American Tower: Three Long-Term Growth Drivers

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Investment Thesis

American Tower (AMT) is a leader in the telecommunications real estate market. As such, they are well positioned to benefit from certain growth drivers: edge computing, the build-out of 5G networks in advanced countries, and the continued build-out of 3G and 4G networks in developing countries. Due to these growth drivers and a history of steadily increasing dividend payments, I rate American Tower a modest buy at $230.

American Tower Overview

American Tower owns and operates telecommunications real estate on several different continents. In total, American Tower’s property portfolio includes ~181,000 communications sites. The graphic below depicts a typical tower site.

Source: American Tower Presentations (Introduction To The Tower Industry)

American Tower generates revenue by leasing tower space to carriers, like AT&T (T) or Verizon (VZ). This allows carriers to install antenna equipment without needing to build towers themselves, which would be incredibly expensive. In this way, American Tower’s expansive real estate network creates a barrier to entry.

But American Tower’s business model also offers another advantage. Each cell tower typically supports 3-4 tenants. But operating expenses are largely unaffected by the number of tenants per tower. This means, with each additional tenant, the return on investment increases. With one tenant, ROI is roughly 3%, but with three tenants, ROI rises to roughly 24%. This represents a cost advantage, which reinforces the barrier to entry.

In the next few sections of this article, I will discuss three factors that should drive growth for American Tower over the next five years and beyond.

American Tower & 5G Networks

Implementation of 5G will require low, mid, and high-band spectrum to provide adequate coverage and capacity. These terms refer to the frequency of the radio waves that create cell networks. Low-band waves have a frequency of less than 1GHz, mid-band waves have a frequency of 1GHz – 6GHz, and high-band waves have a frequency over 6GHz. This is shown in the chart below:

Source: Synopsys

Low band waves travel the farthest, covering hundreds of square miles, but offer the slowest speeds (30-250Mbps), making them good for blanket coverage. Mid-band frequencies offer a good compromise between coverage and capacity, as these waves still cover several square miles but offer faster speeds of 100-900Mbps. High-band frequencies, which will be delivered from small cells rather than macro towers, offer enormous capacity but minimal coverage. High-band waves deliver speeds of 1-3Gbps, but only cover a one mile (or smaller) radius.

So how does American Tower benefit?

American Tower benefits from the necessity of low-band and mid-band support for 5G networks, as this spectrum is typically delivered from macro towers. Rodney Smith, SVP of American Tower, discussed this during a presentation at the UBS Global TMT conference in December 2019.

We do see an environment here where the backbone of 5G network, certainly in the suburban areas and the rural areas, could very well be mid-band spectrum coming off of macro towers.

Furthermore, to support mid-band spectrum, carriers will likely be deploying massive MIMO antennas on macro towers. Massive MIMO works by clustering antennas at the transmitter and receiver to provide higher throughput and lower latency. Rodney Smith also discussed this during the presentation.

Along with those mid-band spectrum that would be used, they’re probably going to be deploying things like massive MIMO antennas and different types of antennas, so that would be a whole new cycle of hardware going up on the towers…

So as those begin to get deployed and put on towers, that’s a revenue cycle for the tower companies.

To summarize, while American Tower will not be involved in deploying the small cells that provide the ultra-fast speeds associated with peak 5G, they will still play an important role. Their towers will be necessary to deliver the low-band and mid-band spectrum, meaning they will continue to generate steady revenue as ‘advanced’ countries build out their 5G networks.

American Tower & International Markets

American Tower has a sizable opportunity in international markets, as 3G and 4G networks are far from pervasive in many regions.

The chart below compares mobile subscribers (size of the bubble) to mobile-broadband penetration in advanced, evolving, and developing markets. Note that broadband penetration refers to the number of active mobile-broadband subscriptions per 100 people-therefore, it is possible to exceed 100%.

Source: American Tower Presentations (Introduction To The Tower Industry)

As indicated above, there are numerous sizable markets in which mobile-broadband penetration is significantly below 100%, primarily in Asia, Latin America, and Africa. This represents a significant future opportunity.

As smartphone usage increases in these countries, carriers will need to make their networks denser to handle the corresponding increase in data transmission. This will involve putting equipment on more macro towers, meaning American Tower will benefit.

To emphasize this point, the chart below shows forecasted growth in smartphone data usage in several key countries.

Source: American Tower Presentations (International Market Overview)

I’d also like to offer a slightly contrarian view here. While I believe American Tower has a substantial international market opportunity, things have been rough in recent years, especially in Asia (India) and to a lesser extent in Latin America.

The chart below depicts revenue growth across American Tower’s geographies.

Source: Created by the author using data from American Tower Investor Relations.

As indicated above, revenue has actually declined in Asia (India), and revenue has grown at a meager 2.8% per year in Latin America. The decline in India has been related to customer churn, partially driven by carrier consolidation, and the impact of foreign currency translations. The story is similar in Latin America, where fluctuations in the Brazilian Real, Mexican Peso, and Colombian Peso have contributed to slow revenue growth.

On the brighter side, revenue generated in Africa is growing very quickly, at over 18% per year. American Tower is rapidly expanding their infrastructure in this region as well, as their tower count has grown at 23% annually in Africa since 2017.

To summarize, I believe there is significant opportunity here. But there are also risks associated with these evolving and developing countries. Carrier-consolidation could drive higher than anticipated churn in the future, and foreign currency translations could continue to dampen results. Investors should watch these metrics closely.

