Energy - NOVEMBER 4, 2015

Can you hear me now?

by Drew Campbell

Communications infrastructure is just a small slice of the overall infrastructure market, and within this sector, telecommunications towers are an even smaller portion of the market, but they also are one of the more interesting stories in infrastructure investing.

The telecommunications tower market is one of the highest growth sectors in infrastructure at the moment, and investors with an appetite for more value-added investments find much to like. As the growth of Internet traffic continues at a strong pace, these assets are in high demand for their capital gains potential, but many participants anticipate after this growth phase, the market will align more closely to what many investors consider a core-like infrastructure risk-return profile — a more passive investment with high-cash yields.

“There is a case to be made for these companies,” says Connie Luecke, senior portfolio manager, senior analyst — Global Telecom & Infrastructure, Duff & Phelps Investment Management. “Despite the differences in regulatory, fee and contract structures, telecom infrastructure is essential in today’s society. While more competitive than the other sectors, it is still a high-margin business with significant cash flows and attractive yields.”

The tower companies are REITs — real estate investment trusts — and they own and lease space on the towers to telecom carrier tenants, much like a real estate company will lease space in an office tower to a law firm or any other company. A single tower can accommodate up to five or six tenants, and because the capital investment needed to develop and maintain tower and related network infrastructure is relatively low, the return on investment with each added carrier tenant can be quite attractive.

“Dividend yields are around 2 percent and cash-flow growth is in the neighborhood of 8 percent to 12 percent driven by both organic and acquisition growth for U.S. listed tower companies,” notes Daniel Foley, a senior financial analyst at CBRE Clarion Securities. “So total returns can be in the 10 percent to 14 percent range.  Over time, as the market matures and less acquisitions are available, investors should expect companies to increase their payouts leading to higher dividend yields, reflecting the high cash-flow generation of their businesses.”

Developing towers and the associated network hardware used to carry signals is not complicated or expensive relatively speaking — it is essentially a pole in the ground with receivers and fiber-optic cables attached — and each tower can comfortably accommodate five or six telecom carrier tenants. Couple this with expectations for strong data and information traffic growth on these networks, and it is easy to see why many investors are excited about the investment opportunity.

“Organic growth comes from an increase in mobile data usage,” says Foley. “As the data usage increases, the need for better technology to accommodate the increase rises as well. The carriers must invest into their networks as they need the networks to be at the cutting edge — that is a competitive advantage. The investment can be new cell tower sites or better equipment, both of which drive growth in the tower market.”

According to a report by network hardware maker Cisco, wireless data usage is expected to grow at a 57 percent five-year CAGR between 2014 and 2019.

Furthermore, the tower market — unlike most other infrastructure markets — is unregulated compared to, for example, the regulated utilities market where regulators set a range within which the companies can charge for their assets.

“It is different from other infrastructure asset classes that have a regulated asset base and are remunerated based on an allowed return,” says Larry Antonatos, managing director, Brookfield Investment Management. “Contracts are struck between the tower operator and the telecom operator, which is a win-win as telecom operators pay only a monthly rental fee without needing to spend up-front capital on building a tower, and the tower operator can add an additional tenant to their tower with little incremental costs.”

Most infrastructure investors who are targeting core-like levered returns in the 6 to 9 percent range have determined telecommunications tower infrastructure’s higher growth and return profile is not the right fit for their portfolios at the moment; however, some investors do invest in these assets, and as the sector matures, the risk-return profile is expected to become more attractive for income-seeking investors.

“Historically, most telecom infrastructure’s returns have come through capital gains,” says Antonatos. “As the assets become more mature cash cows, dividends have become a part of shareholders’ return. We have started to see some tower companies pay out most of their cash flows in dividends, which is attracting more income-focused investors to the space.”

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