After over two years of declining organic growth for U.S. tower companies, we are finally coming out of the trough in new leasing activity. New Street Research see an onslaught of amendment activity on the horizon as U.S. carriers rapidly deploy four new spectrum bands, beginning in earnest in the latter part of 2017. We maintain a detailed, carrier-by-carrier network deployment model, in which we estimate the cadence of colocation and amendment activity for the U.S. carriers, and use these estimates to drive U.S. tower revenue growth. Our model suggests that U.S. gross organic growth should increase by 150-200bps in 2018 and 2019. We think investors are missing this acceleration in growth. Rising activity levels should cause consensus financial estimates to rise, which positions the stocks well to outperform over the next several years.
Where we are in the cycle
After steadily declining for over two years, gross organic growth showed a slight acceleration in the first quarter of 2017. The multi-year slowdown was driven by a lull in activity following the deployment of LTE from 2010-2014. Over the past two years, the big four carriers have spent a total of ~US$40bn on acquiring spectrum, which they are gearing up to deploy en masse beginning in the back half of 2017. See exhibit one.
Exhibit one - US towers gross organic growth
Four new spectrum bands are coming (at least)
There are four key spectrum bands that we expect to be deployed over the next five years in the U.S.: AWS-3 (1.7/2.1 GHz), WCS (2.3 GHz), Broadcast (600 MHz), and FirstNet (700 MHz). Additionally, DISH has a treasure-trove of spectrum, spanning four bands (AWS-3, AWS-4, PCS H-Block, 700 MHz E-Block), a great deal of which must be deployed before 2021. Carriers have already deployed bits of AWS-3 and WCS; however, the vast majority of sites will only begin to be touched in the latter half of 2017.
The number of amendments will nearly double in 2018
Our detailed, carrier-by-carrier deployment model suggests that the number of sites amended by US carriers will increase in 2017 over 2016, and then will roughly double in 2018 over 2017, driven primarily by the deployment of AWS-3, WCS, and FirstNet spectrum. We also layer in 600MHz spectrum deployments from 2019-2021; while these don’t add much to growth, they will sustain high levels of amendments for years to come. We haven’t included the deployment of DISH’s spectrum into our estimates yet; however, given the timeline of their buildout requirements, the deployment is highly likely over the next five years. See exhibit two.
Exhibit two - US amendments at major carriers
Amendments could fetch US$500 / month (at least)
The pricing of these deployments is difficult to gauge for three reasons. First, each spectrum band may require different amounts of equipment depending on what equipment already exists on the tower. Second, FirstNet spectrum is not owned by AT&T, and tower companies may be able to charge more for the deployment of unowned spectrum bands. Third, because carriers are deploying multiple spectrum bands at once, they may be able to negotiate a bulk discount. We typically assume that each piece of equipment on the tower costs $100 / month; and we estimate how much equipment will be required for each spectrum band. On a blended basis, we estimate the amendments over the next five years will be priced at a rate slightly higher than $500 / month, though we believe this may be conservative. See exhibit three.
Exhibit three - New Street amendment pricing expectations
We expect gross organic growth to rise 150-200bps in 2018
When we factor in the pending wave of amendments alongside largely fixed escalators of 2.5-3.5%, we believe gross organic growth will accelerate to 8-9% in 2018 and 2019, up from current levels of 7-8%. This may seem like only a modest increase; however, the towers have high operating leverage (90% incremental EBITDA margins) and high financial leverage (4.5x-7.5x net debt / EBITDA), so a small inflection in revenue will drive a significantly larger improvement to AFFO. We do not think investors are appreciating the magnitude of the acceleration of organic growth that will benefit the towers. New Street Research believe the improving underlying fundamentals will drive upside to financial estimates, which will support strong stock performance over the next several years. See exhibit four
Exhibit four - New Street gross organic growth
Spencer Kurn
Spencer Kurn is a founding partner of New Street Research, LLC, and heads tower company research for the organisation. Prior to starting New Street in 2012, Spencer was a member of the Telecom Services Equity Research Team at Credit Suisse. Prior to joining Credit Suisse, Spencer was a generalist investor on the International Equity Research team at Putnam Investments. Spencer holds a B.A in Economics from the University of Pennsylvania.
