Crown Castle International (CCI) delivered solid Q1 2019 with top and bottom lines growth. We like its current business model as it has price escalators built in its contract with high retention rates. In addition, its business is highly scalable as it can rent out its cell towers to multiple tenants. However, we are concerned about the future returns of its investment in fiber and small cells as many telecom players already have these assets. Crown Castle pays a growing 3.2%-yielding dividend but its shares are currently fairly valued. We think investors may want to wait on the sideline until a better entry point.
Recent Developments: Q1 2019 Highlights
Crown Castle delivered solid Q1 2019 earnings with mid-single digit revenue growth and high-single digit adjusted funds from operations growth. As can be seen from the chart below, its site rental revenues increased by 6% to $1.219 billion in Q1 2019. Its AFFO also increased by 9% to $606 million.
Source: Q1 2019 Earnings Presentation
What we like about Crown Castle and its business
Its revenue is highly scalable
Unlike other properties where there can be only one tenant per site, Crown Castle’s communications infrastructures are highly scalable. The company’s cell towers can host multiple tenants without incurring much incremental costs. We like the fact that majority of Crown Castle’s towers have 2 or more tenants. As can be seen from the charts below, only 29% of its towers acquired and built in 2006 and prior have less than 2 tenants. Although its revenue can easily be scaled higher by hosting more tenants, it may take several years for its newly built tower to attract more tenants. This is evident in the fact that about 47% of its towers acquired and built in 2007 and after have less than 2 tenants. This is much higher than those sites acquired and built in 2006 and prior.
Source: Q1 2019 Supplemental
Price escalations in its contract with high retention rate
Crown Castle’s tower rental business has a weighted average remaining term of about 5 years. Its retention rate is also over 98%. TIn addition, its current leasing contract also contains price escalations that is typically slight below 3% per year. Therefore, its business is stable with predictable revenues.
Source: Q1 2019 Earnings Presentation
Favorable industry trend
According to Ericsson’s 2018 Mobile Traffic Outlook, North America’s average mobile data traffic is expected to grow from 3.2 Exabytes per month in 2018 to 19 Exabytes per month in 2024. This is a growth rate of nearly 6 times in 6 years. In order for telecommunication carriers to meet this demand, they will either modify network equipment on existing towers or add more tower locations. Therefore, we think Crown Castle will continue to enjoy stable and solid growth from its tower business in the next few years.
However, we are concerned about the following
Many telecom carriers already have way more route miles of fiber than Crown Castle
5G will bring lots of opportunities and it will require 3x4 times more small cell sites than traditional 4G cell sites. This is because the frequency that 5G will utilize are higher frequency spectrums that has poorer penetration capabilities than lower frequency spectrums that 4G uses. Therefore, more small cell sites are needed in order to improve the signal quality. In order to capture this opportunity, Crown Castle has been investing heavily to build its fiber network so that small cells can be setup on these fiber networks. The REIT now has about 70 thousand route mile of fiber and 60 thousand small cells. While we like Crown Castle’s strategy to invest in fiber in order to build small cells, this part of the business is still in the initial stage and is capital intensive. It may take many more years of investments in order to establish a network that will result in strong revenue growth. In addition, we are not sure if this investment will generate strong returns in the future as many telecom carriers have fiber and cable infrastructures already. Telecom carriers such as AT&T (T) owns more than 1.1 million route miles of fiber already. Verizon (VZ) also owns about 900 thousand route miles of fiber. These are significantly higher than Crown Castle’s 70 thousand route miles of fiber. Besides AT&T and Verizon, other cable companies such as Comcast (CMCSA) also can leverage its cable assets to build small cells and compete with Crown Castle. Therefore, we think Crown Castle’s focus in fiber and small cells may not generate the same return it can generate from its legacy cell towers.
Source: April 2019 Investor Presentation
Its four major customers represent over 70% of its revenue
Majority of Crown Castle’s revenues are from its four largest customers. As can be seen from the table below, 74% of its total revenue comes from AT&T, T-Mobile (TMUS), Verizon, and Sprint (S). We do not like this mix as any mergers and acquisitions may result in elimination of overlap tower sites. This will negatively impact Crown Castle’s business.
Source: Q1 2019 Supplemental
Valuation: Fairly valued
Crown Castle currently trades at an EV to EBITDA ratio of 24.7x. This is several multiples higher than its 5-year average of 22.6x. However, its EV to EBITDA ratio is slightly less than its peer American Tower’s (AMT) 25.9x. Therefore, we think its shares are fairly valued.
A growing 3.2%-yielding dividend
Crown Castle has consistently increased its dividend in the past 5 years. It now pays a quarterly dividend of $1.125 per share. This is equivalent to an annualized dividend yield of about 3.2%. The company is committed to grow its dividend by about 7% ~ 8% per year. While we think this is achievable, investors should keep in mind that Crown Castle’s investment in fiber and small cells continues to weigh on its free cash flow. In the past 12-months, its free cash flow of $711 million was much less than the $1.93 billions of dividends paid.
We like Crown Castle and its mission-critical infrastructures in the communications industry. However, we are concerned about its future investment in fiber and small cells as these may not generate the same returns comparable to its legacy towers. In addition, its shares are fairly valued. Therefore, we recommend investors to wait for a pullback before initiating a position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.