This Stock Should Trade at a Premium to its Peers
Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Strong barriers to entry and long term recurring revenue streams are characteristics of quality stocks that investors want to own. American Tower (NYSE: AMT), an owner and operator of wireless and broadcast communications sites both in the U.S. and globally, belongs to this category of quality stocks. It is also the least leveraged and most geographically diversified among its peers. Despite this, American Tower is valued at similar EV/EBITDA levels with its peers, which warrants a stock price re-rating, to accord it with premium valuations that it deserves.
Protected by strong barriers to entry
Why are new entrants not competing with American Tower, given that it is such a good business?
Firstly, the construction of new towers is governed by relevant regulatory bodies. For example, in the U.S., the Federal Communications Commission and the Federal Aviation Administration need to approve the building of any new towers. Similar regulations are in place in other countries outside the U.S. Intuitively, regulators are more comfortable with giving the stamp of approval to applicants like American Tower, given its years of experience in building and operating similar sites, listed status and deep pockets.
Secondly, it does not make sense for new entrants or competitors to build a new tower near American Tower’s existing communication sites. This is because American Tower’s existing customers face high switching costs in the form of expenses incurred in linking a carrier’s network to new sites and the risk of network quality deterioration with new operators.
Last, but not least, carriers have greater incentives to lease communication towers from American Tower, rather than build their own infrastructure. Besides the cost savings associated with leasing, speed to market is a critical success factor for carriers in delivering the fastest network to consumers. In contrast with leasing, building a new tower from scratch requires many years of hard work including securing the right locations and obtaining the relevant approvals.
Attractive financial characteristics of business model
One of them is its long term recurring revenue streams. A typical leasing contract for American Tower has an initial term of five to ten years with renewals every five years thereafter. The long term leases provide American Tower with stable revenues. It increased its revenues for every year since 2004, without taking a dip even during the Global Financial Crisis. In addition, less than 6% of its leases are up for renewal every year from 2013 till 2017, with not more than 2% of tenants cancelling or failing to renew their leases historically, according to its most recent investor presentation.
Since the bulk of operating costs such as insurance, property taxes and utilities are relatively fixed, which results in high operating leverage, the addition of tenants leads to higher operating margins.
American Tower’s maintenance capital expenditures typically relate to tower maintenance and IT infrastructure at the corporate level, with the majority of capital expenditures spent on capacity expansion, land purchases and tower construction to drive further revenue growth.
Risks from both operating leverage and financial leverage
Operating leverage is a double-edged sword. American Tower has high customer concentration risk with its top four customers accounting for more than half of its revenues. If any of its largest wireless carrier customers merge, American Tower will likely register low revenues at the same level of fixed costs, resulting in lower profit margins. Furthermore, American Tower is highly leveraged with a gearing of 234%.
American Tower’s peers include Crown Castle International (NYSE: CCI) and SBA Communications (NASDAQ: SBAC). Based on Yahoo Finance data, all three stocks are similarly valued at 20-22 times EV/EBITDA. All three stocks are highly geared, with Crown Castle and SBA Communications having debt-to-equity ratios of 365% and 770% respectively.
Crown Castle is the largest domestic tower operator, with about three quarters of its towers located in the top 100 Basic Trading Areas (BTAs). In comparison, American Tower and SBA Communications have 62% and 58% of their towers located in the top 100 BTAs respectively. American Tower is more geographically diversified with about 30% of its revenues derived outside the U.S., while Crown Castle has only 6% of its revenues generated from its sole international market Australia. Crown Castle currently does not pay dividends like American Tower, which is a REIT. However, Crown Castle has plans to convert into a REIT in 2015-2016.
SBA Communications has plans to grow its current non-domestic revenue contribution of about 6% in fiscal 2012. It recently acquired 800 wireless towers in Brazil at the end of 2012. I am negative on SBA Communications for two reasons. Firstly, I fear that it might prioritize acquisitions over share buybacks as part of its international expansion strategy. Secondly, it is the most highly leveraged of the three, exposing it to higher credit risk and an increased probability of dilutive equity issuance.
There is no doubt that communication tower leasing is a good business, given strong free cash flow generation and barriers to entry for the companies operating in the industry. Among the three major listed players, American Tower stands out for its exposure to international markets and its relatively stronger balance sheet vis-à-vis its peers. American Tower should trade at a premium to its peers based on these characteristics and current valuations offer an attractive entry point.
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Mark Lin has no position in any stocks mentioned. The Motley Fool recommends American Tower . The Motley Fool owns shares of American Tower . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!