American Tower: Signals and Stability - [Business Breakdowns, EP.188]

0:00As an investor, I'm always on the lookout for tools that can truly transform the way that we work as a business. AlphaSense has completely transformed the research process with cutting -edge AI technology and a vast collection of top -tier, reliable business content. Since I started using it, it's been a game changer for my market research. I now rely on AlphaSense daily to uncover insights and make smarter decisions. With the recent acquisition of TIGAS, AlphaSense continues to be a best -in -class research platform delivering even more powerful tools to help users make informed decisions fast.

0:30What truly sets AlphaSense apart is its cutting edge AI. Imagine completing your research five to ten times faster, with search that delivers the most relevant results, helping you make high conviction decisions with confidence. AlphaSense provides access to over 300 million premium documents, including company filings, earnings reports, press releases, and more from public and private companies. You can even upload and manage your own proprietary documents for seamless integration, with over 10 ,000 premium content sources and top broker research from firms like Goldman Sachs and Morgan Stanley, AlphaSense gives you the tools to make high conviction decisions with confidence.

1:06Here's the best part. Listeners can get a free trial now. Just head to alpha -sense .com slash invest and experience firsthand how AlphaSense and Tegus help you make smarter decisions faster. Trust me once you try it, you'll see why it is an essential tool for market research. The Fed has cut interest rates and you may have noticed your savings account no longer yields the same numbers that you saw just a year ago. But with our sponsor today public .com, you can still lock in a 6 % or higher yield on a diversified portfolio of high yield and investment grade corporate bonds if you opened up a bond account.

1:44So if you want to move out on the risk spectrum, capture those higher rates, it is not Not locked in until the time of purchase, so make sure to check out public .com slash business breakdowns or click the link in the show notes to learn more.

2:03This is Business Breakdowns. Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from, and we are here to bring them to you. To find more episodes of breakdowns, check out joincollosses .com. All opinions expressed by hosts and podcast guests are soleater -owned opinions, hosts, podcasts, their employers or affiliates, main -aintained positions in the securities discussed in this podcast.

2:46This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Welcome back to Business Breakdowns. This is Matt Russell and today we are breaking down the communications giant, the infrastructure asset that is American Tower. To break down American Tower, I'm joined by William Heard, founder and CIO of Heard Capital Management. William founded her capital in 2011. Today the firm manages 2 billion in assets, holds about 15 to 20 names and has a very specific criteria for investing in companies. We cover AMT from all angles here. The long life physical assets that underpin the business, the contracted and highly visible revenue stream that also has low churn.

3:32The secular growth story, not just in mobile communications, but in data usage broadly, and some of the microdynamics, like incremental margins, M &A, balance sheet management, and capital allocation. It's a wide range of conversation. Again, American Tower is a business. It's a financial instrument. It's representative so many things in the economy. So it was a very interesting conversation, and it was great to have William join me to break this one down. Now please enjoy. All right, William, excited to have you here to talk American Tower. This is an interesting business for a lot of different reasons.

4:12Interesting infrastructure asset. You have the dynamics of it being a reap and what that means is a proxy for fixed income or various other things just as a security itself. And it's just this business that's very key to what a lot of people use and do on a day day basis, but I don't think it's the household name by any means. So we'll get to all that. Maybe we could just start out with the highest level introduction to American tower, what they actually do, what they actually operate. However, you want to sketch that out. Yeah. We'll be here. American tower is the critical infrastructure that allows this call to happen.

4:50Anything wireless must hit a tower. At the end of the day, what they provide, think of large building on top be it sears towers there's multiple towers but that tall piece of steel on top is slightly American tower but the point is that is the infrastructure and if it's built up from the ground they own both pieces of land supporting that and also like the steel and then the carriers will add all types of components to make sure that they get the throughput of signal. So when I step back they own the physical tower structures they lease this space to the wireless service providers think Verizon, AT &T, and T -Mobile, and radio companies who then put their equipment onto those towers.

