American Tower Corp (NYSE:AMT): The Data “Toll Collectors”
It’s tough making money in a flat market. And with all the uncertainty looming, investors don’t really seem to know what to do with their investment dollars. If the overall market doesn’t grow by itself, you really have to dig deep under the macro issues and into sectors to find fast-growing trends.
For instance, wireless tower companies comprise a sector that supports the telecom industry by leasing space on antennas to multiple carriers.
These companies are simply purchasing an asset and making it available to multiple carriers. The basic idea behind this business isn’t rocket science, but if you’re AT&T (NYSE:T), you just don’t want to offer your real estate to Verizon (NYSE:VZ) or Sprint (NYSE:S).
This is a cash intensive business that was below the carriers and needed to be outsourced. It generated cash, but racked up huge losses and piles of debt. The balance sheets of companies like Crown Castle International (NYSE:CCI) and American Tower (NYSE:AMT) looked terrible 10 years ago because they weren’t generating enough profit per tower.
The Data “Toll Collectors”
But that was during the dark ages, before the mobile data revolution. The thing that carriers didn’t count on however was that cell phones would eventually be used more for data than for voice. Now that Verizon and Sprint all have the iPhone, carriers have to compete on data speed, not just handset choice. This means investing in their networks to widen a path for the increasing wireless data traffic. And guess who the toll takers are on this wireless highway? You guessed it, the tower operators.
The tower companies don’t care whether more Google (Nasdaq:GOOG) Android handsets are sold than Apple (Nasdaq:AAPL) iPhones. In fact, as Apple and Google duke it out by making their phones MORE feature-rich, carriers have to foot the bill for the network upgrades.
The competition isn’t only between the handset vendors, though. Sprint is offering an all-you-can-eat data plan to attract AT&T and Verizon subscribers. By adding the applicationPandora (NYSE:P) into the mix, I’ll never have to listen to commercial radio when I’m in my car again.
Revealing the Hidden Strength
The growth driven by carrier competition is enough to get excited about the industry – but two tactics these companies are implementing will continue to drive growth in the share prices:
1) Real estate acquisition
2) REIT conversion
If you look at Crown Castle’s last quarter, the company only generated $42 million in profits but a look behind the income statement shows $200 million in cash from operations. If you do a deep dive into a company’s financials, you often see hidden problems – not hidden strength.
One of the things the tower operators are doing with their excess cash is buying the land that the towers are located on. This reduces the risk of having to renew leases at much higher prices as well as reducing operating expense (which will make earnings look better).
Looking at American Tower vs. Crown Castle
American Tower has set a trend by converting its operating entity to a real estate investment trust (REIT). This is a substantial benefit for investors because it eliminates double taxation. As a REIT, American Tower pays out 90%of its taxable income to investors and you pay taxes at your individual rate. In the case of retirees who are paying exceptionally low tax rates, this could be a good source of low-tax income. AMT has seen its share price increase 23% this year since converting to REIT status and is the first in the group to do so.
While the new operating structure is convenient for shareholders, this may not be the best course of action for AMT’s competitors. Crown Castle International has publically stated that it will move toward REIT status as well, but not today. Due to the high level of tax advantaged operating losses building up on the balance sheet over the years, the company is already has tax shelters and there is little reason to make the conversion today.
A more likely time frame for the conversion is in 2015 as the “operating losses” run out and the company has to begin paying increased levels of income tax. This delay in REIT conversion might be better for shareholders in the long run. Since CCI is not expected to pay a high dividend at this time, the company can reinvest all available excess cash into new projects at a time when carriers are dramatically increasing LTE spending. So far, CCI has seen a 46% increase in its share price this year.
Given a choice between the two companies, Crown Castle looks to be a better investment – even though the stock has already had a strong run this year. The stock looks expensive on a P/E basis, but depreciation hides the earnings power. If you look at cash from operations rather than net income, the company generated $200 million rather than $43 million in the current quarter.
The company isn’t likely to attempt to achieve REIT status until the tax haven of old operating losses is exhausted. Until that time, the company will reinvest cash flow and leave a stronger operating model to generate dividends when the time comes.