The question clients ask Nick Del Deo most often about investing in shares of companies that own telecommunications towers is whether such purchases represent an opportunity, given that the stocks look reasonably fully valued. An analyst who covers communications infrastructure at MoffettNathanson, Del Deo spoke at the Connectivity Expo conducted by the Wireless Infrastructure Association on May 22 in a session about the investment outlook for towers and infrastructure. Del Deo said people have pegged attractive valuations to what they saw on the wake of the 2016 national election. He said that was a once-in-a-generation opportunity.
“The bull case from here is the same as where it has been over the sweep of the industry’s history: You put up consistent growth for a long period, you generate attractive marginal returns and they don’t get computed away,” Del Deo said.
“When we model these things, we assume some sort of terminal growth rate of a couple years out,” Del Deo said. “It’s a beat-the-faith story. Invariably, the industry puts up growth that’s better than that for a longer period. Although stock prices may look expensive in the near term, they do not look undervalued. If you have a long-term outlook, it seems as though you could make money over time.”
Del Deo said that, ahead of 5G wireless communications network deployment, wireless carriers have not been able to justify the cost of the deploying 4G as prices for the consumers continue to race to the bottom, especially between T-Mobile US and Sprint. He said if you look at the returns on invested capital that the carriers have generated over time, and more specifically at the economic profits, the spread between the return on invested capital and the cost of capital times the amount of money that the wireless carriers have put to work in the business has been flat for five or six years. That period coincides with 4G deployment. He said the wireless carriers make excess returns, but they haven’t increased their returns over time.
The result obtained by the wireless carriers with 4G has implications for 5G, Del Deo said. “If they haven’t been able to monetize 4G, what would make them think they can monetize 5G?” he asked. “What’s different about 5G? When you consider who actually made money with 4G, it was Google and Facebook. I don’t know how you would split up those numbers, but I am highly confident that the profits Google and Facebook generate from using the 4G networks are far higher than what the carriers themselves generate.”
With 5G, Del Deo said a similar dynamic probably is at work. When it comes to applications such as autonomous cars, agriculture, or industrial internet of things (IoT), the carriers have absolutely no competence whatsoever, he said. In Del Deo’s view, the carriers’ track record of developing services on top of their connectivity is abysmal. Moreover, he said the carriers function in competitive market so the returns that they earn get beaten away and the profits are generated by others. Despite the carriers’ disadvantage, Del Deo said there is still some meat on the bones, meaning the carriers have incentives to invest, which is good for the tower industry. But he said investors should keep their expectations in check, given the return dynamic.
Business as Usual
“My three words are: business as usual,” Del Deo said. “I don’t mean to be dismissive of 5G as a technology. It obviously enables lots of cool things. When I think of 5G from a tower perspective or the history of telecom, new technologies and new applications tend to sustain the growth rates, traffic and usage that we have seen over time. In that sense, 5G is going to be similar to 4G, 3G, 2G — what we’ve seen in the past. It will lead to continued, relatively steady rates of investment in wireless infrastructure. Regardless of what the allocation is at the edge or who the customer is, the fundamental tenant remains unchanged.”
Speaking about small cells, Del Deo said they are an expensive way to deploy capacity. He referred to pulling fiber-optic cable to every site, the rent per site and the permitting cost, and said the cost for traffic delivered by a small cell is generally far more expensive than traffic delivered by a tower. He said the difference has important implications for network architecture, whether it is 4G or 5G. There are certain applications for 5G at certain spectrum bands that will have to rely on small cells, Del Deo said.
To the extent that carriers can, Del Deo said, they will default to towers, not to small cells, because towers are cheaper, the carriers are capital-constrained and they care about their returns. He said MoffettNathanson conducted a study to tag several thousand small cells down to the census tract level. He said the study found that small cells are overwhelmingly deployed in the highest decile of census tracts for population density, which is what you would expect, as well as income.
“Carriers are not deploying small cells in high-income areas because they want to serve wealthy customers,” Del Deo said. “Income and zoning are correlated, so small cells are being deployed in urban areas where traditional towers do not work and are being deployed in tough-to-zone areas where it is not possible to construct new towers. In my view, that says towers are the first choice of the carriers, whether for 4G or 5G.”