5:33You gave a good description of it is the tower that makes all of this possible in my area, people constantly complain, there's not a cell tower nearby. It's a problem. And it's one of these things where they're spread around the world, but how many of these exist? You mentioned it's probably American tower on top of some of the buildings that you see, which indicates there's some nice market share there. But can you sketch out that a little bit just in terms of any numbers around the size of this market? Yeah, so what's estimated? There's about five million towers all over the world the time 20 owners of that comprised about a million of those towers.

6:08So it's a how he fragmented like space American tower of all the public comps has the most with about 224 ,000 towers and and pretty significant like international footprint as well. In terms of market share, I guess back in the low math, they're probably like five to six percent. But like I said before, it's really fragment that we don't have hurt information. And sometimes, competently, you can check on the private side. You never know what someone owns as opposed to what is in use. With the towers themselves, you mentioned, there's the steel, sometimes they're on land. Do they actually own that steel?

6:47It's not like they're leasing out the equipment. It is something that they are owners of that Infrastructure that asset. Do they theoretically build them when they are coming into the market? The tower company typically owns the tower structure and the ground interests. It's called the simple or at least model. The carriers would own the equipment and All the other Call them widgets that go on to extend the signal to whatever cell phone carrier had. So, rise in 18T sprint, those would be the customers. They spend annually between 40 to 50 billion dollars a year in a cap ex. That's the revenue for American Tower.

7:26In this market, there's 5 million roughly around the world. Is that a growing number in a significant way? How often are new cell towers coming into the market, even just as it relates to the American tower story is a big piece of this story tower additions versus whether it's price growth or some type of other key to the growth story. Yes, so for American tower given their size and scale, if you step back think about the history, 1995 it was started. They merged with the company called Specterside that gave them more towers, but essentially at one point the teleco is like owned this asset, but during the spinouts that's what gave them the opportunity, but it is estimated that will probably get another million plus towers, a quote unquote, built in the next couple of years.

8:14The demand characteristics are showing way there. So that implies about a 20 % growth rate based on our current estimate of 5 million towers. This is all before AI, just to growth in data, the average person sends 90 text messages a day. I think there's 8 .4 trillion sent a year. We're not going back, I guess, as high as you think about this. Yeah, and with a tower, your point on the demand on data usage, how much is going through terms of waves? How does it work with a tower's capacity? If in my area, the usage picks up substantially, is that going to require another tower to be built? Are there ways to get around that?

8:56What are the dynamics that, how would that actually play out in practice in terms of the need for more towers to be built? So, yeah, so there's the tower itself and then all the things you can do to enhance that propagation, you can reinforce very simply like the land, make sure it can carry more weight, you can add back all capacity to that, you can add small cells, there's no substitute for like the core site itself, and having tons of them globally and well -positioned. And let's assume people are frustrated with the call dropping. A multitude of factors goes into that, but oftentimes it's the proximity to another tower and very simple.

9:35I can't the signal transfer. I was under the technical term called propagation and search rings and things like that. But I think at the end of the day, that it's essence, it's the ground, the height, how much weight it can support, then how many tenants per tower. You should think of us almost like a load factor can be supported. That makes sense. Yeah. And the site itself, I know there's some nimby, not in my backyard characteristics where people don't want the cell towers. But to the extent that there's 31 there, you want to do as much as you possibly can on that site. When it does come to the need for additional capacity, you gave some sense.

10:09The customer base here is the Verizon or an AT &T who is making the investment to upgrade the, whether it's capacity or something like 4G to 5G, these advancements. Are those dollars coming from American Tower? Are they coming from the customers? Is it some mix of both? Investments in the past year are coming from the carriers. Carrier, CapEx, Ben has historically been between 30 and 40 billion dollars a year. If you're a carrier, what you don't want is your customers to have like dropped calls or for there to be latency or slow speeds. That will cause ultimately like term, which is pretty bad because the carriers have subsidized all the handsets that are new and ultimately it's very, very hard to replace a customer once they're off a network.

