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

Well, good morning, and welcome to everyone joining us virtually. By way of introduction, I am Mike Rollins, and I cover the communications infrastructure stocks as well as the cable satellite and telecom stocks for Citi. I have the pleasure of hosting today's REITweek session with Crown Castle's CFO, Dan Schlanger. Dan, thanks for joining us today.

Thanks, Mike. It's great to have -- great for you to have me. I appreciate you doing us with us.

Thanks. Well, before we begin, Citi disclosures are available on the session description page for Crown Castle on the REITweek website. And if you need an additional copy of our disclosures, you can e-mail me at [email protected]. With those details out of the way, Dan, to get us started, I thought it might be helpful to begin with a global perspective. What led the tower model to emerge so early in the U.S. versus other regions of the world? And how would you rate the U.S. model relative to other mature and emerging markets?

Thanks, Mike. It's a good place to start. I think what I would first say about that is that the core of the business model for tower companies like Crown Castle is much like any other shared infrastructure, that we invest in, own and operate high capital-intense assets that then are utilized over a long period of time by multiple customers. And by sharing them among those multiple customers, we're able to reduce the overall cost of operations and investment for each of the customer. So it's much like an apartment building that every single renter pays lower than what they would have to pay if they wanted to build one apartment by themselves. And the developer doesn't really make money until you get a certain amount of occupancy. That's the same place that we enter into with our customers so that we own, in this case, a tower, which is a piece of real estate that just happens to be vertical. And each of our customers rent a specific amount of space on that tower for a period of time. And the business model really started in the early 2000s when the wireless carriers in the U.S. wanted to significantly build out their coverage to allow everybody in the U.S. to make phone calls. And as they were doing that, they knew they needed to spend a lot of money. And one way to raise that money were to -- was to sell towers to companies like Crown Castle and our peers in the U.S. because we could pay more, thereby lowering their costs, and they could then use that capital to invest in the network. And we did that. And our first really significant growth was in the early 2000s as an industry to fill that void. And then over the course of the next decade or so, the wireless carriers built towers again and then again, sold them to us, Crown Castle and our peers as an industry, the tower industry. In the 2012 to 2015 time frame, for much the same reason where they saw a significant wireless network investment requirement coming in to transition from 3G to 4G, looking for capital and understanding they can lower their overall cost of implementation and operation by selling to Crown Castle and our peers. And because we've been able to do that, we believe that we've been able to accelerate the transition through the -- in the U.S. through the different generations of wireless coverage from 1G to 2G or 3G or 4G or whatever else. And we believe we're in a similar time now in the 4G to 5G transition, that having an established third-party tower ownership allows each of those companies to spend less than they otherwise would have had to and therefore, allows them to spend more on actually deploying that new 5G coverage and getting the capabilities into people, consumers hands. And to your question about the U.S., we believe the U.S. is a differentiated country and market for wireless infrastructure ownership. There are a few reasons for that. One, the industry did develop very early on into an ownership by third parties. And that was because the carriers saw the economic benefits of that third-party ownership. So clearly, that they were over -- it overcame their concern on owning such a key piece of the network as a tower. And so they wanted operational control, but they realized the economics were so powerful, it was better to give up that operational control and get the economics than it was to keep the operational control and give out the economics. And we believe that has proven out over time where the wireless carriers in the U.S. have done very well as -- in generating returns for their shareholders as well and providing a very good service for their customers. So it happened very early that shift from self-ownership into third-party ownership, which has not happened around the world until much later and is only now starting to really take hold in the last several years in Europe even. So we believe that's one reason is it. And because of that, that means that the tower and a number of towers in the U.S. is more rightsized to having multiple tenancy on every tower as opposed to each customer owning their own tower and therefore, having too many of them, which is one of the issues that we've seen in other markets below. The second major reason we believe the U.S. is a differentiated market, is because although the U.S. has about 5% of the population of the world, about 20% of the investment in wireless infrastructure happens in the U.S., meaning there's an outsized proportion happening in the U.S., which is creating outsized growth of the wireless networks and generating outsized growth of demand for wireless data in the U.S. When you add all of that together, we think the U.S. is a differentiated market, which is why we [indiscernible].

Thanks. And maybe just leaning further into your comments on this 4G to 5G transition. Can you frame the potential for 5G deployments by the carriers to influence and possibly accelerate the pace of site leasing growth for Crown Castle?

