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Crown Castle International Corp. (CCI)

Founded in 1994, Crown Castle International (CCI) began operating as a real estate investment trust (REIT) in 2014 for tax purposes and is the largest provider of shared wireless infrastructure in the country.

Crown Castle owns and leases more than 40,000 towers and 60,000 miles of fiber supporting small cell networks across every major U.S. market. The company also has a small cell platform with 50,000 small cell nodes on air or under deployment.

Towers account for 81% of Crown Castle's revenue. The company leases its towers out to wireless carriers, which need Crown Castle’s infrastructure to provide wireless services to consumers and businesses.

Tenants deploy communications equipment, coaxial cables, and antennas at the top of Crown Castle’s towers that transmit signals between the tower and mobile devices. Most towers have the capacity for at least four tenants.

Here’s a look at the tower setup, courtesy of Crown Castle’s competitor American Tower (AMT):
Source: American Tower Investor Presentation

Small cell networks and the fiber cables connecting them account for the other 19% of Crown Castle's revenue. Unlike towers, small cells are much smaller and typically located outdoors and often attached to public infrastructure, including utility poles or street lights. Small cells are commonly utilized by wireless carriers in denser, more urban areas to augment the capacity provided by towers and add capacity to their networks.
Source: Crown Castle Investor Presentation

The big four wireless carriers account for 90% of Crown Castle’s site rental revenue, and the company is completely focused on the U.S. wireless market, where over 70% of its towers are located in the top 100 largest markets. Its fiber network is also located in 23 of the top 25 U.S. markets.

Over 80% of the company’s revenue is recurring, and most of its site rental revenue results from long-term leases with initial five to 15-year terms and five to 10-year renewal periods thereafter.

Business Analysis

Despite its customer concentration, Crown Castle’s business model is attractive for a number of reasons, beginning with its predictability.

The company has an average remaining customer contract term of five years and approximately $18 billion remaining in contracted lease payments (compared to just $3.7 billion in 2017 site rental revenue), providing excellent cash flow visibility.

Crown Castle’s tower leases also have built-in price escalators, which are expected to continue adding around 3% to the company’s annual earnings growth. Small cells enjoy annual price escalators as well, although their range is closer to 1.5%.

In addition to annual rent escalators, tower economics are attractive because very little cost is involved to add additional tenants. In fact, the company enjoys a 96% incremental margin when it adds an additional tenant to one of its existing towers.

In other words, if a new tenant brings in $25,000 of additional rental revenue, Crown Castle keeps $24,000 in gross profits. The operating leverage in this business is tremendous, and substantially all of Crown Castle’s wireless infrastructure can accommodate additional tenancy.

As data growth continues accelerating (mobile data demand is expected to double every two years), it seems reasonable that demand for Crown Castle’s towers and small cells will also rise over time as carriers invest in their networks to handle increasing traffic.

Demand should also be helped as T-Mobile (TMUS) pours billions of dollars into improving its wireless network to better compete with Verizon (VZ) and AT&T (T). Additionally, after ultimately walking away from merger opportunities last year, Sprint (S) has committed to increasing its annual network investments by at least $1 billion to $2 billion.

While rumors of a potential merger between T-Mobile and Sprint in 2017 temporarily spooked tower investors since consolidation could give carriers more bargaining power with tower operators, carriers still have no substitutes for wireless infrastructure, which is mission-critical for their businesses to operate.

At the end of the day, the sharing of Crown Castle's infrastructure across multiple parties provides the lowest cost and fastest time-to-market for its customers. By collocating on shared wireless infrastructure, wireless carriers only have to pay for their proportional usage of the infrastructure. 

Instead of needing to occupy an entire company-owned tower themselves, carriers can rent only the space they need to enhance their network coverage and continue servicing their customers.

As a result of these factors, tenant leases have historically enjoyed a high renewal rate. Non-renewals have averaged just 1% to 2% of site renewal revenues over the last five years, for example.

Crown Castle has also been making strategic acquisitions to help expand its portfolio in some of the best markets in the U.S. Some of these recent acquisitions include Sunesys ($1 billion in 2015), a fiber services provider with the bulk of its business in the top 10 U.S. markets; FiberNet ($1.5 billion in 2016), a fiber services provider focused in Miami and Houston; and Wilcon ($600 million in 2017), which has an extensive footprint in Southern California.

The Wilcon acquisition will also increase Crown Castle’s fiber asset base in the fastest-growing market for small cells. The demand for small cells is higher in urban and suburban geographies where towers are not available or are not able to meet carriers' high bandwidth requirements.

With the demand for wireless devices growing rapidly (thanks to 5G, on-demand video, virtual reality, autonomous vehicles, and the Internet of Things), wireless carriers are expected to increasingly rely on a dense network of towers and small cells connected by high-capacity fiber to provide these new services, which require faster speeds and significantly lower latency. 

Small cells can provide carriers with greater bandwidth, helping make these new technology applications available anywhere at any time on any device. As you can see in the diagram below, small cells can complement towers to help increase network capacity, especially in dense urban areas.
Source: American Tower Investor Presentation – U.S. Technology
Management believes, fundamentally, that the wireless infrastructure will change as we move into a 5G world. Crown Castle has positioned itself to benefit in the same way with small cells and fiber that it has benefited over the last couple of decades from the tower investments it made.

The company's boldest move came last year when it more than doubled its fiber route network to 60,000 miles with its $7.1 billion acquisition of Lightower, announced in July 2017.

This deal essentially combines Crown Castle’s leading small cell platform with one of the best metro fiber footprints in the industry, which meaningfully expands the company’s capabilities to deliver small cells nationally at scale for its wireless carrier customers.

