Crown Castle Inc. (CCI) Earnings Call Transcript & Summary

This is Philip Cusick. I follow the comm services and infrastructure space in JPMorgan. I want to thank Dan Schlanger for taking time to do this fireside chat with us today. Dan, thanks for joining us.

Thanks, Phil.

Let's start by talking about the tower industry. What are the latest trends in supply and demand for towers in the U.S.? And how does that demand impact your revenue and costs?

Yes. Let me take a step back and just talk about demand overall in the U.S. and what our tower business is about, so we can get into more specifics about what's going on now. But like all shared infrastructure providers, Crown Castle provides an asset that we then lease up to multiple tenants. The asset in our case is a big steel tower on which wireless communications providers hang antennas. Every time they do that, they pay us for the amount of capacity they take up on the tower, and we get more money as they continue to add capacity. So what drives our business at the core of it is the increasing demand for mobile data in the U.S. So as long as people are using their phones more to do things like watch videos, the -- our customers who are predominantly the 3 large wireless carriers in the U.S., have to continue to add to their capacity, which means to add equipment to our towers. And as we have done that over time, we have taken the returns on those towers up and have really benefited for the shareholders of our company as we've created significant value. And like I said, there's basically -- there are a few ways that our customers do that. The first is they have -- they add additional equipment to put up new capacity, which we would call kind of a first-time install, where they amend the capacity they already have on a tower which we would call amendment. And as that happens, we can add revenue for either first-time install or amendments without really adding any additional cost. The tower is fixed, most of the cost has been spent, and the incremental costs are really borne by the customers themselves. So all we do is maintain the tower, which is, in essence, cut the grass around it, make sure that it's painted, it looks nice and ultimately, it doesn't fall over. So we do structural analysis and make sure it stays up. And then once we add more and more things, it's just more and more revenue without a lot of costs. So that leads to a significant incremental margin expansion every time we add more revenue to a single tower. We have about 40,000 towers in the U.S., each of which, on average, has a little over 2 tenants. So we can add another tenant just with all 3 carriers over the course of that -- over the span of our 40,000 towers and then continue to add amendments on top of that, which is where a lot of our growth comes from. But some of our growth is embedded in the way that we contract with our current customers as well, which is that we have embedded escalators where we generally have 3% increases a year in the revenue. And the churn on our business or the nonrenewals of any specific lease are really low. They're generally in the neighborhood of 1% to 2%. So we have growth in our business from the fact that the escalators exceeds the churn, and then we have this incremental activity that is utilized to deliver the service ultimately to our carriers and users, which is more data going to more phones throughout the U.S. Over the course of the last several years, that amount of data demand has been in the neighborhood of 30% to 40% per year, which has led us to grow in the neighborhood of 5% to 6% at the revenue line and have a longer term growth rate of about 7% to 8% dividend per share growth. Obviously, we're not growing nearly as fast as the demand is growing or the demand for data is growing. That's because there's more efficiency at times. There's also a lot of things that our customers do to make up for capacity without necessarily having to add more equipment. But we don't generally shrink, either. So we're pretty steady growth over the long period of time, and we anticipate that to continue. And I think that's been highlighted by the last few months of this current COVID crisis we're in, that our customers continue to spend money on their networks, continue to put more equipment on our towers and continue to drive the revenue growth that we would have expected even before the crisis. And we're pretty excited about just how well our business is performing during this period. And like I said, that incremental revenue comes with very little incremental cost and very little incremental capital. So it's a really good return on the business as we see that revenue.

Has the current pandemic, where a lot of customers are trapped in their homes, changed the demand outlook for you as it changed some of the mobile demand outlook for data?

Not anything meaningful. Most of the time people spend either in homes or at work, and so a lot of the data that people demand is over Wi-Fi to begin with. There may be a little bit in the last month or 2, where people started driving as much or not about as much, but that's a pretty small blip to the very long-term trend. And the trend is people are using their phones to do more and more things. And those more and more things are creating more and more stresses on our customers' networks, which is what they have to alleviate with more and more equipment on our towers. So even if there is a little bit of a short-term reduction in some of the wireless demand, we don't think that it will impact the spending patterns of our customers. And we see an increased level of -- or an increasing level of activity that we expect through the back half of this year.

Okay. What's the typical length of your leases? And what does the negotiation look like when those leases run out?

