American Tower Company: An Operational Beauty in Ugly Masses of Steel!
How a simple operational model has turned a boring business model into a fascinating cash cow.
A darling amongst investors, American Tower has grown to become the largest tower sharing company in the world. As of June 2015, the Company had operations in 13 countries, $32 billion of non-cancellable tenant lease revenues and free cash flows of approximately $2.1 billion. With gross margins of 73% and free cash flow margins of 45%, the Company is an ideal example of an operational model perfectly matching a solid business model.
Operational Model
How has American Tower turned boring masts of steel into one of the most attractive businesses out there? At its simplest, the operational model entails American Tower allowing competing MNOs to house their antennae on f its 97,000 towers. This process of co-habiting antennae, called “collocation,” is enabled by multi-year contracts, which require MNOs to pay monthly fees in exchange for space on towers for the duration of the contracts’ life (typically 10-15 years). A tower needs a single tenant to be operational, with the second and third tenants easily added to the steel structure as shown below. (4)
By managing towers, American Tower allows MNOs to focus on their core business of providing telecommunication services to customers. Customers don’t want MNOs to spend resources managing a portfolio of towers. MNOs are not experts in the real estate or logistics businesses. Instead, customers want to see MNOs focused on the provision of high speed voice and data to their devices.
Business Model
American Tower creates value by maintaining towers and making sure uptime (the percentage of time towers are operational) is as close to 100% as possible. An MNO saves on capex while benefiting from lower opex (a tower can cost as much as $275,000 to build vs. monthly rental payments of $5,000). For its efforts, American Tower has the right to “lease-up” its towers by allowing other MNOs to put their equipment on those towers. In addition, the long term nature of the tenant agreements mean revenue visibility is locked-in, predictable and stable.
Additionally, the unit economics of a tower are impressive. The addition of a second and third tenants sees gross margins jump to 74% and 83%, respectively. This is because the variable costs per each additional tenant are so low that a large fraction of the incremental tenants’ rent goes straight to the bottom line. As a consequence, the ROI) on a single tower can be as high as 74% (please see below for the unit economics with 1, 2 and 3 tenants). (1)
Business and Operational Models: A match made in heaven!
American Tower’s long term strategy is focused on three pillars: (i) growing its asset base (ii) focusing on operational excellence and (iii) maintaining a strong balance sheet. The firm continues to deliver on all three fronts. Firstly, American Tower has aggressively acquired tower assets under buy-lease-back (“BLB”) arrangements from MNO’s. Most recently, the firm acquired 4,669 towers from Airtel in Nigeria. Secondly, American Tower boasts high lease-up-rates (“LURs). As explained above, high LURs typically imply higher cash flows. Thirdly, the Company has taken advantage of cheap access to debt to support its operations. In fact, American Towers reported a cost of capital of 3.5% and a liquidity of nearly $2 billion in June 2015.
American Tower has a business model that has been neatly matched by a compelling operational model. The model allows for American Tower to generate healthy profits while also lowering costs for MNOS. MNO’s pass on the cost savings to consumers through cheaper usage rates. Furthermore, MNOs invest sale proceeds from BLB arrangements into their core businesses, further benefiting the consumer (e.g. improved 4G and LTE services). Significantly, the attractive cash flows also mean dividends, which put occasional smiles on the faces of shareholders. Everyone wins, everyone is happy. Beautiful.
References
- For illustrative purposes only. Does not reflect any American Tower financial data. Source: American tower presentation as of June 30, 2015: http://www.americantower.com/Assets/uploads/files/PDFs/investor-relations/2015/Introduction%20to%20the%20Tower%20Industry%20and%20American%20Tower.pdf
- Collocating tenants typically pay higher rents than anchor tenants on build-to-suit towers. Source: American tower presentation as of June 30, 2015: http://www.americantower.com/Assets/uploads/files/PDFs/investor-relations/2015/Introduction%20to%20the%20Tower%20Industry%20and%20American%20Tower.pdf
- Calculated as Gross Margin divided by Construction/Upgrade Costs. Source: American tower presentation as of June 30, 2015: http://www.americantower.com/Assets/uploads/files/PDFs/investor-relations/2015/Introduction%20to%20the%20Tower%20Industry%20and%20American%20Tower.pdf
- Source: American tower presentation as of June 30, 2015: http://www.americantower.com/Assets/uploads/files/PDFs/investor-relations/2015/Introduction%20to%20the%20Tower%20Industry%20and%20American%20Tower.pdf
Sources
American tower presentation as of June 30, 2015: http://www.americantower.com/Assets/uploads/files/PDFs/investor-relations/2015/Introduction%20to%20the%20Tower%20Industry%20and%20American%20Tower.pdf
American Tower website: http://www.americantower.com
American Tower 10Q as of June 30, 2015
CapitalIQ
Fascinating, to be honest I had no idea this company existed. The combination of colocation and long-term contracts really do make this an investor’s dream. I’m always intrigued by business that have such a low cost of adding incremental customers and revenue. One thing I didn’t quite understand is why those incremental customers would pay higher rents? My intuition would be that they could negotiate better rates than the first tenant, since adding them makes a single tower so much more economical for American Tower. Especially if it is a build-to-suit tower, I would think that the anchor tenant would pay more for any specialized capabilities it requested.