Markets & Finance

Strong Signals for American Tower


S&P believes the leading wireless tower company offers an attractive combination of earnings predictability and growth opportunities

From Standard & Poor's Equity ResearchAmerican Tower (AMT; recent price: 41), which carries Standard & Poor's Equity Research's highest investment recommendation of 5 STARS, or strong buy, is a market leader in the wireless tower industry. We believe its August, 2005, acquisition of SpectraSite and its ongoing tower purchases will enable it to continue to achieve greater economies of scale through 2009. Due to long-term contracts and annual rent escalations of 3% to 5%, we think AMT has high revenue visibility. We believe increasing data usage and continued market buildouts from the advanced wireless services (AWS) and 700MHz spectrum auctions will provide an additional revenue boost over the next several years.

In the U.S., wireless penetration is roughly 80%, and we believe subscriber growth could begin to slow. However, in our view, voice and data usage will continue to rise at a strong pace as U.S. carriers begin to incorporate unlimited data plans, albeit at higher rates. We think data revenue is in the high teens as a percentage of average revenue per user (ARPU), but will break through to 20% as third-generation (3G) services and unlimited data plans become more popular.

For example, we believe the regional carriers that offer unlimited voice tend to have voice MOUs (minutes of use) that are significantly higher than the usage of fixed rate voice plans from the major carriers. Increased usage typically means carriers must either boost capacity at current cell sites or add additional cell sites, with both options likely resulting in increased revenues for tower providers, and AMT in particular.

New Networks

One other catalyst to the U.S. market, by our analysis, has been the addition of new networks by regional carriers such as Leap Wireless (LEAP; ranked hold; 54) and MetroPCS Communications (PCS; not ranked by S&P; 19). These companies acquired additional spectrum in the AWS auctions and have been building out new markets such as Los Angeles and Las Vegas, with others planned for 2008 and 2009.

Clearwire (CLWR; not ranked by S&P; 13) and Sprint Nextel (S; hold; 7) have also been looking to build out new Wi-MAX networks, which could provide incremental revenue to the tower providers. However, we believe the speed and depth of a buildout from these two carriers is still in question.

Another potential catalyst is the recently completed 700MHz auctions that raised about $20 billion. Although we believe no new national carriers will emerge as a result of the auctions, most of the carriers will likely use the spectrum to augment their networks and for new technologies, which we think could result in incremental rental revenues for the tower companies.

Favorable Position

Internationally, we believe AMT is in a favorable position, with roughly 13% of its revenues derived from operations in Mexico and Brazil. We expect the company to continue expanding in these countries, since both have low wireless penetration rates of around 64%, compared with 80% in the U.S. We think carriers in Mexico and Brazil will build out 3G networks in the near future, which could provide additional growth opportunities. We also believe AMT could expand into India in the future, which we estimate has a wireless penetration rate of around 20%.

Overall, we expect AMT to increase revenues 8% in both 2008 and 2009 due to existing rental contracts and rent increases as well as new market launches and ongoing tower acquisitions. We are including little incremental revenue from prospective Wi-MAX launches, as we believe the timing and magnitude are still in question. We expect EBITDA margins to widen to 68.1% in 2008 and to 68.7% in 2009, from 66.8% in 2007, with expansion driven by AMT's high operating leverage due to a high level of fixed costs. We estimate operating EPS of $0.45 for 2008 and $0.64 for 2009, including projected stock option expense of $0.14 per share in 2008 and $0.13 in 2009.

The company generates a significant amount of free cash flow that we expect to be used in part to help finance the recently announced $1.5 billion share buyback program as well as additional tower purchases and potentially a larger acquisition. We believe AMT's net leverage ratio of 4.2 times should allow it the financial flexibility for future share buybacks or a larger acquisition.

Our 12-month target price of 54 is largely based on 31 times and 27 times our respective free cash flow estimates for 2008 and 2009, in line with the peer target price mean. The target price also represents an enterprise value of 21.9 times our 2009 EBITDA estimate, above the industry average. We believe this premium is warranted by our view of AMT's ability to increase cash flow generation faster than its peers.

Company Profile

American Tower operates one of the largest independent portfolios of wireless communications and broadcast towers in North America, based on the number of towers and on revenue. The company's primary business is leasing antenna space on multitenant communications towers to wireless service providers and radio and TV broadcast companies. The tower portfolio provides AMT with a recurring base of leased revenues from its customers and growth potential to add more tenants and equipment to these towers from its unused capacity. The company also continues to expand its operations in Mexico and Brazil, and we believe it is beginning to put together a team to start operations in India.

Rental and management of the antenna sites is AMT's principal business and accounted for 98% of revenue in 2007. AMT operates a tower portfolio of about 22,807 multi-user sites in the U.S., Mexico, and Brazil as of Dec. 31, 2007. The company signs service providers to long-term leases of usually 5 to 10 years that contain annual lease rate escalations of 3% to 5%. Sprint Nextel, AT&T Wireless, T-Mobile, and Verizon Wireless accounted for roughly 60% of AMT's 2007 tower revenue, putting the company in a prime position for further market expansion projects, by our analysis.