Sure. Like I was mentioning before, we've had several transition -- generational transitions in the wireless market in the U.S. in the -- it's why it's 5G, it's 1G to 2G, 2G to 3G, 3 to 4, now 4 to 5. With each of those transitions, we've seen an increase in the amount of investment required because it has opened up more capacity in the network, which we, as consumers, have used as soon as we've been able to get there. And whereas it doesn't sound like a big deal, if you were to try to go backwards, we would all almost revoke. If you could think back when you had a 3G phone, and it took you 3 or 4 minutes to connect to a website as compared to now, you would never want to go backwards, even though when you were doing it at the time, it felt really great because it hadn't experienced anything like it before. You'd only been on a computer to get on a website. So each of these generational upgrades has happened and generated really positive impacts to the overall economy and to individual people's lives. That's why we keep demanding more and more data is because we all like it. We all use it to run -- we use our phones to run our lives now. And that's been enabled by the investment that the carriers have made in a 4G network that we enabled by having towers and other infrastructure at a lower cost. Moving into 5G, we believe the same thing is happening. It'll be a generational move to where not only will speeds get much faster and coverage get much more ubiquitous, which will drive new use cases. We believe there will also be use cases that will be beyond consumers in industrial use cases where enterprises will use 5G networks to inform their decision making much quicker and therefore, lower costs. And we believe that will generate incremental demand on the networks. And with all of that, we think there's going to be an incremental demand, a significant incremental demand for wireless infrastructure in the U.S., both in terms of towers and in terms of small cells. And I think right now, we are all unclear on exactly what those applications will look like, but we believe there are so many out there that are potential that this 5G network that is being developed now at scale by our customers will really enable a new wave of use cases and applications that we just haven't really seen yet and can't really fathom yet, just like when we were going from 3G to 4G, we couldn't fathom Uber being one of the applications that happened at that point. Sorry, you're on mute.

Yes. Bound to happen once during the session.

Yes. exactly.

As you look at the macro tower business, are you -- what can you share with us in terms of the increasing level of activity that you may be seeing from your carrier customers?

In order to generate all those benefits and to have a network that is ubiquitous and very high speed, one of the requirements is to have a more densified network. So where there are more people, you need more and more sites because more and more people use capacity. And there's only a limited number of capacity -- limited amount of capacity. And in order to increase capacity, one way to do that is add more and more sites that deploy wireless data and allow wireless data to be accessed by us as consumers and enterprises going forward. And therefore, what we're seeing right now is our customer base is very focused on densifying their network and putting new spectrum bands, which is the capacity to carry wireless data. It's in a spectrum band. It's in radio waves and within certain bands of spectrum within that radio wave. That is enabled by putting more antennas on more vertical structures like towers. And right now, all of our customers are very much focused on deploying 5G at scale, and therefore, adding more antennas to more towers, which is driving a higher level of activity and leasing for our business than what we've seen historically and up even in recent history. So what we're looking at from our tower business, we think that we will grow in 2021 at about 6% per year -- I mean, 6% on a year-over-year basis on the revenue for our tower business. And that's generated with two positive things where we get new leasing, plus an underlying escalator within our contract structure, where we have averaged about a 3% year-over-year escalator of revenue in our contracts. So we add the new leasing growth in that 3% escalator, which is offset by churn or nonrenewals on any 1 tower of about 1% of revenue this year. So all of that comes to about a 6% revenue growth. We're seeing 4% leasing growth, 3% out of escalators and then an offset of 1% of churn, which we think is a great business for us, given the stability and predictability of our business. And the size that we have to grow at 6% is a really positive outcome. And at the -- like I just mentioned, at the higher end of what we've seen over the last several years, and we really don't see a reason why that would necessarily slow down, given all of this investment that we think is happening to deploy new bands of spectrum and enable the 5G network.

We often get the question of -- if that could actually go higher in future years, how should investors think about that possibility? Or what could contribute to get that to be potentially greater gross leasing growth in the future for towers?

Yes. It could go higher, but we're talking about -- in our business, ranges that 1% higher would be a significant move. We don't have significant changes in the pace of growth in our business because a lot of what happens within our customers is, they are more capital constrained than they are opportunity constrained. So there's a lot of network needs they want to try to fill. They only have a limited amount of capital to solve them. And therefore, even when there's more of those network needs, some of the limitation comes in, in terms of the capital. Now many of them, many of our customers have been public about how they've raised their capital expenditure expectations precisely because they want to deploy 5G at scale quickly. And that is part of what's driven our growth in 2021 to be 6%, which is higher than what it has been in the recent past. In order to go higher, we would need even more growth out of our customers and more of that capital to be directed towards their wireless network and specifically the radio part of the wireless network, the things that go on the antennas that end up on our towers or small cells, which are just small towers. The -- so the overall thought process for us would be, if that acceleration were to continue, and all of our customers would do that at the same time, then it could be higher than what it is now. What we look at, though, is a longer-term view of this business, where we're targeting 7% to 8% dividend per share growth. And we think that, that 7% to 8% is kind of a good way to think about what we think could happen based on some of the positives, some of the negatives that could come about, and the things that really drive that 7% to 8% or how fast does revenue grow and what's the cost of capital, and we think we've kind of centered on something that is a reasonable expectation of both of those things over a period of time. So not in any 1 year, but over a long time, we think we can grow at 7% to 8%. When those things go well, you end up with what we see in 2021, where our AFFO per share, which is how we size our dividend, is up 11% in 2021 based on our outlook over what we experienced over in 2020. And so we're above the high end of our range right now, but we really want to target that 7% to 8% overall growth. And like I said, if all those things -- all the revenue drivers go well, then we might grow faster than that. If they were all to go poorly, we think we'd be on the bottom end of it.

