Yesterday's announcement of Verizon's (VZ) coming iPad, which will run on its newest fourth-generation wireless network, served as yet another reminder of the race all the wireless telecom companies are in: to attract customers to their most profitable wireless data plans.
With a financial model that does not need to subsidize smartphone costs and is the beneficiary of the wireless carriers growing network capex investment, the wireless tower companies continue to be among the best investment plays on the explosive growth of smartphones and rising data usage.
While there are a number of tower operators, American Tower (AMT) is the largest, and is considered the premier franchise. With a global portfolio of more than 40,000 sites in the U.S., Latin America, India and Africa, its business model is predictable and now offers something to satisfy growth and income investors.
The tower business is intuitive to understand. Wireless phone companies rent tower space to house radio antennas to support their network coverage. These lease agreements can span 15-20 years with built-in fee escalators in the range of 3-4%. With a broad scale of well-located towers, American Tower has become a one-stop partner for Sprint (S), Verizon, AT&T (T) and more than 2,000 smaller wireless carriers around the globe. Importantly, more customers and more antennas co-located on this fixed cost infrastructure directly translate into higher incremental margin business and tremendous free cash flow.
The smartphone and data device phenomenon is not just U.S. centric, and American Tower identified this global trend early on. In the last three years, international revenue has grown from 15% to 30% of sales. The underlying demand trends are consistent amongst geographies: stronger wireless networks to support devices accessing media rich content, recent sales of unused wireless frequencies by satellite and cable allowing for new network builds, rising numbers of urban users increasingly reliant on mobile phones over landline connections and new, early-stage demand within the U.S. from the auto industry and smart grid infrastructure.
With the above non-comprehensive list of some demand drivers for cellular infrastructure, American Tower has seen consistent growth for years. While industry consolidation and customer concentration (20 tenants make up 85% of revenue) are often cited as concerns for the business, customer churn has been extraordinarily low, 1.5% in 2011, as few carriers ever consider reducing network capacity.
With this predictable and sustainable business model it should come as no surprise that American Tower stock has performed exceptionally well. However, 2012 embarks a new transition for the company as it has officially been granted REIT status. Under this tax status, AMT will be required to distribute 90% of its taxable income into the hands of investors.
With legacy net operating losses that offset taxable income, AMT's initial yield will be a low dividend of approximately 1.5%, but the company has tied this yield to a percentage of approximately 30% of ongoing free cash flow. With FCF growing in the high-teen double digits, dividend growth should be exceptional over the coming years and this stock could ultimately end up paying a competitively high dividend. The company describes its current financial strategy as a balanced view of yield vs. growth and is still actively engaged on expanding its portfolio of tower sites with recent acquisitions in Mexico and Uganda.
Compared to REIT indices holdings that AMT will likely be included in, the stock has a lower yield, less land ownership (30% of tower sites but increasing), less debt, higher revenue growth and higher dividend growth potential. Bank of America Merrill Lynch analyst David Barden did an analysis of the potential under ownership of AMT should it be purchased by REIT index investors in comparative amounts to their other indexed holdings and concluded that there exists $4.8 billion of potential new demand for the stock.
With a solid business model and growing demand, AMT might be worth considering for your portfolio.
Also, pay attention to where former AMT CFO Brad Singer ends up. He helped AMT in its early ascendancy and then left to do the same at Discovery Communications. Under his guidance both companies performed exceptionally well. Now, having recently left Discovery Communications (DSCA), it will be interesting to see at what company he appears at next.