Strong barriers to entry and long term recurring revenue streams are characteristics of quality stocks that investors want to own. American Tower Corp (NYSE:AMT), an owner and operator of wireless and broadcast communications sites both in the U.S. and globally, belongs to this category of quality stocks. It is also the least leveraged and most geographically diversified among its peers. Despite this, American Tower is valued at similar EV/EBITDA levels with its peers, which warrants a stock price re-rating, to accord it with premium valuations that it deserves.
Protected by strong barriers to entry
Why are new entrants not competing with American Tower, given that it is such a good business?
Firstly, the construction of new towers is governed by relevant regulatory bodies. For example, in the U.S., the Federal Communications Commission and the Federal Aviation Administration need to approve the building of any new towers. Similar regulations are in place in other countries outside the U.S. Intuitively, regulators are more comfortable with giving the stamp of approval to applicants like American Tower, given its years of experience in building and operating similar sites, listed status and deep pockets.
Secondly, it does not make sense for new entrants or competitors to build a new tower near American Tower’s existing communication sites. This is because American Tower Corp (NYSE:AMT)’s existing customers face high switching costs in the form of expenses incurred in linking a carrier’s network to new sites and the risk of network quality deterioration with new operators.
Last, but not least, carriers have greater incentives to lease communication towers from American Tower, rather than build their own infrastructure. Besides the cost savings associated with leasing, speed to market is a critical success factor for carriers in delivering the fastest network to consumers. In contrast with leasing, building a new tower from scratch requires many years of hard work including securing the right locations and obtaining the relevant approvals.
Attractive financial characteristics of business model
One of them is its long term recurring revenue streams. A typical leasing contract for American Tower has an initial term of five to ten years with renewals every five years thereafter. The long term leases provide American Tower Corp (NYSE:AMT) with stable revenues. It increased its revenues for every year since 2004, without taking a dip even during the Global Financial Crisis. In addition, less than 6% of its leases are up for renewal every year from 2013 till 2017, with not more than 2% of tenants cancelling or failing to renew their leases historically, according to its most recent investor presentation.
Since the bulk of operating costs such as insurance, property taxes and utilities are relatively fixed, which results in high operating leverage, the addition of tenants leads to higher operating margins.
American Tower’s maintenance capital expenditures typically relate to tower maintenance and IT infrastructure at the corporate level, with the majority of capital expenditures spent on capacity expansion, land purchases and tower construction to drive further revenue growth.
Risks from both operating leverage and financial leverage
Operating leverage is a double-edged sword. American Tower Corp (NYSE:AMT) has high customer concentration risk with its top four customers accounting for more than half of its revenues. If any of its largest wireless carrier customers merge, American Tower will likely register low revenues at the same level of fixed costs, resulting in lower profit margins. Furthermore, American Tower is highly leveraged with a gearing of 234%.
