When it comes to investing in real estate, the first image that comes to mind is most likely not cellphone towers. That’s a shame because they're a great real estate investment for a multitude of reasons. Crown Castle International (NYSE: CCI) is one of the largest players in the cellphone tower business and is a real estate investment trust (REIT) that has generated incredible returns for its investors.
With a $71 billion market capitalization, though, some real estate investors might wonder if the company can grow much more or if they'd just be buying the REIT for its dividend. So let’s take a look at the business, what growth catalysts are ahead, and what risks it could face to determine whether this REIT is a buy right now.
A great business
Cellphone towers are arguably the ideal real estate business. They have large, profitable companies as tenants that sign on for leases that typically last for at least five years, and the ongoing maintenance and upkeep costs are minimal. This translates into a business that generates high returns and very few of the headaches that most landlords are accustomed to. The business is so simple and durable that my dog could be the CEO of a cell tower REIT and it would likely still make money.
Crown Castle’s management team is much more effective than my dog, however, and it has done a great job of growing its infrastructure and its bottom line. Over the past decade, funds from operations (FFO) have grown an incredible 807%. Perhaps even more impressive about that number is that Crown Castle has been able to grow its business while also reducing overall leverage. Over that same time frame, the company has reduced its debt-to-EBITDA ratio from 9x to 5.6x (where the lower ratio, the better).
These two things have been big factors in why Crown Castle’s stock has generated a total return -- stock price appreciation and dividends -- of 500% over the past decade.
Even though the company has grown considerably in those ten years, it appears that there is still room to grow the bottom line. Despite having "international" in the name, all of Crown Castle’s assets are in the U.S. One would expect that the U.S. telecom business is a mature one with not a lot of growth, but that's far from the case thanks to 5G.
As telecom companies move to faster network speeds, they need to deploy more equipment to improve both coverage and capacity. That means renting more space on existing towers or looking to become a co-tenant with another telecom company on the same tower.
Getting a new customer to sign up for space on a tower with existing tenants is ideal for Crown Castle because it means additional revenue for marginal increases in operational costs and no new construction costs. According to its most recent annual report, 69% of its towers have two tenants or less. Signing up additional customers to these existing assets could lead to considerable increases in cash flow with little needed in cash outlays to make it happen.
There is plenty of room to grow for Crown Castle, but having all of its cell tower real estate assets in the U.S. poses some unique risks. One of those is the fact that three customers -- Verizon Communications (NYSE: VZ), AT&T (NYSE: T), and T-Mobile (NASDAQ: TMUS) -- make up 75% of its revenue.
Having big, stable, and profitable companies like these telecom giants is generally a good thing because the chances of them not paying the rent is incredibly low, but any single company making a strategic change could have a considerable impact on Crown Castle's bottom line.
In fact, we could see an impact from this high customer concentration this year. Now that T-Mobile and Sprint have completed their long-planned merger, the combined company is likely going to re-deploy assets. According to Crown Castle’s most recent annual report, about 13% of its rental revenue comes from sites where Sprint, T-Mobile, and their respective discount options (Clearwire and MetroPCS) are co-tenants.
This doesn’t mean that 13% of Crown Castle’s revenue will be going away overnight; the two will likely need to adhere to their contractual obligations. That said, there is a good chance that Crown Castle’s revenue could take a hit as T-Mobile reduces overlapping coverage. What’s more, multiple tenants on a single tower have much higher rates of return, so consolidating to a single tenant on some assets could affect overall profitability.
It’s hard to say exactly how much this is going to impact Crown Castle’s bottom line. It’s entirely possible that demand for greater coverage and capacity offsets any declines from the merger. Until T-Mobile and Sprint start the integration process, it's simply an unquantifiable risk.
The bottom line
Crown Castle is one of those businesses that will likely generate a return for you in good times and bad. The core business is incredibly durable, and management has done a great job of creating shareholder value. Because its business is as good as it is, though, investors tend to pay a considerable premium to buy its stock. With a dividend yield of 2.75%, it's well below the 4.5% yield for the Vanguard Real Estate ETF (NYSEMKT: VNQ), which is the largest real estate exchange-traded fund (ETF) and is a decent representation of the broader world of REITs.
To justify that premium price, Crown Castle will need to keep churning out market-beating returns. There is certainly the opportunity in front of it to do so with the deployment of 5G looming, but the T-Mobile/Sprint merger could put a damper on that in the short run.
Overall, Crown Castle is likely going to be a REIT that will generate long-term returns despite some short-term speed bumps in front of it, and it would make a good addition to your real estate portfolio.