American Tower: 5-star wireless buy

by James Moorman, S&P Capital IQ Equity Analyst, S&P The Outlook

This week’s Focus Stock of the Week is American Tower Corporation (AMT), which carries S&P Capital IQ’s highest investment recommendation of 5- STARS, or Strong Buy.

American Tower Corporation operates the largest independent portfolio of wireless communications and broadcast towers in North America, based on the number of towers and revenue.

A market leader in the wireless tower industry, AMT has a significant position in the U.S. and internationally. Through a stream of international acquisitions, its international portfolio now accounts for 46% of its total towers.

Due to its use of long-term contracts and annual rent escalations of 3%-5% in the U.S., we think that AMT has high revenue visibility.

Meanwhile, we believe that increasing data usage and market buildouts from the 700MHz spectrum auctions will provide an additional revenue boost over the next couple of years.

In the U.S., wireless penetration is roughly 102%, and we believe that subscriber growth could begin to slow. However, in our view, voice and data usage will rise at a strong pace, as U.S. carriers begin to incorporate unlimited data plans.

We think data revenue as a percentage of average revenue per user (ARPU) is in the thirties, but will grow at a solid pace as 4G networks roll out and more 4G smartphones and tablets are introduced.

Increased data usage typically means that carriers must either boost capacity at current cell sites or add additional cell sites, with both options likely resulting in increased revenues for AMT, in our opinion.

American Tower recently gained real estate investment trust (REIT) status for its U.S. operations. In converting to a REIT structure, the company paid out $0.35 per share to existing shareholders on December 23, 2011.

We believe the conversion to a REIT will allow AMT to minimize taxes on its real estate assets and distribute cash flow to investors, yet still drive growth and repurchase shares.

While the company will be required to distribute at least 90% of its pretax profits from its real
estate assets, we believe AMT had roughly $1.0 billion in net operat-ing losses (NOLs) in 2011 that can be used to offset pretax income and reduce the total amount of distributions.

In our view, the combination of AMT’s solid revenue growth, high EBITDA margins (we estimate 64.8% for 2011), and significant NOLs will allow it to distribute cash to shareholders while continuing to invest in the company.

Internationally, we believe that AMT is seizing opportunities to expand at a rapid pace.

It has progressed from roughly 7,021 international towers, or 25.7% of AMT's tower base at the end of 2009, to 18,466 international towers and exposure to eight foreign countries — roughly 46.2% of its total tower portfolio and 26% of revenue — by the third quarter of 2011.

We expect the company to keep expanding in these countries as emerging markets tend to have lower wireless penetration rates and are still rolling out 3G networks.

Our 12-month target price of $76 is largely based on 22-times our free cash flow estimate for 2013. The target price also represents an enterprise value of 17-times our 2013 EBITDA estimate, above the industry average.

We believe this premium is warranted by our view of AMT’s ability to increase cash flow generation faster than its peers.

Risks to our recommendation and target price include slower demand in the tower lease business if carriers begin to cut back on spending, and difficulty servicing AMT’s $5.8 bil-
lion of debt obligations.

There is also a degree of customer concentration as AMT’s three largest customers accounted for 51% of 2010 tower revenue.

We view American Tower as well positioned to benefit from the global growth in wireless services. We also believe the company’s REIT status will help it to minimize its tax liability, attract new investors, return cash to shareholders and continue to grow internationally.

With our target price indicating potential appreciation of 23% from current levels, our recommendation is Strong Buy.

Learn more about this financial newsletter at S&P The Outlook.