10:58investments in capacity to put fall into three buckets adding a new tower altogether upgrading or replacing outdated equipment and adding equipment to an existing tower in order to strengthen its system. So I think of this fleece allows in the past along a lot of costs. It has getting bedded, a bit escalators if you will, our creeps simplest in nature and the catbacks there's a maintenance element and there's our growth element. So a new bill put in that growth category maintenance, American towers run radius in between one and two billion in cat backs, but the contracts are written such that a lot of those costs they can like pass along, and on the data center business can almost charge them for more uses as well, but to increase the throughput or signal strength, there are tons of things you can do to reinforce that signal, but to be without that space and just be in a dead space, that's why you see the consistency see the revenue growth than the ankle -marrange and continue to go higher as a result today.

11:58Yeah, it seems like the asset itself, where it is geographically, it's very hard to build similar to a railroad or something along those lines where getting a new one in a core area is incredibly difficult. Just on that data center point, it's interesting. Is it that American Tower actually owns these data centers and operates a similar model of leasing out the capacity within the data centers to the customer base? and how big of a segment is that? Yes, so let's precisely that. The Core Side acquisition was completed in December 2021. Currently, it's about 8 % of revenue, but it's expected to get to about 10%.

12:32And then it's been clear that data centers are American towers like highest priority in terms of catbacks of their multi -billion dollar budget, 34 % of it is specifically like allocated to data centers. In terms of growth, core site has grown about 12 % year over year. Last quarter, they had the highest amount of sign leases going record. That's pretty important because at the end of the day, the demand strength has been driven both by GNI and the fact that supplies can strain giving them ultimately a good amount of pricing power. But the scarcity of those assets gives them about 50 % operating margins.

13:14AMT acquired 24 data centers and what these data centers support is a co -location services from American Tower for both the physical infrastructure and the 5G build out. So it's the infrastructure plus applications which again is a complement to an existing business that American Tower already has. And you touched a little bit on the history there. One of my natural questions when and you mentioned the customer base was, why don't the carriers just own these assets themselves? It seems like that would make sense. I imagine spin -offs likely related to some of the AT &T stuff, but some more of the origin story in terms of why this piece of the value chain is isolated on its own.

13:58Can you get into that? How far back does this one go? And the sector as a whole, does it have this long tenure? Is there something unique about what created it as an isolated sector within the mobile value chain? So I think back in the day, the reason they spun them out was themselves were evolving. So it was deemed a non -core asset. They were in student streaming as opposed to running these assets themselves. I'm sure some of them have regrets because those tell folks are pretty mature business. It's consolidated as opposed to American tower like the other direction. I think we hit on with the argument, but the tower company's art critical infrastructure as opposed to the fact that you attack on any one of the three large carriers that's probably going to get through.

14:39are other use cases that are embedded in the device that you're paying for and really add data. Yeah, I think that they're so often these businesses where something that was once deemed a non -core asset eventually turns into a crown jewel somewhere else or isolated on its own. And sometimes assets themselves, when they sit outside of a portfolio, can be viewed and valued more independently and appropriately. So certainly makes sense. You touch a little bit on the leasing model, the structure of how they set up customer contracts. Can you get into that just a little bit more? Is there anything that's usage -based?

15:13Is it simply flat fee? You mentioned escalators. How would you outline the contracted revenue base and just how much fluctuation there actually is year to year? Yeah, so very little fluctuation. So there's definitely new tower build brushes those that are like amended. So if we assume the existing power it probably has the following characteristics. Along -term lease, so five to 10 years to begin with rent escalators as well and then also options that ultimately lead to 20 to 30 year lease for these towers. It's a past due model so the operating leverage is there and like I said the core what American top provides is the critical infrastructure but they also have like a development business as well and given that their global gets interesting 50 % of their revenue growth comes outside of the U .S.