Yes. Generally speaking, we sign leases that are 10 years with our customers, where we get that 3% escalator every year. And then by the time that we get relatively close, call it, within a few years of that 10th year, both we and our customers get to the point where we want to start trying to renegotiate because they don't want us to not allow them to get on our towers. Given the amount of towers we have, if we just didn't allow them one day, a lot of their network would go down. So they don't want to be in a position where they could lose their customers by providing an inferior network to utilize for their customers. And they also want some security and certainty over the pricing, and we don't want churn. So pretty much 3 years or so before the end date or -- it could be earlier than that or later than that depending on the specific discussion we would have and negotiation we would have with the customer, we would start talking to them about how we want to renew this master agreement over a long period of time for another 10 years. And generally speaking, we have reached those levels of agreement without very much issue at all because all of our interests are aligned to continue this relationship, and we think we treat our customers well and we think our customers treat us well. And that relationship is really important to us. The relationships with our customers are very long term, and we see them as one of the big assets of our company. And so we can usually get to the point where we renegotiate those agreements pretty easily with our customers. Now it's always a negotiation and they always want to pay less, and we always want to make more and all that happens. But ultimately, we get to an answer that we think both we and our customers are very happy with.

Okay. Sprint has been acquired by T-Mobile. What does that mean for the activity and churn risk over time in your business?

Yes. So historically, as we look back on the industry overall, there have been lots of consolidation in this industry. 10 years ago or so, we had 8 wireless carriers in the U.S., now we're down to 3. The consolidation that has happened before the Sprint and T-Mobile merger happened was kind of 8 to 4, and our company grew through all of that. And the reason for it is, like I said earlier, our business is tied to the underlying data demand more than it is tied to the market structure of who supplies the demand. And as more people have more devices, demanding more data, somebody has to provide that. And we have seen that the resulting companies continue to spend on the network. And even when there have been synergies, which there have been, and how does that impact us is when 2 companies come together and they're both on a tower together or they're on a tower -- where they're both on a tower together, then they may -- one of them may come off that tower. And when those synergies do happen, they've been overwhelmed by the incremental capital that is being spent to improve the network and expand the network. With Sprint being acquired by T-Mobile, we believe it's a very similar outcome, where the amount that they're going to spend is increasing. And they have been very clear about that publicly, that part of the reason for this merger was to get the 2 companies together so that they can use the combined spending power of that new entity and the combined holdings they have in terms of network capacity to compete really well with AT&T and Verizon. And as they see the network going forward, what they really -- I believe what they want is to spend more on the network. As they said, spend more on the network than they would have separately, so they can compete better with Verizon and AT&T. On the flip side of that, they have said that they want to reduce the number of towers they're on from kind of -- they're on about 110,000 is what they've said across the U.S. right now, and they only get down to about 85,000 by the time they're done. And we think we can withstand that without too much issue, partly because, like we were talking earlier, we have 10-year initial term contracts. We have 5 and 6 years left on the term with T-Mobile and Sprint, and those contracts are noncancelable. They can't just call off antennas and not pay us. So they don't want to pull off antennas and continue to pay us. So we think we have 5 or 6 years left to -- that works through before we get any significant hit from any type of synergy realization they may have. And in that 5- or 6-year period, we really believe that they will continue to spend significantly on our network, which will mean that we will have more revenue later than we would have otherwise. And if you look at that 110,000 down to 85,000, it's about a 20% reduction overall. And combined Sprint and T-Mobile in the neighborhood of 30% of our business. So even if you take just pro rata the 20% of that away, it's in the neighborhood of 5% or 6% of our total revenue, which we think would happen over the course of, I don't know, 2, 3, 4 years, sometime in the future when they can get out those contractually. So we're looking at an incremental 1% churn for a few years, which is similar to what we saw with acquired networks historically. And like I said, our company was able to grow through that just because of the underlying data demand. We don't see any reason that this wouldn't be much different.

Okay. And you mentioned there were mergers 10 years or so ago from the 8 that we had 10 years or so ago. Is this deal similar to any of those mergers in terms of the difficulty and the amendments that they'll have to do from here?

I'm not sure if it's significantly different. I think there have been some of those mergers where they were -- the acquired entity didn't have as many subscribers as what Sprint has. So I think it's going to be a little more difficult to maintain the network quality for the current spreads of subscribers than some of those other mergers would have had. But generally speaking, our customers are really good at network optimization, and they can get through that. I think that with this, a lot of the reason that T-Mobile and Sprint wanted to get together was to take some of the holdings that Sprint had that will allow them to increase the capacity of the network, which is wireless spectrum that's allocated by the FCC and can purchase the licenses purchased by these wireless carriers. Sprint had a lot of that wireless spectrum available, and T-Mobile wanted access to that to add to their network capacity, and we believe that they're public -- and they have said publicly that, that's a lot of the reason they wanted to get together was to try to get the combined purchasing power and spending power of the business to allocate that spectrum faster. See, that kind of leads us to feel really good about how this merger comes together is that the new T-Mobile will spend in order to get those -- that spectrum out and available to their customers to improve their network. And like I said earlier, 5 or 6 years from now, we can start worrying about what the churn will look like.

