stock.
• At a P/AFFO multiple of 21, we think price appreciation will come from AFFO growth not multiple expansion.
• If the government privatizes the telecom industry, AMT could benefit from accelerated investments in 5G.

Headquartered in Boston, American Tower Corp. (NYSE:AMT) is a major independent tower player that owns, operates, and develops real estate for wireless and broadcast communications. Formed in 1995 as a unit of American Radio Systems, the company came into existence after it was spun off after the merger of its parent company with CBS Corporation (CBS). The company is structured as a Real Estate Investment Trust (REIT) that has rapidly expanded in developed as well as emerging markets. The company's growth strategy has been mainly implemented through mergers and acquisitions, and its global presence is one of the key attributes that has made it one of our largest holdings, even as we have pared back exposure over time.

Source: Wireless Tower Communication Operator, Cell Site Lease Solutions | americantower.com

AMT's global portfolio comprises of 149,000 cell sites, and it is experiencing robust growth. Unlike some of its competitors, AMT has deep and broad global presence, and it has established itself as a leading tower company within the United States, France, Germany, Mexico, Argentina, Brazil, Chile, Colombia, Paraguay, Peru, Costa Rica, India, Ghana, Nigeria, South Africa, and Uganda. The table below highlights the number of sites within each country and the amount of revenue and margins produced by each.

In the latter half of the table, international tenants are listed for each country, which we highlight that many of the tenants are customers in multiple countries, including the US.

In India, specifically, India is experiencing rapid consolidation among carriers, which the company has been expecting. At first glance, consolidation may seem to be a negative for the company as redundant exposures per tower are reduced, but the company thinks that consolidation is leading to more rational markets on the demand side among carriers and the supply side among tower companies. Eventually, the company expects there to be 4-6 mobile operators that are well capitalized and with significant scale to roll out 4G across the 1.2 billion population of the country.

In the US, which has just one-third of the company's towers, the company owns and operates over 40,000 towers and has already engulfed heavily populated regions in the Eastern, Mid-West, and West Coast cities. The potential to expand into less populated areas in the Rocky Mountain States and portions of the Southwest is still prevalent.

AMT Strategy

As we mentioned earlier, AMT has adopted a global outlook for developing its target market. In fact, the company had targeted the Mexican and Brazilian markets even before it began to consolidate its position in the domestic market. However, the company could not gain a strong foothold in these countries due to the global recession of 2001. It was only after it acquired Spectrasite that AMT began to seriously plan about a global expansion strategy. Initially, the company began to target emerging markets that had strong growth potential and which were in the early stages of wireless development. The idea was to have a first-mover advantage in these markets and replicate its domestic market strategy in other markets as well.

AMT uses a three-pronged strategy to expand its services depending on the current infrastructure of the market, the technology available, and the consumer trends evident in each.

In emerging markets, many countries have completely by-passed the fixed-line infrastructure that prevailed in the U.S. and many other highly developed countries. This has allowed these countries to close the gap in its telecommunications infrastructure compared to that of the U.S. With wireless technology, there was no need to replicate a fixed-line system, and many countries that never built out that infrastructure have jumped directly to wireless. Within these markets, the demand for wireless data continues to increase and will only accelerate as more and more people are connected.

The second prong is focused on rapidly changing markets, like India, for example, which has turned its focus to the development and building of 4G technology. The local carriers have been investing heavily in building out denser markets to meet the demand of an already well-connected population.

In the more advanced economies, like the U.S., the next big thing will be the roll-out of 5G networks. 5G will be required for meeting the demands of smart homes, self-driving cars, and automation. The recent memo by the Trump administration to nationalize a portion of the telecom industry may be a benefit to AMT and other tower companies as the roll-out of 5G is accelerated in the 'interest of national security'. There is always the risk that given an inch, the government may extend its reach into the infrastructure space, but at least on the surface, any increase or speeding up of 5G investments would be good for AMT.

Source: Introduction to the Tower Industry and American Tower presentation, June 2014

Outlook

While AMT continues to acquire cell sites in foreign markets, it is best positioned to take advantage of the upcoming 5G deployments that will shape the future. The company has a big opportunity to leverage existing customer relationships as AT&T (T) and Verizon (VZ) begin 5G deployments in domestic markets. AT&T will be deploying 5G networks in at least 12 markets in 2018 while Verizon will be rolling out its 5G services in five US cities at the end of 2018.

By 2023, it is estimated that 20% of the world population will be covered by 5G networks that are required for technologies like Internet of Things (IoT), autonomous driving, virtual reality, and immersive 4K video. Additionally, 5G will empower wireless service providers to compete with cable providers by allowing greater amounts of data to be streamed to any device anywhere. Hence, the revenue-generating potential of 5G is extremely attractive. A report by Moody's Investors Service argues that the roll-out of 5G wireless services will increase capital spending of US carriers by several billion dollars per year.

In addition to 5G, the growing consumer demand for services like video streaming, social networking, and M2M communications has forced telecom service providers to deploy additional spectrum and cell sites to maintain or improve on coverage levels and data transmission speeds. Like its tenants, AMT is also preparing for the advent of 'smart cities'; hence it has partnered with Philips Lighting to develop smart poles that will not only help wireless carriers improve their network coverage but also support the installation of energy-efficient LED lighting. The growth in mobile data traffic needed to make this all happen is exponential.

Source: American Tower Corp US Technology Update Presentation, June 2017

Where We See Some Risks?

Companies like Uniti (UNIT) and Crown Castle (CCI) have focused more of their efforts on small-cell technology and fiber, which can be critical components of the overall telecommunications infrastructure. Both small cell and fiber are more important for data transmissions over shorter distances and within and across residential and commercial structures. Some carriers have invested heavily in ensuring that these segments of the network are maximizing the quality and speed of data transmission to meet consumer demands. I recall just a few years ago, when buffering was an acceptable part of downloading a movie or video, whereas consumers today are instantly frustrated by this…

Valuation

I believe AMT is reasonably priced on a multiple basis at a price/AFFO multiple of 20x, based on estimated 2018FY AFFO of $7.39. Therefore, we forecast that returns from the stock will come primarily from FFO growth, which is estimated to be 9% for 2018 and 12% for 2019. Combined with a dividend yield of 2%, investors may be looking at a potential return of 11% to 14% annualized over the next couple of years.

The broad market pullback may be scaring some investors away, but after the recent drop, AMT has come down 14% from its all-time high. I mentioned earlier we have been reducing our exposure gradually as the stock hit new highs. With this recent pullback, another entry point could be imminent.

Disclaimer:

Please note, this article is meant to identify an idea for further research and analysis and should not be taken as a recommendation to invest. It is intended only to provide information to interested parties. Readers should carefully consider their own investment objectives, risk tolerance, time horizon, tax situation, liquidity needs, and concentration levels, or contact their advisor to determine if any ideas presented here are appropriate for their unique circumstances.

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Analyst’s Disclosure: I am/we are long AMT, CCI, UNIT, QTS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.