American Tower (AMT; recent price: 41), which carries Standard & Poor's Equity Research's highest investment recommendation of 5 STARS, or strong buy, is a market leader in the wireless tower industry. We believe its August, 2005, acquisition of SpectraSite and its ongoing tower purchases will enable it to continue to achieve greater economies of scale through 2009. Due to long-term contracts and annual rent escalations of 3% to 5%, we think AMT has high revenue visibility. We believe increasing data usage and continued market buildouts from the advanced wireless services (AWS) and 700MHz spectrum auctions will provide an additional revenue boost over the next several years.
In the U.S., wireless penetration is roughly 80%, and we believe subscriber growth could begin to slow. However, in our view, voice and data usage will continue to rise at a strong pace as U.S. carriers begin to incorporate unlimited data plans, albeit at higher rates. We think data revenue is in the high teens as a percentage of average revenue per user (ARPU), but will break through to 20% as third-generation (3G) services and unlimited data plans become more popular.
For example, we believe the regional carriers that offer unlimited voice tend to have voice MOUs (minutes of use) that are significantly higher than the usage of fixed rate voice plans from the major carriers. Increased usage typically means carriers must either boost capacity at current cell sites or add additional cell sites, with both options likely resulting in increased revenues for tower providers, and AMT in particular.
New Networks
One other catalyst to the U.S. market, by our analysis, has been the addition of new networks by regional carriers such as Leap Wireless (LEAP; ranked hold; 54) and MetroPCS Communications (PCS; not ranked by S&P; 19). These companies acquired additional spectrum in the AWS auctions and have been building out new markets such as Los Angeles and Las Vegas, with others planned for 2008 and 2009.
Clearwire (CLWR; not ranked by S&P; 13) and Sprint Nextel (S; hold; 7) have also been looking to build out new Wi-MAX networks, which could provide incremental revenue to the tower providers. However, we believe the speed and depth of a buildout from these two carriers is still in question.
Another potential catalyst is the recently completed 700MHz auctions that raised about $20 billion. Although we believe no new national carriers will emerge as a result of the auctions, most of the carriers will likely use the spectrum to augment their networks and for new technologies, which we think could result in incremental rental revenues for the tower companies.
Favorable Position
Internationally, we believe AMT is in a favorable position, with roughly 13% of its revenues derived from operations in Mexico and Brazil. We expect the company to continue expanding in these countries, since both have low wireless penetration rates of around 64%, compared with 80% in the U.S. We think carriers in Mexico and Brazil will build out 3G networks in the near future, which could provide additional growth opportunities. We also believe AMT could expand into India in the future, which we estimate has a wireless penetration rate of around 20%.
Overall, we expect AMT to increase revenues 8% in both 2008 and 2009 due to existing rental contracts and rent increases as well as new market launches and ongoing tower acquisitions. We are including little incremental revenue from prospective Wi-MAX launches, as we believe the timing and magnitude are still in question. We expect EBITDA margins to widen to 68.1% in 2008 and to 68.7% in 2009, from 66.8% in 2007, with expansion driven by AMT's high operating leverage due to a high level of fixed costs. We estimate operating EPS of $0.45 for 2008 and $0.64 for 2009, including projected stock option expense of $0.14 per share in 2008 and $0.13 in 2009.
The company generates a significant amount of free cash flow that we expect to be used in part to help finance the recently announced $1.5 billion share buyback program as well as additional tower purchases and potentially a larger acquisition. We believe AMT's net leverage ratio of 4.2 times should allow it the financial flexibility for future share buybacks or a larger acquisition.
Our 12-month target price of 54 is largely based on 31 times and 27 times our respective free cash flow estimates for 2008 and 2009, in line with the peer target price mean. The target price also represents an enterprise value of 21.9 times our 2009 EBITDA estimate, above the industry average. We believe this premium is warranted by our view of AMT's ability to increase cash flow generation faster than its peers.
Company Profile
American Tower operates one of the largest independent portfolios of wireless communications and broadcast towers in North America, based on the number of towers and on revenue. The company's primary business is leasing antenna space on multitenant communications towers to wireless service providers and radio and TV broadcast companies. The tower portfolio provides AMT with a recurring base of leased revenues from its customers and growth potential to add more tenants and equipment to these towers from its unused capacity. The company also continues to expand its operations in Mexico and Brazil, and we believe it is beginning to put together a team to start operations in India.