Okay. And at the same time, DISH is looking to build a new network. And talk about DISH using what they call virtual techniques rather than traditional. Does that change the revenue outlook for you?

Yes. Starting with DISH in general, as part of the Sprint and T-Mobile merger, one of the conditions was to sell some of their business to DISH and the future of the business to DISH so that they can be a fourth competitor in the market, and DISH is required by that settlement to cover a specific portion of the U.S. with a new network to give new options. It has been a long time since the U.S. has seen the build-out of a nationwide network by a different carrier. Like we talked about earlier, the last 10 years have been a consolidation story, and this is an expansion story. So first and foremost, I would say, the impact is positive. And we're looking forward to what that will do for our towers because like I said earlier, our towers are necessary infrastructure to allow for the deployment of that network. So we and our competitors, there are 2 other publicly traded tower companies, American Tower and SBA, all 3 of us will benefit from DISH building out a network over the nation to meet the standards they agreed to the settlement to get the Sprint and T-Mobile deal signed and approved. And as we look out and see DISH building out, we're very excited about what that means for us and what that can mean for the overall industry. And given how the location of our towers, where we're mostly in urban areas, we think that will be a focal point for what DISH will look at, at first. And they're trying to, as you pointed out, build that network with what they call a virtual architecture, which means some of the electronics that run where traffic goes. So if you think of data moving around, how that data is governed and where it's pushed and how it gets back to get to the original requester. So you got a Facebook undergone, you want to look at a picture, goes and grabs from a data center and send it back to you. How well that happens, they want to do that with what they call virtual, but it's not really virtualized. It's just more centralized. It's that some of that electronic equipment is going to be housed more centralized locations so that they can then allocate out towards the edges of the network like our towers the right amount of network capacity at the right times. And that virtualization, as they call it, they believe, will lower the overall cost of both building the network from a CapEx perspective, but also the ongoing operating expenses of running the network in the future. The good thing for us is those electronics are what they do. We don't actually own those. Like I said earlier, we own the tower itself, and then they can put whatever they want on it as long as they pay us. And it doesn't really reduce the amount of equipment that's going on the tower because they still need antennas that allow for spectrum to go out. And as long as they need those antennas, they're going to have to have towers. As long as they need towers, they're going to have to come to us, given our ownership of 40,000 towers in the U.S., and we feel really good about our position in talking to DISH and -- or when we talk to DISH, we feel really good about our position of our towers and how we can get at least our fair share of network.

And is there any formula where if they use smaller antennas or smaller electronics that they would have a substantially lower rent than a traditional carrier?

We generally price by weight, the weight of the equipment they put on the tower and the wind loading of the equipment. So if you think about the tower has the capacity, that capacity is, however much stuff you can put on it without it falling over. So the structural capacity of the tower is what we sell. And we measure that by weight. Obviously, if you put more weight higher up on the tower, a lot more to fall over. Or by wind loading, which is these antennas when put next to each other act as sails. And as the wind comes through, they'll catch the wind, and obviously, the more of those things you have up at the top of the tower, the more pressure is on the tower. So we price for wind loading and weight. So yes, a smaller piece of equipment is probably less wind catching and lighter than a bigger piece of equipment. But there's nothing that would say that the way they are going to deploy their network would allow them to have smaller pieces of equipment because antennas themselves are limited by physics. The size of the antenna has to approximate the size of the wavelength that is being pushed out by that antenna. And their wavelengths are the same wavelengths as other people's wavelengths. So there's no real benefit that we can see that they'll be able to significantly reduce the size of equipment that's going to be on the towers and therefore, demand a significantly lower price from that perspective.

That makes sense. And why are you confident that they would use you? What's the risk of someone else overbuilding you and either DISH or one of your other customers moving on to that side instead?

Yes. It's another good question, and it's a place where, again, the business model of the towers is just a great business model because in most cases, there are regulations that prohibit the build of a new tower when a tower already exists because these are big, ugly pieces of steel. And people don't want them in their backyards, they don't want them in their front yards, they don't want them in their lines of sight generally. So most municipalities have some prohibition from a regulatory perspective on building new towers. So the new towers being built in the U.S. right now are generally in the suburbs, where people are expanding out and there is no coverage today, and we need a new tower. But there's probably in the neighborhood of 150,000 towers in the U.S. and the incremental supply is probably in the neighborhood of 1,000 to 1,500 in any 1 year, so maybe 1% supply growth because you just can't build that many. And because what we said earlier, when I mentioned earlier, most of our towers are in the top 100 markets in the U.S. Over 70% of our towers are in the top 100 markets in the U.S. When you get into those more densely packed areas is when those regulations get harder and harder to overcome and build it. So we have a lot of a natural competitive position that we appreciate because those towers exist, and it's hard to build something nearby. We would like to believe because of that, we'll get more than our fair share other than just our 40,000 of the 150,000 towers from DISH. But all of that's going to have to be part of a longer negotiation and how we talk to them and how we treat them and how they talk to us and what value we provide to them. But I do think it yet again shows the power of the tower business that new customer can come in, and the only way to get a new nationwide network built is to come to us and our competitors because you can't have that -- it's really hard to deploy any type of sizable network without us participating in that build.