16:04You decompose it in more I think they have 42 ,000 dollars in the States. They have 180 outside of the United States but it's called American Tyler. So if you think about the growth in industry and data usage and all the use cases those investments should bear fruit and they're extremely disciplined which I also think what separates them from some of the other folks as well. It doesn't feel as an investor that this man routine does anything by accident. The free cash flow went up during the feds rise in rates. The spending while it wasn't as historically even, it's not like it went to zero and then came back.

16:45I think that Evan Flows just came down to win is the new iPhone whatever gonna come out as opposed to if and when there is demand by the line network. So the activity and sort of the amendment cycle I would argue I is a leading indicator, but also like the scarcity of the asset shouldn't be for God. And that's what drives that value. And it's interesting, I think, with this model, when you have that visibility oftentimes, this natural opportunity to add leverage to the business, easy to lend against high visibility of cash flows. I know in the financial crisis, it actually got into a choppy situation where it was pressured.

17:25They since come out of that. But when you talk about the management team today, how long have they been around? Has there been big shifts in terms of mandates and management teams in terms of how they strategically run the business? Let's manage the team has grown up. A lot of them were there in different seats early in their careers. But I think the capital discipline, being to handle financial flexibility, being clear about what the priorities are of the growth, paying down the data center, acquisition, all of those I think were forethought and preserving their financial flexibility because they believe that ultimately they would succeed.

18:02And their balance sheet management, I think 11 % of their debt is floating right as opposed to some of the other tower companies that numbers like north to 20%. So that financial flexibility and they're giving that their reap, they have to pay a dividend as well. That all makes sense. Yep. There's something to be said for management teams that tend to be reactionary, which if you're very cyclical business can be understandable versus those that can see through cycles, even during downturns, they're consistently spending on growth opportunities for the future to your point because you know what demand is lying out there and it's a matter of when not if.

18:39Has M &A been a part of their DNA for a long period of time when it comes to towers themselves? You mentioned it's very fragmented industry, so I would imagine you have the ability to acquired towers as well from other companies or just actual companies themselves. Is that something that's part of their playbook? Yeah, so acquisitions have been a meaningful part of A &T's growth story. It's what I alluded to earlier as a risk management, making sure that at all times, they had the financial flexibility to both grow by acquisition, fund the dividend, and acquire portfolios globally. And they most recently acquired Selexis in 2021, which gave them additional 30 ,000 hours in Germany, Spain, and throughout South America.

19:25And then most recently, they made the data center acquisition core site, which we discussed prior. When it comes to again, very impressive margin profile fits this really interesting asset when it comes to the visibility into that, But the potential swings that you could have would be from investments, whether it be M &A or organic growth. How much fluctuation do you see year to year? Sounds like the margin stays the same, but we're going to think about, but after a cat backs, free cash flow number and how much that might swing year to year, do you see drastic moves when they go through investment periods?

20:02What does that look like? Not really. Again, this is a business that has the end -grown margins of 97%. So, yeah, free cash flows are constant because they're a reap. They have to pay out good amount of that in the form of like a dividend. So, it's not volatile. The price action has been volatile, but I would argue that was more driven by rates and that inverse relationship between REITs and interest rates going up. But if you go back and look at the free cash flow, it was going up. Martin never really would go down or like to tear it. But if you look at some of the competitors, there's one down.

20:38Billings growth was negative. American dollars is not, their Billings growth is not negative. Pretty healthy business. I would argue with all whether I said it with strong, induced demand characteristics embedded. Yeah, and you mentioned a bit about the unique dynamics of a REIT required to pay out 90 % of income of some sort in terms of how they determine that. So when you key in on that number, or it sounds like that has been steady growth. There's been consistency there because it does feel like they have a lot of potential avenues for growth, which in a traditional business, you would see much more fluctuations, you would make the case for, well, we should be reinvesting these dollars back into the business because there's high return growth opportunities, but here they're able to manage or balance that growth while still maintaining that distribution.

