Tower Industry Research Note
Industry growth 2003-2008. The tower industry has experienced good, but not spectacular, growth in the past five years. Since 2003, wireless subscribers grew at a CAGR of 11.2% from 158 million to 270 million. As wireless penetration increased, new cell sites (e.g. tenants) increased from approximately 163,000 in 2003 to over 230,000 by 2008, a CAGR of 7.3%. The CAGR of cell sites was slower than that of subscribers as wireless networks became more efficient. The number of new towers increased at a CAGR of 7.1% from approximately 83,625 in 2003 to 117,780 in 2008, almost keeping pace with cell site growth. Our estimate of total tenants per tower increased from 1.9 in 2003 to only 2.0 in 2008.
Actual vs. Projections. How did that compare with our projections? Catalyst predicted that wireless penetration would reach between 65-75% by 2008, roughly 20% below the actual levels. Our usage predictions, however, were too aggressive. MOUs/sub/month have formed a plateau below 400 minutes/per month, whereas our original projections were close to 800 minutes per month in 2008. Furthermore, data usage has been climbing, so the actual network utilization per subscriber probably lies somewhere in between the two figures. Subscribers per cell site were slightly worse than our conservative case. The combination of better-than-expected subscriber penetration and worse-than-expected network utilization resulted in a cell site CAGR (7.3%) that fell on the lower end of our base case range of 6.9% to 8.8%. Our estimate of tenants per tower of 2.0 is well below our original base case range of 2.2 to 2.5.
Outlook for 2009-2013. As mentioned above, wireless telephony has definitely become a saturated market as MOU’s and subscriber growth have slowed dramatically. Historically, cell site growth benefited from the dual effect of increasing penetration and usage. Going forward, we believe that cell site growth will mainly be driven by the rising need for data speed and capacity requirements related to network upgrades and advanced smartphone applications.
- High Case: If the carriers need to accelerate their network deployment to accommodate the rising use of data, we project a high case 5-year CAGR of 5.5% for cell sites, which would translate into about 8.5% revenue growth. The high case would imply that towers have one cycle remaining of being a mature growth industry.
- Low Case: If network efficiency can be maintained, given improved technology and the carriers’ increased spectrum holdings, we project a low case CAGR of 2.5% for cell sites, which would translate into about 5.5% revenue growth. It should be noted that for the last 4 years network efficiency has actually been improving, which has been a drag on cell site growth. The low case would imply that towers are a mature industry.
- Slow lease up: We would assign 50%/50% probabilities to both cases. A wrinkle is the continued high growth in the number of towers which has been suppressing total industry lease-up. While such slow lease-up contradicts what we hear from market players as the average lease up of 0.1 to 0.2 tenants per tower per year, Bank of America predicts 5-year tower count growth of 3.5% per annum, which would imply lease-up of only 0.04 tenants per tower. For all we know, the industry may be using acquisitions to mask slow “same-store-sales” growth.
- Business model and valuation: We continue to love the business model, and think that at 15-16x EBITDA the public companies are roughly fairly valued. The higher multiples enjoyed by the industry in the mid-2000s appear to have largely been a function of the credit securitization boom. Given the growth trends and relatively tight risk spreads, we see more downside risk than upside potential in the industry multiples. We no longer consider the wireless tower industry to be a growth industry, and recommend investing in the industry only on a situational basis.
Tower Demand and Supply Analysis
Wireless penetration. Wireless penetration has followed an almost perfect S-curve pattern. At roughly 90% penetration, the wireless telephony is saturated, with only laggards left to adopt the product. We can therefore expect subscriber growth of only a couple of percentage points a year for the rest of this decade.
Usage per subscriber. Minutes of use (MOU) reached over $1.1 billion in 2008. Even though voice minutes only grew 4% in 2008 vs. 17% in 2007, text messaging tripled in 2008 to 1 trillion messages. As seen in the chart below, MOU growth accelerated from the late 90’s to 2006. In the last few years, the growth has slowed and we believe going forward MOU/Sub/month will remain relatively steady.
