EUR 850.00 For Business Accounts Only

Morningstar | Crown Castle's Strong 2Q Results Driven by Lower-Quality Revenue; No Change to Our Fiber Skepticism

Crown Castle's second-quarter numbers looked great, with higher-than-expected revenue and profits serving as a prelude to the firm raising 2019 guidance. However, 100% of the outperformance relative to our forecast was due to nonrecurring network services and other revenue rather than site-rental revenue (leasing revenue on towers, small cells, and fiber). More importantly, we are yet to see impressive fiber revenue results. Our inability to find a competitive advantage in fiber led us to our no-moat rating, and until the firm can parlay its high capital spending into outsize revenue growth, we expect to maintain our preference for pure-play tower businesses. After incorporating the current results, we are raising our fair value estimate to $86 from $84, but we still see shares as overvalued.

Total revenue grew 11% year over year, though site-rental revenue grew at a more typical 6% rate. The consolidated gross margin--which we expect to trend upward due to tower and small-cell operating leverage--was up 100 basis points from last year's second quarter, and the adjusted EBITDA margin was effectively unchanged at 58%.

Fiber revenue grew 6% year over year, and we estimate small-cell revenue growth within the segment was in the low teens. We project small-cell revenue to grow double digits throughout our 10-year forecast, but we don't believe it adds value until Crown colocates multiple tenants on each fiber run, thereby leveraging the investment. According to management, anchor tenants will continue to dominate for the foreseeable future, so we expect fiber capital intensity—greater than 80% over the last 12 months—to remain high. Fiber gross margin was up 50 basis points year over year, which we attribute mostly to the lagging, lower-margin fiber solutions sales rather than operating leverage. We still anticipate margins will continue trending up as small cells make up a continually greater portion of segment revenue and more colocation occurs.

Crown disclosed that it is likely to achieve only the bottom end of its 2019 target for 10,000-15,000 new small cells, as municipality and utility delays lead to longer construction timelines. While the incremental revenue would have been nice, especially as the fiber building continues regardless of small-cell deployment, we don't view this as a major setback. We think it's much more important to see a shift toward colocated small-cell nodes than the gross number of nodes added in a given quarter.

Towers remain a huge bright spot but are unfortunately overshadowed by the firm's fiber ambitions. Management indicated that current tower leasing activity is at its highest levels in more than a decade, and we expect the environment to continue as carriers deploy equipment to keep up with growing mobile demand. Segment revenue grew 13% year over year, as the network-services revenue growth, which depends largely on new tower installations, was entirely attributable to the segment. Tower site-rental revenue growth was 6% year over year, while operating margin was steady at about 64%. With low-double-digit capital intensity, the mature tower business is very economically profitable.