Sunday, February 27, 2011

High Growth Plays in Wireless Infrastructure

American Tower $AMT is a great way to buy into the wireless infrastructure market. It competes well with the likes of other cell phone tower companies like SBA Communications $SBAC and Crown Castle International $CCI. However, as with any company, the question arises of evaluation and future prospects.

Wireless Infrastructure Growth

Long term growth looks assured for this industry. The move from 3G to 4G will stimulate a massive pick up in bandwidth demand as will the increasing penetration of smart phones and internet purposed mobile phones. In addition, the roll out of telecommunications and bandwidth to the emerging markets continues apace. All of this is great news for the cell tower providers.

The business model of AMT, SBAC and CCI is to undergo large amount of capital expenditures initially, in order to roll out a network of towers. This usually involves having longer term contracts with the network providers (in order to guarantee cash flows) and then selling initial 'stack' on the tower to new entrants or as an expansion to the existing clients. The marginal cost of adding a new customer is low, so the key to future growth is to add scale while you can.

Cash Flow is the Key

American Tower is the leader player in this space and generated the best margins, however margins are one thing and capital expenditures are another. Essentially, the cell tower companies can expand the network of towers by either acquiring existing towers or buying land and, constructing towers via capital expenditures.

Naturally, an investor would want a company to aggressively roll out expenditures early on, but also see that the reported growth is covering expenditures. In addition, margins and growth should indicate that the company is on the right track to delivering long term sustainable cash flows. American Tower is delivering on most of these objectives but what about the evaluation?

American Tower Evaluation

At the current price of $53.76 American Tower has a market cap of $21.4bn and an Enterprise Value of $26.09bn. Gross Margins are very high at above 76% and the company is already generating operating margins of nearly 40%  Revenues grew at 15% in 2010 and are set for 15% and 10% growth in 2011 and 12 respectively. So, all looks fine from the top line perspective.

However, as discussed above, the key is cashflow and whether American Tower is on a good evaluation or not. Turning to the 2010 results, AMT managed to generate $1.02bn in operating cash flows and spent $346m on capital expenditures. This implies free cash flow generation of $647m but this needs to be put into the context of a growing business. For example, of the capital expenditures $277m was spent on expansionary capex whilst nearly $70m was for maintenance capex. It would be easy to assume that the maintenance capex is giving a better long term picture but there are some caveats here.

Firstly, the capex figures only include expenditures for land and new construction. As a matter of fact, American Tower also spent a further $899m in acquiring communication sites with $570m of that spent on international sites. So clearly, capex is only one part of the equation. The key to getting a 'snapshot' look is to consider that American Tower depreciates its property, equipment and construction in 15-20 years, so the mid point of the useful life estimation  is 17.5 years. Looking at American Tower's balance sheet shows $3.62bn, which if depreciated (straight line) will give maintenance capex of $206m. Assuming this is the 'normalised' capex would give 2010 normalised free cash flow of $815m and a FCF/EV of 3.1%

This is ok for a business growing operating income and Ebitda in the low teens. However, it is not cheap for a relatively early stage business that is competitive and needs to demonstrate that it can expand margins.

I took a pass.

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