We think AMT could also benefit from increased data usage, which will require service providers to add capacity to their cell sites, as well as from carriers that expand their networks. Carriers such as Leap Wireless, MetroPCS, and Clearwire are currently building out new networks and should increase growth, in our view. Additionally, U.S. carriers recently spent close to $20 billion on 700MHz spectrum and could begin to enhance their networks as early as 2009, potentially with 4G networks.

We expect international growth to benefit AMT in 2008 and 2009. The company has roughly 2,300 wireless towers and approximately 200 broadcast towers in Mexico, and about 700 wireless towers in Brazil. Combined, these countries accounted for 13% of tower revenue and 14% of tower operating profit in 2007. Mexico and Brazil have penetration rates of roughly 64%, vs. 80% in the U.S., and we believe service providers will continue to build out their networks as well as deploy 3G networks with recently acquired spectrum. We expect these markets to continue to provide significant growth. (Of the 182 towers AMT acquired in the fourth quarter of 2007, approximately 70% were located in Latin America.) An additional growth area is India, which, with a penetration rate of around 20%, is poised for strong growth in our view. AMT has set up an office in India, and we believe future developments there could be very promising.

The company derived about 2% of its revenue from network development services in 2007. AMT generates revenue by providing tower-related services, including site acquisition and zoning—in which it helps customers determine the optimum site location—as well as acquiring land rights and taking control of the permitting process. AMT also provides structural analysis that encompasses evaluating how much equipment a tower can tolerate or if the tower needs to be altered. While a small portion of total revenue, this allows AMT to provide its customers with a high level of service.

Company Outlook

Following a 10% revenue increase in 2007, we see revenue growth of 8% in 2008 and in 2009, reflecting increased lease activity per active tower and more new towers. We believe AMT will benefit from favorable tower industry trends, such as wireless carriers' demands to improve their network quality and coverage both in the U.S. and internationally.

We are positive on AMT's operating discipline, and look for operating expenses as a percentage of sales to continue to decline in 2008 and 2009. Driven by higher tower utilization, we forecast EBITDA margins widening roughly 130 basis points, to 68.1% in 2008, from 66.8% in 2007, and then to 68.7% in 2009, a level that is well above the peer average.

We estimate operating EPS of $0.45 for 2008 and $0.64 for 2009, including projected stock option expense of $0.14 per share in 2008 and $0.13 in 2009. The company announced a new stock repurchase program on Mar. 14, allowing it to repurchase up to $1.5 billion in common stock, which could provide a boost to share price performance, in our view.

We expect AMT to report first-quarter results on May 2. We forecast revenue of $378 million, EBITDA of $257 million (68% margin), and EPS of $0.10.

Valuation

AMT shares recently traded at 24.5 times and 21.3 times our respective 2008 and 2009 free cash flow estimates, well below the multiyear high of 31 times, but above the low of 14 times. Furthermore, the shares traded at 19.2 times our 2008 and 17.7 times our 2009 EV/EBITDA estimates, well below the high of 44 times and above the low of 14.6 times achieved in March, 2004. We believe the shares should be trading at the higher-end of historical ranges due to AMT's high degree of earnings predictability in a difficult economy. We also think AMT has several potential catalysts, such as acquisitions, international expansion, and a full-scale deployment of Wi-MAX.

Relative to its peers, AMT has greater financial flexibility, by our analysis, with a 4.2 times net leverage ratio, vs. 7.5 times at Crown Castle (CCI; buy; 39) and 8.3 times at SBA Communications (SBAC; buy; 32). Similarly, AMT has an adjusted EBITDA margin of 67%, vs. 55% at CCI and 51% at SBAC.

Our 12-month target price of 54 is largely based on 31 times our 2008 and 27 times our 2009 free cash flow estimates, in line with the peer target price mean. The target price also represents an enterprise value of 21.9 times our 2009 EBITDA estimate, above the industry average. We believe this premium is warranted by our view of AMT's higher margins, ability to increase cash flow faster than its peers, and greater degree of financial flexibility.

Corporate Governance

We have a mixed view of American Tower's corporate governance policies. On the positive side, in our view, no board members from outside the company have any affiliation with AMT and there is only one director from within the company. Both the nominating and compensation committees are made up of only independent external directors. All members of the board of directors are elected every year, and the company does not have a poison pill defense to takeovers.

However, we also view several factors unfavorably. These include the combination of the chairman and chief executive officer roles, the power of the board of directors to alter the size of the board without shareholder approval, and that shareholders are without cumulative voting rights in electing directors. Additionally, the board has authorization to change the bylaws without shareholder approval.

Investment Risks

Risks to our recommendation and target price include slower demand in the tower lease business, which would decrease revenues. Also, a proliferation of emerging technologies and alternatives, such as distributed antennae systems that rest on streetlights and tall structures, could potentially reduce tower demand. AMT has a relatively concentrated customer base with roughly 60% of revenues coming from four service providers. Further consolidation in the industry or slower-than-expected planned network expansion could also reduce revenues.

Conclusion

We believe that American Tower offers an attractive combination of earnings predictability and growth opportunities. The company has a stable revenue base in the U.S., and new market entrants through the buildout of a nationwide Wi-MAX network could provide additional growth. Additionally, we think AMT has a greater amount of financial flexibility than its competitors, which could allow it to make a strategic acquisition at attractive prices. It also recently announced a $1.5 billion share buyback plan. Our 12-month target price of 54, based on free cash flow multiples, represents upside potential of more than 30% from current levels.


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