American Tower & Edge Computing

American Tower has recently entered the edge computing space by opening six edge data centers. The locations of these data centers are shown in the map below.

Source: American Tower

These data centers will be connected to and operated by Colo Atl, a subsidiary of American Tower acquired in 2019. American Tower has also partnered with Flexential, allowing them to leverage Flexential’s connectivity fabric (FlexAnywhere), to connect their Colo Atl facility to Flexential’s data centers. FlexAnywhere also provides connectivity to public cloud providers, such as Amazon (AMZN) Web Services, Google (GOOG) Cloud Platform, and Microsoft (MSFT) Azure.

What is edge computing? And why is it important?

Edge computing pushes data processing to the edge of the network, closer to the end user or end device. By reducing the distance data must travel, edge computing reduces latency, meaning end devices receive responses more quickly. This is critical for time dependent applications and IoT devices, such as an IoT sensor helping to operate an autonomous vehicle.

There is also another benefit to edge computing: reduced costs associated with bandwidth and data transmission. It is expensive to create a network that supports enormous bandwidth, with the capacity to process and store large amounts of data. If some of the data can be processed at the edge, less data is sent back to central data centers or the central cloud, meaning fewer costly servers, switches, and routers are necessary to support those data centers.

What does this mean for American Tower?

American Tower now owns edge data centers, which means they can sell edge capacity to clients. This will allow those clients to place their hardware and software applications closer to end-users, reducing the latency associated with those applications. As I’ve discussed, this addresses a wide array of use cases, all centered around supporting IoT devices and other time-dependent applications across a range of industries: finance, gaming, healthcare, logistics, manufacturing, and transportation.

Revenue from these data centers has not yet meaningfully impacted American Tower’s financial performance. But management’s decision to pursue this market seems like an excellent capital allocation decision, as the edge data center market is expected to grow at 25% per year, reaching over $53 billion by 2030. And tower sites are an ideal location to place edge data centers to support mobile edge computing and IoT devices.

As a last note, I believe this gives American Tower an edge over competitor Crown Castle (CCI). While Crown Castle has invested in Vapor IO, Crown Castle itself does not own any edge data centers. However, American Tower’s other major competitor, SBA Communications (SBAC) has also entered the edge computing space with the purchase of a data center in Chicago in August 2019. The company also purchased another data center in Jacksonville, Florida in August 2020.

Financial Update

American Tower has grown revenue at roughly 8.5% per year since 2016. This is depicted in the chart below.

Source: Created by the author using data from American Tower Investor Relations

However, revenue growth in Q2’20 and Q3’20 decelerated to 1.2% and 3.0%, respectively. In the most recent quarter, the deceleration was primarily due to the negative impact of foreign currency translations (-$89 million). On an FX-neutral basis, revenue grew 7.6% YoY.

Despite the 3% rise in revenue, Funds From Operations (FFO)-a measure of cash flow in REITs-dropped roughly 3% YoY in Q3. This too was primarily a result of foreign currency translations (-$49 million), and partially due to a loss taken on the early retirement of long-term obligations (-$37 million). Excluding these, FFO would have increased roughly 7% YoY.

As I mentioned earlier, there is risk associated with American Tower’s international markets, especially in developing regions of the world. Investors should pay close attention to this, monitoring for signs of trouble, such as sharply accelerating carrier churn or sharply decelerating revenue growth.

Valuation

In this section I will use free cash flow to examine potential returns over the next five years.

Over the last five years, American Tower’s FCF per share has increased from $3.40 in Q4’15 to $6.29 in Q3’20, representing 13.8% annualized growth. This gives a Price-to-FCF multiple of 36.5x at the current share price of $230.

However, FCF growth has slowed in recent years, so I will conservatively assume 12% growth over the next five years. I’ve also selected conservative FCF per share multiples: 35x, 30x, and 25x.

Finally, American Tower has grown its dividend by roughly 4.6% each quarter over the last five years. If this trend continues, the dividend will reach $2.68 per share by Q2 2025. Over that time, investors will collect $36.14 per share. My valuation model provides returns before and after accounting for these dividends, and in the latter scenario, assumes the dividend was not reinvested.

Source: Created by the author

In my bull scenario, American Tower generates a 13% annualized return over the next 5 years. And in my bear scenario, I estimate a 6.4% annualized return. I believe this range adequately addresses opportunity and risk, as the Price-to-FCF multiple has been between 25x and 35x for the majority of the last five years. This is shown in the chart below.

Data by YCharts

For the sake of comparison, the S&P 500 has returned an average of 8% per year since 1957. So American Tower beats the market average in two of three scenarios above.

As a final note, this valuation model would be significantly impacted if growth in FCF per share was higher or lower than the estimated 12%. For instance, at 10% FCF growth, the bull scenario returns an annualized 11%. But at 15% FCF growth, the bull scenario returns an annualized 16%.

Conclusion

As I’ve outlined in this article, American Tower has opportunities in 5G, international markets, and edge computing. And driven by these catalysts, I believe American Tower will generate market-beating returns in the years ahead.

However, if you’re looking for monster growth, I would not recommend this stock. American Tower is not going to bring 5x returns in the next five years. But if you’re looking for a relatively safe investment that pays a steady dividend, while still retaining the potential for share price appreciation, American Tower meets these criteria.

Disclosure: I am/we are long AMT, AMZN. 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.