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Towers of power
Shares of cellular tower operators have dipped on wireless merger concerns. They shouldn't.
January 29, 2004: 12:53 PM EST
By Paul R. La Monica, CNN/Money senior writer

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NEW YORK (CNN/Money) - They're ugly and obtrusive. "Trees" aren't supposed to look like that, are they?

I'm referring to cellular towers, those monolithic metal structures that dot the nation's landscape. And although these towers may not be aesthetically pleasing, the business of running them is actually quite attractive.

There are four publicly traded companies in the tower business: American Tower (AMT: Research, Estimates), Crown Castle International (CCI: Research, Estimates), SpectraSite (SSI: Research, Estimates) and SBA Communications (SBAC: Research, Estimates). These firms own and operate the towers and lease antenna space to big wireless carriers like Verizon Wireless, Cingular and AT&T Wireless so they can transmit cell phone signals across their networks.

The four stocks enjoyed solid runs last year thanks to improving fundamentals. The companies, which are all fairly highly leveraged, have been taking advantage of low interest rates to refinance debt and that has boosted free cash flow growth. Higher rental rates also helped to lift revenues.

Stocks won't be towering infernos

But the tower stocks have taken a hit lately due to concerns about how consolidation among the wireless sector could affect their businesses. AT&T Wireless, long rumored to be a takeover candidate, confirmed earlier this month that it would soon review bids from Cingular as well as Japan's NTT DoCoMo. Vodafone may also make an offer.

Since news broke of Cingular's interest in AT&T Wireless earlier this month, shares of American Tower, the largest tower company, and SBA Communications, the smallest, have fallen about 15 percent. SpectraSite's stock is down 5 percent while Crown Castle's shares have slipped nearly 8 percent.

Wall Street appears to have several worries about consolidation, particularly if Cingular emerges as the winning bidder for AT&T Wireless. That's because that deal would essentially reduce the number of major national wireless carriers from six to five.

That could mean that a combined Cingular-AT&T Wireless would be able to cut down on the amount of space they need to lease since there could be some redundancies in their networks. And that would lead to a lower amount of lease renewals. In addition, a fewer number of carriers might have more pricing power, which could drive down rental rates.

But analysts think these concerns are overblown. For one, now that cell phone users are able to change their carriers and keep their numbers, a higher emphasis on call quality is probably going to be needed to hold onto customers.

"If Cingular buys AT&T Wireless, you can't just rip an array of antennas off the towers," said Greg Gorbatenko, an analyst with When2Trade, an independent research firm. "They'll need the equipment to handle the call flow since the same net number of customers need to be served."

With that in mind, a smaller group of national carriers probably would not wind up with more pricing power since the carriers have few alternatives if they want to keep expanding their coverage.

"You just can't put up a tower anyplace anymore because of zoning issues," said Seth Potter, an analyst with Punk, Ziegel & Co. "If carriers need the site, they need the site." Potter added that most of the carriers enter into multi-year rental agreements with the tower companies, which leads to a steady, recurring stream of revenues.

Buying opportunity if AT&T Wireless sells out

Still, if AT&T Wireless does agree to officially sell out, the stocks would probably take another hit. But Jonathan Atkin, an analyst with RBC Capital Markets, said that savvy investors should take advantage of a pullback.

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"It would be a great buying opportunity if the tower stocks got significantly hurt by news of a wireless merger," Atkin said.

In fact, Atkin estimates that even if there were two major wireless mergers (which would reduce the number of major players to four) in the next few years, the impact on long-term cash flow and revenue growth rates would not be significant enough to justify a big sell-off.

To be sure, the stocks are risky. Investors need to realize that most of the companies are not expected to generate actual earnings for years due to massive depreciation and amortization costs associated with building and maintaining towers. In a sense, that makes the companies similar to cable firms.

High debt loads should be a concern as well. To that end, SpectraSite just emerged from bankruptcy protection last year. So Gorbatenko thinks investors need to proceed with caution with this stock. And SBA, due to its small size, is not widely followed on Wall Street.

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Wireless Phones
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By Paul R. La Monica

But American Tower and Crown Castle appear to be relatively stable bets, Potter said. American Tower reported a healthy 12 percent increase in leasing revenues in the third quarter. The company has also been selling off non-core assets in order to raise cash.

Crown Castle has significant international exposure, with 45 percent of its third revenues coming from the U.K. and Australia. So wireless mergers in the U.S. will affect it far less than other tower companies.

Yeah, cellular towers may be eyesores. But the stocks aren't.

When2Trade's Gorbatenko and Punk, Ziegel's Partner do not own shares of the companies mentioned in this piece and their firms have no investment banking relationships with them. RBC Capital's Atkin does not own shares of the companies mentioned but RBC has done investment banking for American Tower.

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