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American Tower Corporation (AMT)

American Tower (AMT) was founded in 1995 and converted to a REIT business structure in late 2011, minimizing its taxes on its real estate assets and kicking off its dividend program.

The company owns a portfolio of approximately 149,000 towers that are located mostly in suburban and rural areas and leased out to wireless carriers under long-term contracts. American Tower’s infrastructure is used by carriers to provide wireless service to consumers and businesses, transmitting signals between towers and mobile devices. Most towers have capacity for at least four tenants.

American Tower operates similarly to a triple-net lease REIT in that its tenants pay for almost everything needed to transmit signals (e.g. communications equipment, cables, antennae) except the tower and land that American Tower maintains. As a result, the company's maintenance costs are extremely low.
Source: American Tower Investor Presentation
Approximately 55% of American Tower’s property revenue and more than 70% of its total profit are generated in the U.S. with the rest from international markets (Asia 18% of revenue, Latin America 18%, EMEA 10%).

However, over 70% of the company’s communications sites are located internationally, where prices and capacity utilization are lower today. American Tower’s large international reach helps the business achieve reasonable tenant diversification. The company’s largest customers are Verizon (16% of revenue), AT&T (15%), Sprint (9%), and T-Mobile (8%).
Source: American Tower Investor Presentation

Business Analysis

American Tower has arguably one of the most predictable and lucrative business models of any dividend stock in the market.

First, the company enjoys very high visibility into future earnings thanks to its long-term leases with wireless service providers. Almost all of American Tower’s leases are non-cancellable and usually include an initial term of at least 5-10 years with multiple 5-year renewal periods.

Price escalators are embedded into American Tower’s leases as well, with the U.S. averaging 3% annual price increases and international markets’ escalators typically based on local inflation indices. These predictable gains provide a dependable base for organic growth.

The company currently has commitments of approximately $34 billion in non-cancellable tenant lease revenue, which provides great visibility because that amount is worth more than five times the company’s annual property revenue.

You can also see 69% of American Tower’s global leases are not up for renewal until at least 2021, further reducing the potential for surprises any single year.
Source: American Tower Investor Presentation
When leases have come up for renewal, the company has historically enjoyed 98-99% annual renewal rates based on property revenue, reflecting the limited alternative sites that tenants have to choose from when their leases come up for renewal (regulation and zoning requirements help limit supply).

Another reason why American Tower enjoys such strong renewal rates is because it’s cheaper for wireless carriers to outsource their communications site infrastructure needs rather than build and operate their own tower sites.

By spinning off their towers to companies such as American Tower, wireless service providers free up capital that can be used to pay down debt and reinvest in their networks’ quality, which is core to their businesses.

American Tower has historically benefited from wireless carriers exiting the operations of their tower sites.

For example, the company acquired exclusive rights to lease and operate more than 11,000 wireless communications towers from Verizon in 2015 for approximately $5 billion. These towers had existing average tenancy of 1.4 tenants per tower, well under their available capacity.

Other notable deals include American Tower’s purchase of a controlling stake in Viom Networks, an Indian cell tower company, for $1.2 billion in 2015. The company also entered into Nigeria, Africa’s most populous country, in a $1 billion deal in 2014.

American Tower can capture incremental leasing activity on these assets and spread its fixed costs over a greater number of towers, driving its returns on invested capital higher over time.

Adding additional tenants and equipment to existing towers is extremely profitable, with incremental gross margins of 97%. In fact, the company’s return on investment for each tower increases from 3% with one tenant to 13% and 24% with two and three tenants, respectively.
Source: American Tower Investor Presentation

Unlike many REITs, American Tower’s maintenance capital expenditure needs are very low, too. Maintenance spending has historically averaged less than 3% of American Tower’s revenue. As a result, the company has been a free cash flow machine over the years.

With a global average of 1.9 tenants per tower (less than half of available capacity), the company has substantial room available to add future tenants. As American Tower gradually fills out its towers around the world, its assets will likely earn significantly higher returns on capital because the incremental cost of adding a new tenant or additional equipment to an existing tower is very low.

Roughly 30% to 40% annual growth in mobile data traffic in the U.S. and the increased adoption of smartphones around the world is fueling the need for wireless carriers to continue investing in their networks’ density to meet demand.
Source: American Tower Investor Presentation
This is particularly true in markets outside of the U.S., where smartphone penetration in many regions is less than 50% today. The technologies deployed in most emerging markets are oftentimes 2G and 3G (i.e. much less advanced than those in the U.S. market), and American Tower’s occupancy rates are low by design, about 1.5 tenants per tower.

Wireless service providers in these markets will need to invest more in their networks to expand and improve their coverage, and increased adoption of wireless data applications (e.g. email, internet, video) and lower cost smartphones will put further upward pressure on network spending.

As you can see below, most developing and evolving markets significantly trail the U.S. in both wireless penetration rates and mobile broadband (3G/4G) penetration.
Source: American Tower Investor Presentation
Closing this gap will take many years, if not decades, but American Tower’s strategically-located infrastructure is positioned nicely for the increasing proliferation of wireless devices and the increasing usage of high bandwidth applications on those devices.

The company’s presence in many different markets that are in different stages of wireless development provides healthy diversification as well. 

While management expects 5% to 7% annual growth in the U.S., which accounts for roughly 75% of operating profits today, international tenant billings have been growing more than twice as quickly in recent years.