Del Deo said that the Citizens Broadband Radio Service (CBRS) frequency band at 3.5-MHz is not a good frequency band for towers to serve. But he said there is a lot of enthusiasm about using it for indoor wireless systems. He said the question is not whether 3.5-MHz spectrum works indoors, but whether the business model that involves building owners using CBRS spectrum to build their own indoor systems works.
Historically, nothing was stopping the building owners from building their own wireless communications systems, except their competency, Del Deo said. He said they do not have experience operating these networks, so it makes sense to hand them over to a specialized operator such as American Tower or ExteNet Systems. Having the new spectrum band available doesn’t change that dynamic, he said.
Because building owners are not experts at operating wireless networks, Del Deo said he suspects that if more RF spectrum becomes available, the number of indoor systems may grow because it would be easier to obtain the spectrum to make them work. But he said that does not necessarily mean less opportunity for those who now specialize in operating those networks.
Sprint and T-Mobile Merger
Turning to the proposed merger of Sprint and T-Mobile US, Del Deo said it differs from past mergers or attempted mergers, primarily on the network integration side. “Historically, we have seen two kinds of mergers, one where an acquiring company retains the bulk of the acquired network to expand density and coverage, and the other where the acquiring company moves the spectrum over and wipes out the legacy network,” he said. “What we have here is a bit of a hybrid. T-Mobile would wipe out a big part of Sprint, but the spectrum bands the two companies have do not line up. A lot of antenna space lease amendment work for tower owners goes along with that.”
Regarding the U.S. Department of Justice (DOJ) review of the merger proposal, Del Deo said the merger already is highly concentrated according to the DOJ’s horizontal merger guidelines. He said the companies take the position that their merger doesn’t reduce the number of competitors from four to three if Facebook, Comcast and others are taken into account. “I don’t really buy that,” Del Deo said. “They don’t operate wireless networks. The cable companies rely on the largess of the mobile operators for access to networks.”
Del Deo referred to the success T-Mobile has had in the wake of a previous merger it intended with AT&T. He said it played out better than they had ever hoped. The DOJ would be aware of that.
In the near term, Del Deo said he did not expect the pending merger to affect the amount of business the two carriers will do with the tower companies. He said if the companies were to change their behavior, they would undercut the argument behind the merger. What he said would not change is capital expense spending, investment levels or competitive intensity.
Del Deo said that despite the companies’ claims, it is conceivable that post-merger, the competitive intensity among wireless carriers could decline, in which case the industry in aggregate would spend less, even if the Sprint and T-Mobile combination spent more.
“The more carriers you have, the greater the degree of inefficiency in the market, which the towers benefit from,” Del Deo said. “If you had one carrier in the market, it would spend less than we have in spending aggregate today. If you had two carriers, they probably would spend less than four carriers spend today. So the question really is: Is there some sort of hump in spending between four and three carriers over the long term? I don’t know the answer, but my hunch is that it’s probably something similar to what we have today, or maybe a little less.”
The next Connectivity Expo is set for May 20–23 in Orlando, Florida.
Executive Editor and Associate Publisher
Don Bishop joined AGL Media Group in 2004. He helped to launch and was the founding editor of AGL Magazine, the AGL Bulletinemail newsletter (now AGL eDigest) and DAS and Small Cells magazine (now AGL Small Cell Magazine). He served as host for AGL Conferences from 2010 to 2012, appearing at 12 conferences. Bishop writes and otherwise obtains editorial content published in AGL Magazine, AGL eDigest and the AGL Media Group website. Bishop also photographs and films conferences and conventions. Many of his photographs have appeared on the cover, in articles and in the “AGL Tower of the Month” center spread photo feature in AGL Magazine. During his time with Wiesner Publishing, Primedia Business Information and AGL Media Group, he helped to launch several magazines and edited or managed editorial departments for a dozen magazines and their associated websites, newsletters and live event coverage. He is a former property manager, radio station owner and CEO of a broadcast engineering consulting firm. He was elected a Fellow of the Radio Club of America in 1988, received its Presidents Award in 1993, and served on its board of directors for nine years. Don Bishop may be contacted at: firstname.lastname@example.org.