It is early in the baseball season, and Chicago-based Wells Fargo Securities is already saying “wait until next year.” But they are not talking about the Cubs. It is the 5G Ramp.
With AFFO multiples at a two-year high (five-year high for American Tower), the tower sector rating was ready for a downgrade to Market Weight from Overweight. American Tower’s shares, in particular have been downgraded from outperform to market weight. However, the firm is still recommending Crown Castle.
The risk/reward strategy may not be working at the current valuations of low 20s X AFFO, according to the firm’s Communications Infrastructure & Telecom Services Equity note. And there is something else. Expected growth among the public tower companies in the first quarter has been more conservative than originally thought.
“Recent checks have indicated that while spending has continued, it has not realized the growth that was hoped for in 2019,” Jennifer Fritzsche, senior analyst, wrote. “We believe spending will ramp in 2020 but much has to be digested before this can be seen. We struggle to see near-term drivers for further multiple expansion from these levels.”
Among the near-term issues impacting wireless carrier spend, are shortfalls in the AT&T FirstNet/One Touch initiative and general Verizon tower spend. T-Mobile maintains its 600 MHZ coverage buildout, buy has slowed on the capacity site rollout because of the proposed Sprint merger.
Wells Fargo still believes the fundamentals in the tower sector are healthy in the future. But for now, 4G still rules.
“All contacts agree there is pent-up demand and movement will be seen and look for 2020 spend to be better than 2019,” Fritzsche wrote. “We believe most of the spending that the carriers are doing today with the macro tower players are more centered on 4G initiatives than anything related to 5G.”
Despite the 5G talk, investment in LTE will see plenty of runway in 2019, which is leading to more new tower builds, tower executives say. T-Mobile is building coverage sites for its low-band 600 MHz and 700 MHz spectrum, and AT&T is contemplating a network improvement project as well as its FirstNet-related project. Both of which involve ample new sites, Alex Gellman, CEO, Vertical Bridge, told AGL eDigest.
“We are in a renaissance period for good old macrotowers in the next few years ahead of 5G,” Gellman said. “The reason I feel that way is we are seeing a lot of rings for new towers. The economics and speed of collocations is hard to beat, but there will be new builds as well.
Ron Bizick, CEO, Tarpon Towers, described the new-build business as “vibrant.” It is bringing good times to the independent tower companies.
“There are a lot more towers being built in the rural areas to fill out the white spaces, particularly for AT&T’s FirstNet,” he said. “We are seeing the other carriers build out their coverage, as well. We have targeted some rural areas where we think a second tenant is possible, but only a second tenant.”
With that said, carrier capital expenditures are a quarter-by quarter-question mark. In the first quarter of 2019, tower owners will be looking closely at the capex budgets of AT&T and Verizon after the Big Two pulled back on their spend toward the end of 2018. AT&T’s reduced capex came after the Time Warner deal closed and Verizon shaved $1 billion off its guidance after announcing 44,000 in layoffs last year. Additionally, Verizon had a $4.6B write down of Oath (Yahoo and AOL).
“They pushed capex out at the end of 2018. Was that a trend or a one-time occurrence?” Gellman said. “The layoffs and the write down may be a signal a greater focus on the network in the future.”
Last year’s big story, the Sprint/T-Mobile merger, is carrying over to this year. It was bad news for some tower companies, which saw Sprint business go away after the deal was announced. Gellman believes the quiet surrounding the deal is a portent for its blessing from the Department of Justice. In the long run, he believes the merger will be positive for the industry.
“Sprint has not spent on its network in a meaningful way for a number of years, while T-Mobile has been very aggressive,” he said. “A stronger, larger T-Mobile will be excellent for our industry. T-Mobile is solely focus on its network, while AT&T and Verizon have other places to put their capital and have sometimes invested elsewhere than in the network. If T-Mobile is the same size as AT&T, it will be more difficult for it to do that.”
Jennifer Fritzsche, senior analyst, Wells Fargo, believes the Sprint/T-Mobile merger will go through in the first half of 2019. “Our regulatory checks suggest that the DoJ/FCC approval process has been relatively drama-free thus far,” Fritzsche wrote in an Equity Research note. “We do, however, believe that T-Mobile will have to divest assets – most likely spectrum – to receive approval. The New T-Mobile plans to create a more scaled, viable competitor to AT&T and Verizon, and help turbocharge the carriers’ push to 5G.”
Towers Still a Wall Street Darling
Fritzsche has written that the towers will be remain a compelling investment for shareholders 2019, despite the possible Sprint/T-Mobile merger. Tower stocks beat the S&P index in 2018 (+4.9 percent vs. S&P -6.2 percent), and in 2017 (+40.4 percent vs. S&P +19.4 percent).