With over 70% of its communications sites located internationally, American Tower is positioned to benefit from higher network spending over the coming years and decades.

Riding this secular trend should hopefully enable American Tower to continue delivering double-digit adjusted funds from operations (AFFO) per share growth, just like it has done over the last decade. 

While there are numerous strengths to American Tower’s business, several notable challenges could arise in the future.

Key Risks

While fluctuating foreign currency exchange rates and volatile network infrastructure spending by wireless service providers can impact American Tower over the short-term, these issues are unlikely to impair the company’s long-term earnings power.

The primary risks that could structurally disrupt American Tower’s future are technological changes, customer consolidation, and the success of management’s capital allocation strategy.

Starting with technology, American Tower is obviously dependent on wireless service providers continuing to need its towers to transmit communication signals.

Network deployments today generally consist of multiple layers—traditional macro cell towers (like the ones American Tower leases out) provide a blanket of coverage, while a combination of other technologies (i.e. small cell) are also used to increase network capacity, especially in dense urban areas.
Source: American Tower Investor Presentation
The smartphone boom and widespread move to 4G wireless technology by U.S. carriers drove substantial demand for more macro sites (i.e. towers) over the last decade.
Source: American Tower Investor Presentation
With many carriers now looking to 5G wireless technology, there is some uncertainty about what the final architecture and standards will look like – and how important tower sites will be.

We are still years away from the 5G standard being officially defined, much less deployed on a wide scale basis, but there is speculation that some infrastructure investment could shift to fiber and small cells to meet the density requirements of 5G.

This would potentially reduce the role of traditional towers in certain areas and threaten the favorable economics they enjoy today.

You can read more about how the tower companies are responding to this potential threat here. Not surprisingly, American Tower does not believe these new technologies are a viable alternative to towers but can complement them in certain cases, such as in densely populated areas.

Less than 1% of the company’s towers are in locations with at least 10,000 people per square mile, so there is presumably little threat to American Tower’s legacy business under this assumption.

It’s also worth pointing out that over 80% of the U.S. population lives in suburban or rural areas, where more than 95% of the company’s U.S. towers are located.

These areas seem like less of a fit for small cell deployments, and continued growth in international wireless markets over the coming years can help American Tower continue diversifying away some of the 5G technology risk in the U.S.

Importantly, 4G infrastructure is expected to maintain market share over 50% through 2025 as 5G begins to gradually ramp up. As you can see, while new generations of network technologies have been introduced in the past, the lifecycle of legacy technologies has continued to be 15-20 years or more.
Source: American Tower Investor Presentation

Somewhat related to technology risk, it’s no secret that the major wireless carriers in the U.S. are struggling to growth their revenue. Their lack of growth is causing them to more closely scrutinize their deals with tower companies, who enjoy strong economics today.

According to Steel In The Air, “wireless carriers aren’t sitting idly by but are instead actively seeking to relocate some of their more expensive sites. Whether these efforts are selective and focused primarily on “scaring” the tower companies, or they represent actual and significant savings on operating expenditures going forward, we don’t know. Either way, we believe that there will be clear proof of the extent of these efforts in 2017 and that this will negatively impact the tower companies.”

American Tower’s scale, lease renewal schedule, and geographic diversification help, but this is still a risk to keep in mind.

Similarly, tower companies can be adversely affected when carriers merge together, which allows the combined companies to rationalize overlapping parts of their networks, share equipment, and decide not to renew certain leases.

A possible merger between Sprint (10% of American Tower’s total revenue) and T-Mobile (8%) has long been speculated, for example.

While this deal no longer looks likely, if it were to happen in the future, Sprint and T-Mobile only have 4% revenue overlap on American Tower’s sites today. Those contracts have around five years to run, too. In other words, there would likely be minimal impact if such an event occurred.

Furthermore, citing the Sprint-Nextel, AT&T-Cingular, and Verizon-Alltel mergers, American Tower claims it has enjoyed 20-25% more business from each combined entity 12 to 18 months after the deal compared the amount the company was receiving from the individual entities.

How can this be? Essentially, the combined company now has to service an even broader base of customers, even on overlapping towers. Combining businesses also tends to result in more capital that can be reinvested in the network for the long-term.

International wireless markets are much more fragmented, so this could be a bigger risk in those regions. Furthermore, American Tower’s customer concentration also makes it dependent on the financial health of wireless service providers.

The final major risk to consider is management’s capital allocation decisions. American Tower has made a number of major acquisitions in recent years, stretching the company’s balance sheet while deepening its presence in a number of international markets (including India and Nigeria).

It’s extremely important that American Tower can generate strong returns from international markets as they continue maturing and capacity fills up on the company’s tower sites.

You can see that yields on American Tower’s long-standing international builds are very favorable, and its more recent sites need to follow a similar trajectory for the long-term growth story to hold.
Source: American Tower Investor Presentation

Closing Thoughts on American Tower

For investors seeking long-term dividend growth and capital appreciation, American Tower appears to be an interesting candidate to consider. The economics of the tower business are quite favorable, and the earnings potential of American Tower’s existing tower base in developing markets is substantial. 

As a result, management believes the company can deliver 20% annual dividend growth going forward, which would be one of the fastest rates in the entire real estate sector. 

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