Buy the towercos, instead of the telecoms? Growing mobile demand and rollouts of 5G could make the business models of independent tower companies an attractive draw.
Demand for mobile data is booming, as more people connect to more devices that require greater speed and bandwidth.
Cellular towers, while hardly glamorous, are the backbone behind these connections—and the rollout of 5G mobile internet connectivity will make them all the more indispensable. Meanwhile, the business models of these independent tower companies, or towercos, are tough to beat, given high barriers to entry, low operating costs and pricing power.
Our team recently compared every major cell-tower market in the world to identify regional differences and pinpoint our global top picks. Out of the 11 names we cover globally, we rate four stocks as Overweight.
Put simply, we believe one of the best ways to leverage global data growth and 5G build-outs may be a focus on the towercos, not the telecoms. We expect global towercos to grow both site-leasing revenue and earnings at roughly a compound annual rate of 9% over the next three years.
However, given the rich multiples in some markets, including the U.S., investors will want to be selective. As such, our team recently compared every major cell-tower market in the world to identify regional differences and pinpoint our global top picks. Out of the 11 names we cover globally, we rate four stocks as Overweight, five as Equal-weight and two as Underweight. (For more information, ask your Morgan Stanley Representative or Financial Advisor for the recent report, Global Towers: 5G and Tower Monetization Driving Value Creation.)
In the early days of cellphones, the telecommunication companies built and operated their own towers. While many still do, a growing share of the business is going to towercos, which primarily generate revenue by leasing space on their communication sites to wireless carriers and other tenants. Lease contracts vary, based on such factors as tower location and capacity, and space, weight and position on the equipment.
Because towercos can host multiple carriers, they have an operational edge over telecom-owned towers: Increasing the number of tenants per site also boosts margins and returns. In fact, incremental gross margins from an additional tenant can be more than 90%.
Building new towers requires navigating local zoning laws and potential pushback from the public, but this initial hurdle ultimately serves as a competitive moat. Once up and running, towers typically garner long-term contracts, high renewal rates and, in many markets, lease-rate escalators to the tune of 3% annually.
Meanwhile, the rollout of 5G only adds to demand for infrastructure. Although 5G networks will include small cells and distributed antenna systems (DAS), macro towers form the periphery of these networks.
South Korea provides a good early example of how 5G can amplify data usage growth. Since the commercial launch of 5G in early April, that market has seen average data usage per month more than double, even triple, for subscribers moving from 4G to 5G—roughly 4.5 million as of the end of 2019.
Relative to their global peers, U.S. towercos have two advantages: Higher barriers to entry due to stringent zoning laws in key markets and lease escalators that give them more leeway to raise prices, vs. the inflation-indexed pricing norm in many other regions.
While we like the long-term tailwinds of U.S. tower companies—and are overweight one U.S. towerco—we would be remiss to ignore near-term headwinds, including high valuations and the lingering uncertainty around a pending merger between two major carriers. In fact, carrier consolidation, or network-sharing agreements among carriers, that can translate to less demand per site poses a key risk for towerco investors.
In Europe, towercos stand to benefit from strong double-digit market growth, coupled with 5G-related investments needed to improve network density. We also see potential for Europe's largest carrier to monetize a substantial number of its towers by the end of 2021.
Indeed, investors might want to keep an eye on the tower monetization trend in Europe, India and Indonesia. Although U.S. and Chinese carriers have largely divested their tower assets, carriers in those regions still own a relatively high percentage of towers. We think many may look to sell or spin out those assets to deleverage, and while they can still get a market premium.
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