Is it 2010 again? That was our first thought when we saw the announcement this past week that Verizon was expanding FiOS in Boston. Specifically, the carrier announced it would be “replacing its copper-based infrastructure with a state-of-the-art fiber-optic network platform across the city.”
The company will invest $300 million in the project in six years (remember Verizon is big customer of Dycom Industries, a fiber installation engineering company). Verizon is already technically IN Boston but in a very limited way (get ready Dorchester they are coming your way!).
Boston is an interesting city because in addition to being one of the donut holes of Verizon’s FiOS footprint (Baltimore is too), it has been a city they have talked a lot about when it comes to its wireless small cell push. I don’t think this is a coincidence. Fiber is KEY to its small cells and VZ is very serious there.
So while wireline is still important to them, no question. Math would dictate (remember wireline for Verizon is less than 10 percent of its combined operating income) many of these recent “wireline moves” by Verizon (think XO acquisition, FiOS push, etc) may be more related to wireless than anything.
EDITOR’S NOTE — Fritzsche is the senior analyst/managing director of Wells Fargo Securities. This is an excerpt from one of her Equity Research notes.
April 5, 2016 — Compounding towers’ current growth worries is the anger of the carriers concerning rising escalator costs, usually set at 3 percent annually, according to Jennifer Fritzsche, Wells Fargo senior analyst. AT&T has openly criticized the tower model, saying that if the carrier is growing at only 1 percent, it doesn’t want a vendor growing faster.
“In the case of AT&T and Sprint, there is almost a perfect storm surrounding the public tower companies. Although I have followed AT&T for 17 years, I have never seen them publicly comment on a vendor so angrily, as they have the tower companies,” Fritzsche said in an arm chair interview with AGL Magazine’s executive editor and associate publisher Don Bishop at IWCE’s Network Infrastructure Forum, held last month.
Fritzsche noted the speculation that AT&T may be attempting to bypass the major public tower companies with their requests for proposals.
“Some say that AT&T is trying to muscle some of the smaller tower companies into lower escalations,” Fritzsche said. “The tower companies clearly have leverage with existing macro sites, but new incremental sites that are coming, if there is a purposeful move around the public tower companies, that is somewhat alarming.
“Part of this is probably posturing, because they are currently negotiating master leasing agreements with the two largest tower companies, but you have woken up the sleeping bear,” she added.
Fritzsche, who is a sell-side analyst, spoke about her March 4th downgrade of the tower sector and how it was misconstrued by some as being a negative judgement of the tower industry. Her actions — she kept American Tower at a buy, moved SBA to a hold and kept Crown at a hold – were based on the short-term prospects for revenue growth, she said.
“Will these stocks move quickly? I didn’t think they would. I don’t see the catalysts for this group in the near term,” Fritzsche said. “I would characterize it as a holding pattern. The carriers, which I follow, have a lot to digest right now. They just spent $45 billion at the AWS-3 auction, and they have the broadcast incentive auction coming.”
The timing of AT&T’s return to capex growth in towers is the subject of much uncertainty, according Fritzsche. “With one of the major customers of the tower industry not moving quickly, I did not see the upside of the revenue estimates that I have in place for the tower sector,” she said.
Deploying fiber in the ground is currently dominating AT&T’s capex, and it follows an industry trend toward using fiber to support wireline over the top (OTT) services, small cell deployment and macro backhaul.
“I don’t see that changing right now. They view fiber as the critical element to support, not only the OTT broadband connection, but longer term as the plumbing that will undergird the strength of their wireless network,” Fritzsche said.
While some criticized the AT&T/DirecTV deal, Fritzsche said he she liked the media play quite a bit. “Although linear TV is experiencing downward pressure, more video is being watched than ever through over the top (OTT) services and on mobile devices. Now, AT&T has a hand in each honey pot,” she said. A healthy AT&T will be good for towers in the long run.
January 7, 2016 — Because of the new economics of providing wireless services, carriers no longer believe the current tower leasing model is sustainable, which may lead to a divergence from the traditional business model for renting space on towers, according to some in the industry.
“As the wireless industry continues to mature and carriers increasingly compete on price, revenue growth has slowed and profit margins have been squeezed. Carriers’ costs have increased due to the rapid growth in spectrum prices, tower rent escalators and tower rent increases related to the rollout of new technologies,” said Ronald Bizick II, CEO, Tarpon Towers.