Okay. With the 1/3 of our time left, let's talk about the third of your business that comes from small cell and fiber. How do those businesses compare to towers?

Yes. Again, maybe just one quick step back to talk about small cells. The term small cell is kind of an all-encompassing term that means a smaller tower. So generally speaking, towers are built between 50 and 250 feet high, and they're built somewhat far away from each other, somewhere from 1/4 mile to 1 mile or 2 away from each other. But because the amount of data being demanded has increased so much over the last 5 years or 10 years, the ability to use only towers has gone away because they can't get close enough together, both for the regulatory reasons we were speaking of earlier, but also as they get close together, they cancel each other out. They have interference. So in order to get more capacity, more network into people's hands, the carriers have had to spend money to build small towers, which we call small cells. Those are generally 25 feet tall or lower. They sit on utility poles or street lights or traffic lights, things like that, and blend in very well to the cityscape. And that allows them to utilize the spectrum they have more efficiently by adding more and more sites. And by more and more sites, they add more and more capacity so you and I can watch Game of Thrones more on our phones. And when we add -- as we saw that trend happening, we invested in order to get in front and really early on and start thinking, "Okay, small cells is going to be a new area of growth for us." And we think that it looks a lot like the tower business; same customers, same demand drivers and generally same contract terms. So the 10-year terms, the escalators are about half of what they are with towers, about 1.5% a year. And the churn is in that same 1% range. So it's very similar to the tower business, and we've been investing heavily because we see that as a really good way of elongating the growth or accelerating the growth, depending on what happens with our business going forward. And as part of building small cells, what we understand and the whole industry understands is in order to have that small cell, it needs to be connected by fiber because the small cell pushes it out wirelessly only from that small cell to the customer, whatever your handset, your phone is. But from the small cell back into the network to go back to the data center, and the example I gave earlier where if you want a picture in Facebook, it has to go pick it out of a data center. That's all going to be the fiber because that can move at the speed of light. And we own the fiber that connects our small cells back to their networks, and that has been where we spent this tremendous amount of money recently. So we've bought a lot of fiber. We've built a lot of fiber [indiscernible] 25 markets in the U.S. because we understand that those are where the markets where it's most likely small cells will be required because the density of demand is in those markets. And as we've done that, we've gotten more and more comfortable that we build these and other carriers, so we get an anchor built, that is what we call the first carrier. We build it, we get about a 6% to 7% return on that capital for the first carrier, which is not over our cost of capital. But when we add a second tenant to that, which happens over the course of about 10 years in our business, our returns go to the 10% to 12% range. So we then clear our cost of capital. And as we get a third tenant on it, we go into the mid- to high teens. So we think this is a really good business, and we're at the very early stages of it, where we're spending a lot of money on immature assets, but building up a huge pipeline of future growth for the business as we continue to invest in fiber and get small cells to go on that fiber.

As you said, you've spent a lot of money on it. When could those businesses start to generate cash rather than require more?

Yes. Right now they're generating cash. The requirement that we have now to spend is discretionary. We could stop spending on building new if we wanted to cut off the future value. But much like towers, we could have done that after we owned 500 towers, and we would've missed out on the rest of the 40,000 we now own if we just never built another tower or bought a tower that was already -- that was at a low yield because of a shared infrastructure. So as we see this playing out, we don't really want to reduce our discretionary capital. But we want to make that discretionary decision based on the economics of that specific situation. So we look at each situation and make sure that the lease-up that we see coming is sufficient and come soon enough -- it's come soon enough to allow us to make a return on our capital. And as long as that's true, we want to continue to invest, and we have found plenty of opportunities to do so. When that ceases to be true or it isn't true in a specific market in the U.S., which there are plenty that we have not built out, we just don't spend the money. And so our business -- the underlying business is generating cash because the revenues we bring in are significantly more than the cost structure in that business. It's just that we want to continue to build more to build this pipeline and future growth that we are in our business. And for ultimately, to generate significant returns over and above our cost of capital so that we can deliver value to our shareholders through increasing the dividend. [Technical Difficulty] Yes. Hopefully, you can hear me, but Phil is frozen. So we're coming up to the end of our time anyway. So Phil, if you can hear me, I thank you for agreeing to do this and hosting. I appreciate everybody's time listening to us today, and look forward to talking to you some time in the future. If you have more questions, please feel [Audio Gap]