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The investment case for American Tower is a solid one built on steady annuity-type income with increasing revenue from emerging markets.

Whenever we think of telecommunications companies, we tend to think of the large network carriers like Vodacom and MTN; or in the US, AT&T and Verizon. Seldomly do we think of the underlying infrastructure that supports those carriers.

Surely these large mobile network providers own and operate the infrastructure they use. Right? Wrong. Well, mostly wrong. Our focus in this issue is US-based and New York-listed American Tower (with share code NYSE: AMT), which owns and operates around 175 000 cell phone towers around the world.

Let’s start with surveying the landscape and building an understanding of what we’re investing in. Voice and data from your mobile device make its way to other devices via networked telecommunications equipment installed on cell phone towers (cell towers).

A cell tower, in its most basic form, is a tall structure built to host the networking and transmission equipment of multiple cellular network operators.

Basically, the cell tower houses the “routers” that your phone connects to and uses to gain access to the cellular network.

As time has passed, newer“generations” of data technology has enabled us to do so much more than we ever imagined possible. With each new generation of data technology (3G, 4G, and now 5G), comes the need for higher-frequency radio waves (so-called spectrum), which facilitate more and more efficient data consumption.

3G technology enabled anyone to surf the web, while 4G allowed us to stream high-definition video seamlessly. Now 5G is going to make data transmission even faster, enabling autonomous vehicles and improved cloud-gaming experiences and who knows what else.

In essence, as we create more advanced technology and improve our ability to send and receive more and more data, so our use of and demand for data increases, exponentially. For instance, when we moved from 3G to 4G, people went from surfing the web to streaming Netflix, thus increasing their data consumption by over 1 500% (see graph 1).

Data, and the ability to send and receive it, is big business. Also, data consumption per person is projected to increase by 35%per year for many years to come. Of course, the biggest risk the telecommunications companies has is that they cannot keep up with demand.

If they don’t have enough networking equipment on enough towers to create enough coverage, they will lose customers due to poor coverage and connectivity issues. This, of course, forces them to constantly add transmission capacity and new cell towers.

Defensive business model

Tower companies make money by leasing vertical feet on their towers to network operators, who need a place to install their signal transmission and reception equipment. This essentially makes them landlords, with three responsibilities: the land the tower is on, the tower structure itself, and maintaining a backup power source to ensure functionality if there is a power cut.

The mobile network operator is responsible for everything else, from the transmission equipment to the fibre connections. The only thing the tower company must do, is ensure that its three responsibilities are met. Moreover, each cell tower can accommodate the equipment of four different mobile network operators.

This means that often, tower companies such as American Tower can be structured as real estate investment trusts (Reits). As we know, Reits are companies that own, operate, or finance income-producing real estate and generate revenue by leasing out the properties they own. In the US specifically, Reits are required to pay out 90% of taxable income as dividends.

This basically means that companies like American Tower are a great source of income via dividends.

Considering that the average term of a cell tower lease agreement is between five and ten years, income is stable and predictable.

American Tower usually has an annual rental increase clause in these lease agreements that increases rent by 3% a year.

That is great, although the fact that so many towers need to be fitted with new equipment to now accommodate 5G transmission equipment means that mobile network operators need to negotiate ‘amendments’ to their lease agreements. This is nothing out of the ordinary either and usually these amendments see a 5% increase in annual rental fees.

In other words, even if technology stands still, tower companies like American Tower will have predictable earnings growth. If technology keeps advancing, and with the imminent global rollout of 5G networks, that earnings growth is highly likely to be higher than what is factored in already.

Read more
This article originally appeared in the 18 February edition of finweek. You can buy and download the magazine here.

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