5G Isn't Enough to Justify Tower Companies' Valuations
We think the best of times for U.S. tower spending has already occurred.
The arrival of 5G has fueled investors’ appetites for seemingly any company they perceive will be affected by the new technology. A notable exception, which we think is correct, is the lack of exuberance for U.S. wireless carriers, especially AT&T and Verizon. In what we expect to be a repeat of the experience with 4G, wireless carriers will not be the companies to extract greater profits from these more advanced networks. Competition has restrained pricing power for them. We think investors have failed to extend this logic to the next step. If carriers aren’t seeing boons to their businesses, they are unlikely to ramp up spending on their wireless towers to much higher levels than they’ve been recently.
Unlike the carriers, however, tower stocks’ upward trajectories took a big step higher over the past year, and valuations reached unprecedented levels. We think 5G mobile networks are a primary rationale for the excitement. Usage of 5G networks is now in its infancy, but investment in towers in preparation for it has been happening for years. In many cases, carriers can now turn on their 5G networks without any further increase to their tower payments. More important, tower spending is less dependent on the wireless technology being used than the amount of mobile data traffic that the networks must handle. These factors lead us to believe that spending on towers will remain robust, but it is unlikely to reach new levels.
Looking closely at the wireless carriers supports our view. AT&T (T), which has spent aggressively on towers in the past two years, and Verizon (VZ), which plans to spend heavily on small cells for 5G rather than towers, have both said they expect to slow their pace of new tower spending. T-Mobile (TMUS), which is now integrating Sprint’s network, is likely to ramp up tower spending in the next two to three years, but it will then be able to decommission Sprint’s tower sites, leading to lease cancellations on towers. Dish Network (DISH) needs to build a wireless network and may pick up many of those leases, but financial restraints and specifics of its promises to the U.S. government as part of the T-Mobile/Sprint merger cause us to question whether it will do any more than make up for the loss of Sprint.
We think the best of times for U.S. tower spending has already occurred. The advent of 4G caused mobile data traffic to grow at rates that are unlikely to be repeated with 5G, as many of the “Internet of Things” functions that 5G is likely to enable should take much less bandwidth than things like mobile video, which exploded with 4G. We expect traffic growth to remain high and significant network investment by carriers to continue, but we don’t expect a different environment from what we’ve experienced in recent years. The economic and technological realities lead us to believe that continuing deployment of 5G equipment as the networks mature will look remarkably similar to what 4G has required.
With the U.S. market unlikely to be a catalyst for tower stocks, we look to their other businesses. In that regard, American Tower (AMT) is our favorite, as it has exposure to fast-growing emerging markets in India, Africa, and Latin America. SBA (SBAC) has less geographic diversification, while Crown Castle (CCI) operates exclusively in the United States. Crown Castle is the only company that has a prominent business apart from towers: its U.S. fiber business, where it also offers small cells. However, despite the critical factor that small cells are likely to be in 5G networks, we don’t think Crown Castle’s fiber business will be highly profitable. Building out the fiber and small cell network is extremely expensive, and we think the carriers have too many alternative providers--including the ability to do it themselves, in many cases--for the investment to earn sufficient returns.
Against the backdrop of the current environment, valuations for all the tower companies have moved to extreme heights, but we don’t expect revenue growth to materially accelerate from already high levels. We believe the stocks have risk to the downside if interest rates rise or if the market is disappointed with steady to decelerating rates of revenue growth. We believe all tower companies are expensive and at risk of seeing material stock price declines, but we continue to favor American Tower on a relative basis. If we had to own a tower company, it would undoubtedly be American Tower, and that’s the one we’d enthusiastically recommend on a pullback in what remains a great albeit seemingly overheated industry.
This information was published Aug. 10 as part of a Communication Services Observer, which is available to Morningstar’s institutional clients.
Matthew Dolgin does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.