As a result, carriers are looking to change the traditional tower leasing model in order to control their costs and align tower owners’ interests with their own.
“Carriers may be somewhat stuck with their current and legacy deals with both big and small tower companies, but I expect to see the carriers increasing downward pressure on rents and escalators on both new collocation and BTS leases,” Bizick said. “I think we are on the verge of the next great inflection point in the evolution of tower ownership and leasing.”
Wells Fargo Securities has done some research that has shown that AT&T is attempting to move some towers to secure lower rates.
“While we believe this is unlikely to happen, it seems to us that AT&T is showing a bit more ‘muscle’ with the tower companies these days,” Managing Director Jennifer Fritzsche wrote. “This begs the question: if AT&T begins to push back, will Verizon likely follow? A large portion of the tower companies’ recent growth has been driven by amendments. If the two largest wireless players begin to challenge these economics, it could impact the tower companies’ top-line growth rates.”
Alex Gellman, CEO, Vertical Bridge said the pressure on escalators from the carriers is only logical considering the economic environment. The tower industry needs to make adjustments accordingly.
“The more efficient the tower industry can be, lowering our costs, the better. That will allow us to help them address their costs,” he said. “Fundamentally, we are in the real estate business. If you have good locations, they will pay reasonable rent and stay a long time.”
The extent to whether the carriers can be successful in changing the tower leasing business model is not an issue in the short term. In the long run, however, the evolution of the tower leasing model could have a profound impact on tower companies, especially public companies.
October 16, 2014 – The timing, really, could not be worse. Unless you are a stockholder, of course. In the middle of performing due diligence and possibly raising debt and equity for a bid on Verizon’s towers, Crown Castle is facing tension among its investors.
Activist investor Corvex Management, which owns a $1 billion stake in the tower company, has told the tower company it must “correct its capital allocation plan” and reduce its cost of capital before it bids on the 12,000 tower portfolio.
In a letter to shareholders, the investment advisor said Crown Castle would be the best positioned bidder from a strategic standpoint but not from financial point of view, because its stock price is depressed.
“We believe Crown Castle’s current capital structure and capital allocation plans taken together are sub-optimal, and that the combination of de-levering the balance sheet while maintaining an artificially low payout ratio has pressured the company’s valuation and led to Crown Castle trading at a discount to its peers,” Corvex wrote.
To improve its valuation, the tower owner should either begin paying more than $4 a share in quarterly dividends or pay $1.60 per share in dividends combined with ongoing buybacks, according to Corvex. These capital allocation changes would drive a 27 percent re-rating of equity in the short term and possibly a 60 percent improve in the long term, the investor asserts.
“Once the company’s equity currency has strengthened, Crown Castle can aggressively pursue a Verizon towers transaction, creating even greater long-term value for shareholders. However, if the company does not have the right cost of capital, it should not be pursuing acquisitions or issuing equity, whether for Verizon’s towers or any other transaction,” Corvex wrote.
Corvex believes “excessive equity funding” was used by Crown Castle last year in its purchase of AT&T’s Towers for the “relatively high price” of $4.85 billion for 9,700 sites.
“It is critical that the company avoid a similar stumble in any potential Verizon transaction,” Corvex wrote.
Corvex noted that a higher payout ratio would increase Crown Castle’s appeal to REIT investors, while also attracting yield-oriented investors.
Jennifer Fritzsche, senior analyst, Wells Fargo Securities, expects Corvex’s letter and the two options to be well received by shareholders.
“We believe the shift toward increasing its payout ratio, coupled with the recurring nature of its dividend secured by the Big 4 wireless carriers, would be viewed positively by yield investors,” she wrote.
Crown Castle acknowledged that it had received the Corvex letter and said the tower company plans to address capital allocation policy, including dividends, on its 2014 third quarter earnings call scheduled for October 31, 2014.
“We receive input from many of our shareholders on a regular basis, and we welcome the dialogue and perspective,” Ben Moreland, Crown Castle president and CEO, said in a prepared statement. “Over the last decade, we have returned more than $3 billion in capital to shareholders through share purchases and dividends. We continually review our capital allocation strategy and consider all input from our shareholders as we aim to create long-term shareholder value.”