Smartphones & Data Demand. Existing wireless subscribers have greater access to handsets with capacity-intensive activities such as internet surfing and music downloads. As increasingly sophisticated phones such as the iPhone, Droid, and Blackberry devices have become more popular, data services have expanded rapidly, with revenues up 39% in 2008 vs. 2007. Smartphones generate 30x the traffic of basic feature phones and the iPhone alone uses over 300 MB per month compares with 60 MB for lesser smartphones and 1MB for traditional handsets. Globally, smartphone penetration is currently 18% and approximately 40% of new devices are smartphones. Domestic smartphone penetration has reached about 8% or 21 million devices. These data-driven smartphones should contribute to strong wireless data growth, which in turn would fuel tower site demand. According to Benchmark research, data now represents roughly 25% of total wireless industry revenue.
Cell Site Demand. Wireless carriers will continue adding capacity through cell sites to support the higher data speeds, network upgrades and improved coverage to differentiate themselves as carriers.
AT&T, Verizon and T-Mobile are active and expanding as each plan to deploy 4G technology over the next few years. This is positive for the tower industry as this build out will put pressure on other wireless carriers to follow suit in order to remain competitive.
Emerging carriers including Cleawire, Leap Wireless, MetroPCS and Cox Communications are also actively building networks. Clearwire’s initial tower installations are full-sized and could potentially reach as many as 4,000 cell sties in 2009. Cox Communications is a new tower tenant launching a 3G network, and will likely build a 4G network in the future.
Mergers in the telecom carrier space have reduced the number of national wireless carriers from six to four. T-Mobile might bid for Sprint Nextel but because the two companies operate on different technologies the consolidation of cell sites would take a few years. Long term we should expect the industry to consolidate down to 2-4 players, but the network consolidation would be very gradual and will likely be offset by improved network capacity.
The risks to the upside from data growth is that the major carriers have acquired large chunks of spectrum in recent auctions, and that 4G network equipment is expected to be more efficient than existing 3G data equipment. Wifi roaming, femtocells, in-building wireless (DAS) and software defined radio are all innovations that may not only allow carriers to maintain network efficiency, but actually improve it. (Please see page 10 for more explanation of these technologies.)
The following chart illustrates the strong period of subscriber growth from the mid-to-late 1990’s to 2005 where wireless carriers were investing ahead of network demand as subscribers and MOU’s increased dramatically, requiring both coverage and capacity sites. From 2006 to 2008 cell site growth slowed even as subscriber and MOU growth was slowing. We believe that the slower growth was driven primarily by the decline in coverage sites. In the next five years, the increasing need for data speed and capacity could cause cell sites to grow faster than subscribers (the “high case”). In our downside case, (the “low case”), we expect that cell sites will increase at the same rate as subscriber growth, as carriers are able to maintain their network efficiency even as data demand rises.
Total Cell Site Count. We have outlined two possible scenarios for cell site growth: a high case and a low case, based on our two cases for subs per cell site. We do not believe that it is worthwhile to sensitize subscriber growth, as the market is already saturated.
The high case: Our high case assumes that cell sites growth will be in the high single digits for the next three to four years, before growth declines to approximately 1-3%. This case assumes a 5 year CAGR of 5.5% and a ten year CAGR of 3.8%.
The low case: Our low case is more conservative allowing for a continuous deceleration of growth over the next ten years, assuming cell site growth will be more in line with the growth of wireless subscribers. This case assumes a 5 year CAGR of 2.5% and a ten year CAGR of 1.6%.
We place a 50%-50% probability on these two cases. The demand for network updates and increased data capacity will ultimately drive network development and expenditure for major wireless carriers, offset by potential efficiency improvements and other innovations.
Revenue growth. If we assume a 3% average escalator for the industry, that implies 5-year revenue growth of 8.5% in the high case and 5.5% in the low case. 10-year revenue growth would be 6.8% in the high case and 4.6% in the low case.