“Even with these recent moves, we believe towers will remain very topical in 2019,” Fritzsche wrote. “In our view, there exists a number of tangible catalysts (i.e., FirstNet, T-Mobile’s 600 MHz deployment, 5G densification efforts, edge computing, etc.), which should more than offset expected choppiness in international markets (particularly India) and impact from carrier M&A (namely Sprint and T-Mobile) in the short term.”
Carrier leasing activity, which has grown year over year in recent quarters, is expected to continue to increase in the coming 12 months, according to Fritzsche.
“There is much ‘naked spectrum’ that has yet to be deployed (600 MHz, FirstNet 700 MHz, AWS-3, WCS, 2.5 GHz, mmWave, etc.) – where towers will clearly play a role,” she wrote. “Most deployments are part of multi-year strategies designed by the carriers and complement what they plan to build for densification needs ahead of 5G technology rollouts.”
Wells Fargo Securities reports that it has received several queries about how the proposed tax plan will impact the wireless industry. To begin with, carriers such as AT&T and Verizon would see effective tax rates decrease from 35 percent to 20 percent, as well as favorable tax deduction changes.
“Many in our telecom space will benefit from the proposal to allow companies to take a full tax deduction for capital expenditures given the capital-intensive nature of our industry,” wrote Jennifer Fritzsche, senior analyst. “AT&T has indicated if tax reform is implemented it will spend an additional $1B in capex. We would not be surprised if other companies pulled forward some investment to take advantage of this significant tax deduction.”
Since American Tower and Crown Castle International and SBA Communications have become Real Estate Investment Trusts (REITs), Fritzsche commented that there is are positives in the bills for REIT investors as well.
“We think there are several positives for REITs,” Fritzsche wrote. “For one, the Senate and House bills have proposed to lower the dividend tax rate on REIT income to ~25-30 percent (from the ordinary income tax rate of nearly 40 percent). Furthermore, tax reform could pull forward the investment cycles of many data center/tower customers.”
February 16, 2017 — Applauding Communications Sales & Leasing’s (CSAL) REIT structure, dividend yield and diversified growth strategy, Wells Fargo Securities announced today that it has commence coverage with an outperform rating.
“We expect CSAL to show nice organic growth in its fiber segment (Uniti Fiber),” wrote Jennifer Fritzsche, senior analyst. “By having many ‘tools’ in the tool box, the CSAL model should appeal as a new vendor of choice for wireless carriers as they move forward with their respective network densification initiatives.
Wells Fargo Securities believes CSAL will grow its tower portfolio network densification build-to-suit (BTS) contracts in concert with its fiber optic network buildout.
“Importantly, CSAL views towers as complementary to its fiber services and would expect any BTS opportunity to be linked to fiber contracts,” Fritzsche wrote. “We would expect CSAL will become more active in the tower sector throughout 2017 and beyond.”
CSAL acquires and constructs both wireless and wireline communications infrastructure. It currently owns 4.2 million fiber strand miles, 468 wireless towers and other communications real estate in the United States and Mexico.
“[CSAL’s] diversification is driven by opportunistic M&A,” Fritzsche wrote. “CSAL is focused on acquiring and constructing mission critical communications infrastructure, with priority being fiber (61 percent of pipeline), towers (22 percent), ground leases (13 percent), and consumer broadband (4 percent).
July 6, 2016 — Verizon Telematics, whose “hum” consumer vehicle connectivity business contributed 176,000 connected device adds in Q1 of this year, has purchased Telogis, a fleet navigation Software-as-a-Service (SaaS) provider with distribution through Ford, General Motors, Hino, Isuzu, Mack and Volvo’s Class 8 truck unit.
“This unit should serve as a nice complement to VZ’s [consumer vehicle] telematics division,” wrote Jennifer Fritsche, senior analyst, Wells Fargo Securities, wrote. “We believe this acquisition represents an interesting strategic move to ramp up its scale in the telematics space.”
Verizon’s purchase of Telogis will create one of the largest telematics company in the United States and it marks the first time a wireless company has bought a telematics concern, according to Fritzsche.
“But we do not think it will be the last. The telematics industry is highly fragmented with many smaller players funded by venture capital. We expect to see additional consolidation among these players to scale their platforms and appeal to a wider base of customers,” she wrote.
Terms of the transaction have not been disclosed and it is expected to close in the second half of 2016. PJT Partners and Wells Fargo Securities, LLC acted as financial advisors and Debevoise & Plimpton acted as legal advisor to Verizon. Barclays and J.P. Morgan acted as financial advisors and Paul Hastings acted as legal advisor to Telogis.