Acquiring Lightower better positions Crown Castle for growth in small cells and is expected to be immediately accretive to adjusted funds from operations (AFFO) per share. As a result, dividend investors will be pleased to know that Lightower is expected to increase Crown Castle’s long-term dividend growth rate target from 6-7% to 7-8%.
Source: Crown Castle Investor Presentation
Back to the tower business, which generates the majority of the company's revenue today, many of Crown Castle’s towers are located in areas with strict zoning restrictions and other regulations, limiting supply and making its infrastructure harder to replicate by new entrants.

Crown Castle’s cost structure is also fairly stable because the company maintains long-term control over the majority of land under its towers. In fact, about one-third of Crown Castle’s site rental gross margin is generated from towers on land the company owns, and its current portfolio of ground leases have an average remaining term in excess of 30 years.

More importantly, over 75% of its site rental gross margin is from towers where the land is owned or controlled by the company for at least 20 years. There is little risk of Crown Castle losing control of its real estate assets. 

Since Crown Castle generates extremely stable free cash flow, has very low maintenance spending needs, and owns a good portion of its land and properties, it can reasonably afford to maintain more debt than the average firm. However, the company still maintains an investment grade credit rating, which allows it to continue accessing capital on favorable terms to invest opportunistically in growth projects.

Overall, Crown Castle appears to have a fundamentally strong business that enjoys high barriers to entry and seems to have a solid growth outlook for at least the next five years, especially if 5G infrastructure needs play out as management expects.

Thanks to continuously growing demand for data and a portfolio of mission-critical wireless infrastructure, Crown Castle has delivered very reliable growth throughout numerous market cycles. The company’s rental revenue and gross income have increased every year since 2002, and that trend seems likely to continue for the foreseeable future.

Key Risks

The biggest risks facing Crown Castle are customer concentration and evolving technological trends.

AT&T (27% of rental revenue), T-Mobile (23%), Sprint (22%), and Verizon (16%) account for about 90% of the company’s total revenue.It goes without saying that the loss of any of Crown Castle’s major customers would be devastating. The U.S. wireless market is also an oligopoly, so there’s really not much Crown Castle can do to diversify its customer base.

Fortunately, losing a customer is next to impossible given the mission-critical nature of Crown Castle's infrastructure, the nationwide coverage carriers must provide, and the economics of the business (sharing the wireless infrastructure, rather than owning their own, provides carriers with the lowest cost and fastest time-to-market for their customers; it would make little sense for them to own and operate towers themselves). 

With that said, the carriers are never happy with the rates they pay infrastructure companies like Crown Castle and would love to reduce their operating costs. AT&T and Verizon announced an agreement last year to work with a third company to construct hundreds of new towers, hoping to create a new alternative to working with the incumbents. However, it seems unlikely that such actions can really move the needle given the industry's high barriers to entry and the massive scale of the leading players (Crown Castle has more than 40,000 towers, mostly located in the largest markets with the greatest capacity needs). 

However, Crown Castle could suffer from customer consolidation. For example, rumors of a potential merger between Sprint and T-Mobile last year created some fears. Had the companies reached an agreement to combine, it would consolidated two of Crown Castle's major customers, posing risk of non-renewals as the carriers look to combine their wireless infrastructure needs on overlapping towers.

The good news is that combined companies are able to service an even broader base of customers, even on overlapping towers. Bringing together Sprint and T-Mobile, for example, would likely result in more capital that can be reinvested in the network over the long term.

In fact, citing the Sprint-Nextel, AT&T-Cingular, and Verizon-Alltel mergers, rival 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.

For now, Crown Castle is the largest wireless infrastructure player in the market and has long-standing relationships with the major carriers. It’s hard to imagine any of them being able to operate a network without the use of Crown Castle’s products and services, which likely explains the excellent 1-2% non-renewal rate the company has historically enjoyed.

Besides customer concentration risk, Crown Castle could be impacted by changes in wireless deployment technology. If wireless networks become more efficient (e.g. network sharing) or experience a substantial change in design, demand for Crown Castle’s wireless infrastructure could decline.

Other technologies such as WiFi, satellites, and mesh transmission systems could eventually serve as substitutes for the company’s wireless infrastructure as well. None of these potential evolutions can happen overnight, but they could potentially jeopardize Crown Castle’s earnings five to 10 years from now – no one knows.

The company’s industry is also heavily regulated by the FCC, FAA, and local ordinances. They control the siting of towers and oversee tower and antenna structures, amongst other issues. It seems unlikely that a new regulation would crop up and harm Crown Castle’s business, but the company does face some regulatory risk.

Finally, near-term demand can be impacted by trends in capital spending by the major carriers. If they decide to pull back on plans to expand their coverage or capacity, Crown Castle could temporarily see reduced demand for its wireless infrastructure. This risk factor doesn’t impact the company’s long-term outlook, but it could potentially cause near-term volatility.

Overall, there are a few risks that could jeopardize the company’s very long-term future. However, the near- to mid-term outlook looks good. Technology changes are likely to happen at a moderate pace, and it’s hard to imagine any of Crown Castle’s major customers no longer needing its services anytime soon.

Closing Thoughts on Crown Castle International

The investment case for Crown Castle is very interesting. As demand for data and wireless connectivity continues to grow, the company’s wireless infrastructure should become even more valuable.

Crown Castle also has room to add more tenants to its existing towers at very high incremental margins and appears likely to continue enjoying annual price increases across its portfolio of leases.

When combined with the industry's high barriers to entry, the lack of viable substitutes, and Crown Castle's greater push into small cell networks in anticipation of 5G, the company's cash flow and dividend should continue to grow at a healthy pace in the years ahead.

While Crown Castle is not without its risks, it seems to be one of the more attractive REITs for investors seeking a combination of income and growth.

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