EUR 850.00 For Business Accounts Only

Morningstar | Crown Castle Consistently Executes Its Plan, but Spending Requirements Keep Firm Overvalued

Crown Castle's third-quarter results contained no surprises, and we saw little to alter our view of the firm. In its last full quarter before it laps last year's Lightower acquisition, site rental revenue grew 33%--in line with our expectation--with organic growth of about 6%, consistent with the mid-to-high single-digit growth we project over the next decade. Adjusted EBITDA margin was just below 58%, within the narrow range where it has been for the past year and just a bit below our full year expectation. In the year since acquiring Lightower, Crown's management has consistently delivered on its targets, and we don't have reason to doubt that will continue. Rather, we have trouble seeing the value proposition in its fiber strategy, as we think it will take too much time to justify the required investment. The foray into fiber made us doubt Crown's ability to outearn its cost of capital over the next few years and led us to label it a no-moat firm. We are maintaining our $80 fair value estimate, leaving shares overvalued, in our view.

Management's excitement over fiber rests on the need for U.S. wireless carriers to densify their networks, and it is pleased with that progress. It concedes that anchor tenants on fiber provide only mid-single-digit returns but says that colocated second and third tenants bring the yields into the teens. On its third-quarter earnings call, management suggested that the ratio of anchor to colocated tenants remains about 70/30; it should add about 0.1 tenants per node per year, on average; and it remains on pace to have 50,000 small cell nodes on air by the end of 2019. Furthermore, it expects capital expenditures of about $1.5 billion in 2019, likely close to 30% of sales for the second consecutive year. We expect the company to deliver, but we think the limit to the amount of small cell nodes the company can add per year, current pricing, and required capital spend make its valuation unjustifiable.

We model the proportion of colocated to anchor tenants on small cells to increase significantly over the next decade, which would result in significant operating leverage and lower capital spending per node. We project company-wide EBITDA margins to expand over 500 basis points by 2027 and for capital expenditures to fall to low-to-mid teens as a percentage of revenue, all while the company grows sales mid-to-high single-digits each year. We don't expect the firm will have great pricing power on small cell nodes. One of our initial concerns about fiber was that it was plentiful, and Crown may not have competitive advantages with it. Management itself stated that it thinks the low-cost provider, which it intends to be, will be the one that wins business. In aggregate, we think this means Crown will continue to add about 15,000 small cell nodes annually for the foreseeable future but that its pricing power will be capped, leaving few openings to make the economics more attractive.

Crown's tower business remains strong but unexciting in our view. It grew site rental revenues by over 7% in the quarter, and it says business remains strong, as all four U.S. carriers are investing. We expect strength to continue and for segment revenue growth to be mid-single-digits annually throughout the next decade. However, the firm is not actively trying to grow its tower footprint, so we think the fate of Crown Castle continues to rest on its fiber ambitions.