Tower Sector Report
In the following excerpt from the Wall Street Transcript's Telecommunications Equipment issue, Clayton Moran, Stanford Group Company, discusses the outlook for the tower sector.

TWST: Looking back at 2008, how would you characterize the business in the tower space?

Mr. Moran: The communication towers business has been strong for many years now, benefiting from sustained network development by the largest wireless carriers. Wireless carrier network deployment is driven by consumer usage of their wireless products which has shown steady growth. What we are currently seeing is, as subscriber growth has slowed down a little, usage trends have remained strong. For instance, the use of wireless data services grew about 50% in 2008 and now represent over 20% of carrier revenue per user. This is, in part, due to e-mail, text messaging and Web surfing on traditional handsets, but is also largely driven by smartphones, which are making Web surfing and watching videos and TV and other things much easier and more compelling for users. So the demand from wireless subscribers is driving wireless carriers to invest in their networks by building new cell sites, therefore driving good growth for tower companies.

TWST: So there was no interruption in 2008 despite the financial issues and the economic slowdown?

Mr. Moran: It's interesting because what we have seen from the macro economy is two things - one, a credit crunch, and two, a severe recession. The credit crunch does impact the tower stocks, but the recession does not impact tower cash flow. Tower cash flow appears largely, if not completely, immune to the recession due to towers' positioning as a mission critical service provider for wireless companies. For instance, the recession is unlikely to cause Verizon Wireless and AT&T to remove or reduce the size of their wireless networks. But the credit crunch and the limited credit availability does impact tower balance sheets and tower valuation multiples.

Over the past year, tower cash flow has grown steadily, but tower stocks have declined about 50%. The drop is due to investors' fear that tower companies will have a hard time rolling over their debt and getting attractive debt terms, and also because the overall stock market has seen significant valuation multiple contraction.

TWST: Have they been able to raise the capital they need?

Mr. Moran: Yes, but at elevated prices. Crown Castle (CCI) rolled over its credit facility in late December 2008, paying 8%-8.5% interest, up from 4% or so. Crown Castle has about a $170 million drawn on this credit line so it is relatively minor compared to its $5.6 billion of debt. But the refinancing of this credit line was the first test of the credit markets for the tower companies since this credit crunch began. We view the outcome as positive, given the severe reduction in access to credit. We also believe that resilient tower cash flow will enable relatively attractive terms in the future.

There is no major tower refinancing risk in 2009. There is only one small tranche Crown Castle has coming due of $294 million. SBA Communications (SBAC) and American Tower (AMT), the other two public tower companies, don't have any refinancings in 2009. Therefore, the risk is distant. It primarily starts in 2010, yet investors have been very concerned about what the potential impact is on towers.

TWST: So in this kind of an environment, hiding out is I guess the first thing investors do. With lack of knowledge, they stay on the sidelines.

Mr. Moran: Yes, I think with so much uncertainty around the availability and cost of debt, investors have fled to the sidelines in a lot of different stocks. That's happened with the towers as well.

TWST: As you talk to the companies, what's their attitude? What are they thinking about at this point?

Mr. Moran: They see strong trends in their core business, just as we do. So I think, to some extent, mid-level tower executives are probably scratching their heads right now because their cash flow remains resilient and their growth outlook strong. The C level executives are very much aware of the credit environment. I think they are certainly disappointed in the way the stock market has treated their stocks, but they recognize that there's a lot of uncertainty and a lot of credit concern in the overall marketplace. At the same time, tower Chief Executives and Chief Financial Officers recognize that tower cash flow is like an annuity or it's probably the closest thing you'll find from a public company, because their underlying tenants, Verizon Wireless, AT&T and others, are on five-year to 25-year contracts. Basically they are 25-year contracts that renew every five years automatically. So the revenues that come from these contracts are as highly recurring as you'll find. So if you think of the business and what lenders seek in a borrower, this would be as good as lenders could find. As such, the leaders of the tower companies are probably a bit perplexed that things have gotten so bad that lenders and investors are questioning their ability to repay debt down the road.

TWST: Are there any signs that the telecom companies are cutting back on infrastructure building because of the economy?

Mr. Moran: Yes. Sprint and AT&T have indicated that they will pull back a little bit, and I think it's likely that we'll hear from other telecommunications companies that capital spending will be reined in somewhat. If you look at the natural progression of a recession, sometime after you see the consumer impact, you typically see capital spending from businesses decline as well. But we believe that AT&T and Sprint and those types of companies will pull back on wireline spending and spending in other areas outside of wireless since wireless has been their strongest profit driver.

In addition, if you look at the two largest wireless companies, AT&T and Verizon Wireless, we think they're unlikely to pull back on wireless spending - AT&T because of the launch of the iPhone and the resulting network demands, and Verizon because they are historically very steady in building out their network. So the two biggest wireless companies are unlikely to reduce capital expenditures. As such, we doubt that the tower growth outlook will change.

TWST: What kind of growth do you see for the tower companies over the next couple of years?

Mr. Moran: In 2008, tower organic revenue growth was about 10%. In 2009, it'll probably be more like high single digits, 8% or so, and probably will taper off over the upcoming years in part because of the magnitude of the industry.

Tower companies have very strong operating leverage. Once the tower is built, the cost associated with operating that tower is pretty much fixed and as tenants are added - say, Verizon to a tower that already has AT&T as a tenant - the margins improve dramatically. As a result, the largest tower company today, American Tower, has gross margins over 75%, and those are improving every quarter. While revenue growth is not as high (15% or 20%) as you'd like from growth companies, cash flow growth is very strong as a result of the superior operating leverage. Furthermore, free cash flow per share growth should be robust as well, even in this credit environment. Free cash flow per share should grow at 20% or better for these companies in 2009. So the growth characteristics remain very attractive.

This brief excerpt is from The Wall Street Transcript's just published Telecommunications Equipment issue, a report offering a timely review of the sector to investors and industry executives. This 121-page feature contains a roundtable forum and industry commentary through in-depth interviews with top management from 22 firms and 3 analysts. The full issue is available through  The Wall Street Transcript Online.