Tower supply. Tower supply is difficult to project, and much depends on local zoning conditions. The exact U.S. tower count is not known. Various sources have come up with various estimates. According to Bank of America/Merrill Lynch, current tower supply is as follows:
Towers grew at a CAGR of 7.1% from 2003 to 2008. Catalyst projects that the overall tower count will expand by a CAGR of approximately 3.6% for the next five years (based on Bank of America projections). Over the next ten year period, we are decelerating the growth to a constant 1.2% after 2014, resulting in a CAGR of 2.4% from 2008 to 2018.
Lease-up rates. If we lay the total cell site growth cases over the tower supply assumptions described above, we arrive at the following projections for cell sites (tenants) per tower and the annual lease-up rate per tower. Lease-up rates are projected to gradually fall over the next ten years as cell site growth and tower growth slows.
It is hard to rely on these tower count numbers. They imply a far lower lease-up rate both for the past 5 years and for the next 5 years than is commonly considered industry standard. While for the most part we will rely on the total cell site demand and revenue projections, the slow lease up rates should not be ignored. There is the possibility that the industry is masking slow “same-store-sales” growth with serial acquisitions.
Publicly Traded Comparables
For large public tower companies, the TEV/EBITDA multiple is analogous to a TEV/TCF multiple for a smaller, private tower company, given that a large company would not need to adopt the overhead of the smaller company in an acquisition. The mean TEV/EBITDA multiple is 15.4x, as of 9/30/09. The mean net debt/EBITDA is 5.3x.
The mean Total Enterprise Value to Unlevered Operating Free Cash Flow multiple is 19.4x, implying a UOFCF yield of 5.2%. If we add a long term UOFCF growth rate of 5% (a little better than the mean of our 10-year high and low case to account for modest margin improvement), we arrive at an implied cost of capital of 10.2%. That is a reasonable return for a public company with the low risk profile of the tower business model.
Historical trading multiples
The rise and fall of tower multiple clearly mirrors the rise and fall of the credit bubble / securitization market. Tower companies began issuing mortgage backed securities at very low interest rates in the mid-2000s. When that market dried up, valuations came down. Simple as that.
Note: Multiples are adjusted for AMT’s acquisition of Spectrasite in September 2005 and CCI’s sale of its UK subsidiary in June 2004.
Potential Technology Advancements that could pose significant risks:
Satellite Transmission: Capacity enhancements, particularly low earth orbit satellite transmissions could pose potential risk to the tower industry. AT&T signed an agreement with a commercial satellite company, TerreStar, which plans to launch a satellite into space that could pick up signals from specially enabled phones. If satellite phones became reliable, the focus could shift from towers to satellite communication. However, even if the satellites were to successfully launch, it would take several years to change phones/service plans.
Femtocells: Femtocells are essentially small cell phone towers that allow service providers to extend service coverage indoors to improve cellular and mobile data reception in a home or business. Femtocells and Internet calling over Wi-Fi networks, including Mesh Wi-Fi or municipal Wi-Fi could offload some minutes from the traditional wireless networks and potentially reduce the need for carriers to enhance network capacity. Femtocells appear to be as much a complement to wireless networks as a threat since they pull customers away from traditional landline service toward mobile.
Distributed Antenna Solution: DAS is a relatively new technology that could be a threat that could reduce the need for wireless carriers to locate equipment on towers. Outdoor DAS solutions deliver coverage in locations where towers are not a viable option. Indoor DAS can be build in a building (ex. Casino or mall) as a wireless infrastructure that works with all service providers and frequencies.
Software Defined Radio (SDR): Traditional hardware based radio devices limit cross-functionality and can only be modified through physical intervention. This results in higher production costs and minimal flexibility in supporting multiple waveform standards. By contrast, software defined radio technology provides an efficient and comparatively inexpensive solution, allowing multi-mode, multi-band and/or multi-functional wireless devices that can be enhanced using software upgrades. The use of these technologies allows new wireless features and capabilities to be added to existing radio systems without requiring new hardware. By using a software reconfigurable hardware platform, a single radio and terminal can support a variety of terrestrial, satellite, and line-of-sight (LOS) waveforms.