21:30Yeah, it's because of the contractual nature of that revenue stream, the scarcity value and their scale. Again, like this manager team is extremely clear, there's a slide that sort of breaks down the capital priorities and as an investor, that's a great thing to know. So you can retest in a real time and make sure that it makes sense. You can look back and a big part of our process is what we call the say to do ratio. It's do management teams say and do the things that make sense giving the strategy to the outline of American tolerance that question because they break it down to like internally what are the competing needs for the business and how they're thinking about the future as opposed to just some random number being thrown out on ironing's call.

22:11So I'm curious on that slide, what do they outline in terms of the priorities and whether they rank it or not, what does that look like? Yeah, so the discretionary bucket is the biggest followed by redevelopment and ground improvements to existing structures, ground lease purchases, and startup costs. They delivered, given the sale of an asset they once owned, I expect them to do a creative acquisition, just given their existing scale, and they've been consistent deployment towards both acquisitions and share repurchases and they paid to do it. So the bottom line is that the great allocators of capital to level set on the REIT dividend versus the free cash flow number.

23:02REITs are unique vehicles. So can you just walk through when you reference the dividend versus when you're referencing free cash flow a little bit about those two measurements and just how you're coming to them. Yeah, so I'll separate the two just because I think it's easy, they're related, but to your point, they're not the same. In terms of dividend for 2024, it's been flat, and they've been very clear about why, and that was to prioritize their deleverging effort. That optionality, given like all the stuff going on in Mac, where I think will be appreciated. But if you look back, the dividend has grown, double digits, every single year for the past 10 years.

23:41On the free cash flow side, AMT has about 30 % free cash flow margins, and they generate three to four billion of free cash flow year. I believe free cash flow margins will continue to expand as operating leverage due to some of the acquisitions and so business mix skewering toward like data centers and that 50 % margin they have today, that business mix should allow for those margins to continue to expand. So pretty excited about the free cash build build the consistency of that over time I think it's pretty impressive given their skill and I think you've hit on it a bit in terms of what reads represent as a security in the market They are used oftentimes as a proxy for fixed income.

24:30How do you just think about that dynamic when it comes to owning the name you try to own the business sometimes the business can get disconnected from the stock. To take that into consideration when it comes to things like rate cuts or what's moving from a yield perspective and knowing that that's going to have some impact on the security itself. I think like the security versus cash flows are two different distinctions and that's what we try to do as investors. Price action is an indicative of like or has not been historically indicative of any deterrent in their business model to or put their capital allocation priorities at risk.

25:07So I think the reach structure just allows us to participate from a total return standpoint. The reach grown consistently as well. And when they had to pause that period of time, what they said, we're gonna hold back. It got made sense. It was a ton of uncertainty. It wasn't because of over leverage or anything like that. You mentioned total return considerations here, goffin times. For a long period of time, the dividend yield, it was a thing, but you didn't really factor it in. It was, what is the share price going to do, whether it's multiple expansion earnings growth, and you thought about return without factoring in the dividends.

25:43Here, it's such a key piece of it. I think it yields just under 3 % as of this recording. So, how do you factor that piece of it in when you're thinking about hitting whatever your return hurdle is, and knowing where that yield is going to go, versus what you're going to get from price appreciation. Yes, so free cash flow. We talked about they have three to four billion as of today. I would argue the dividend is safe. There's no risk. I don't mind the discussion around how fast they should grow it because again, I think they're good capital allocators. So if they're making acquisitions such as Corsite or a teleportfolio somewhere in Africa, do you have to trust given their track record that it will make sense and be elected credo?

26:22What we want is profitable growth, not just growth for the sake of growth. And we want to understand what are the priorities for my capital allocation side so we can make our own assessment about whether that makes sense. The dividend, I think it just makes the story like it would be better to be honest. So that's all I've thought about it. I've never really been like, rates are going up, you shouldn't own it because of the dividend. That's just not how I think about businesses. is protecting when you have a long term view, and particularly when you can use disconnects or those dislocations to add to it.