Thanks. We're also getting a number of questions in from the audience today. So we'll try to get some of those included in the conversation. Just one more question on the macro tower side. Sometimes you enter in these master lease agreements with the carriers that are multiyear in nature. And one customer who's doing a lot of work, both the 5G and integrating the network is T-Mobile. What are the possibilities for you to enter into a longer-term holistic or MLA agreement with T-Mobile? And how should investors think about that possibility and how that may impact your business?

Yes. As you mentioned, we have these master lease agreements with our customers. And they govern the responsibilities, rights and obligations across our tower portfolio both ways and then the pricing that we may have in there. We proactively renegotiated a lot of those agreements with T-Mobile in front before they had merged so that we could have a longer-term contract than we would have had otherwise. So the first renewal of that contract would come up as far away from their potential merger as possible. So we thought about that at the time of having these discussions a few years ago. And right now, we have about 5 years left on average in our contracts with both T-Mobile and the legacy Sprint. So as they have come together now in our one company, we are in the position of having some time between the current -- having time between now and when that nonrenewal happens, 5 years is a pretty long time, and a lot of activity could happen in those 5 years. So what we are looking for now is working with T-Mobile to determine what they want, what they really value out of the relationship. In addition to us having the towers, what do they really want? How do they want to utilize towers? What is their major -- what are the major pain points? How can we help them solve those pain points? And then figuring out what we want, which is to limit the amount of churn on our towers is one of the things we want this because they've talked very openly about network synergies being -- some reducing the number of towers they're on, specifically the number of towers where Sprint and T-Mobile each had antennas, and they may not need all of those in all cases. So we would like to try to work with them and come up with a future path that benefited us both. And if we can do that, then we would be absolutely excited to do so. But if we were to just let the current MLAs run, the current agreements run their course, that would also work for us because, ultimately, we, as an industry, continually renegotiate these agreements over time. And their initial term particularly for 10 years, but we very rarely get to the end of the 10 years before we renegotiate them because our customers want certainty, we want certainty, there's no reason not to continue to renegotiate, work well together. So we'll have really good conversations with T-Mobile. We hope to continue to do so. And like I said, if we can come with something that is mutually beneficial, where they get something they're looking for, we get something we're looking for, we'd be more than happy, and we'd be very excited to enter into the new agreement.

We have a few questions coming in on the small cell front. So if I had to combine these questions into just a couple of high-level asks. The first one would be how does Crown view the importance of having the fiber in small cells under the same roof as your towers? And do you see carriers deemphasizing or emphasizing small cell deployments over time? And then just a final point there, is there a catalyst to watch out for that could drive an acceleration of these deployments?

Sure. Just to be really quick to explain small cells. Like I mentioned, towers are vertical structures on which antennas are hung. They're generally somewhere between 50 and 300 feet in height. And most of them are really between 70 and 250 feet. When we talk about small cells, and they cover somewhere between 0.25 mile radius to a 3- or 4-mile radius around that tower, depending on where they are and how many people are in that radius. The more dense the population gets, the smaller the radius gets to be able to control -- to supply the demand. Small cell are a similar concept that are vertical structures on which antennas are on, but they're typically 30 to 40 feet in height. And they many times are on existing light poles or utility poles or streetlights or something -- or traffic light, something like that, that's already existing. And they're connected by fiber optic cable back into the network. We have invested heavily in that fiber optic cable and the small cells because we believe that as the density of demand continues to increase, the density of the network needs to continue to increase. And we believe 5G will be a catalyst for that, that more and more demand will happen and more and more dense places like cities, and therefore, we want to own fiber and small cells in those cities. We've concentrated our investment in the top 30 markets in the U.S. for precisely that reason. And believe there is a tremendous amount of upside in small cells going forward. It is -- the reason we've done that, like I said, is as the density needs to get more and more dense or as the network needs to get more and more dense, the towers can't get close enough together. You can't build more towers in many municipalities because most of them have some sort of regulation against building a tower where one already exists. And they start to physically interfere with each other. As you get them too close together, the radio waves actually start to cancel each other out a bit. So you go to small cells, and we think that, that is absolutely something that is going to be a huge part of the network going forward. And we have seen to date that the return -- the profitability of those small cells are very much in line with what we would have seen on towers, if not a little better, and think that we have a very good opportunity to generate significant returns over and above our cost of capital on those small cell investments. The -- as of right now, what we're seeing and what -- and I'm just reporting what I have read in the public commentary from our carrier customers is that as they have spent a lot of money on mid-band spectrum, which would be what Sprint brought to T-Mobile and what Verizon and AT&T bought in a recent spectrum auction of C-Band, what's called C-Band, but it's in the 2.5-gigahertz to 4-gigahertz spectrum band. With that, there's going to -- there's a necessity to cover a large part of the U.S. And the characteristics of those mean they do need to be somewhat close together. What we're seeing right now and what the customers are doing is they are focusing on towers because towers are still the best and most economic and efficient way to deploy that supply, the spectrum, over a large population in geographic areas. And they have said that they want to focus on that macro tower portion of the network upfront. But we absolutely are -- believe that over time, small cells will become a more and more important part of the network architecture. To your point of what's the catalyst for that is hard for us to determine the -- as a pinpoint the exact timing of when it will happen. Currently, we are on pace and have been on pace in recent history to deploy about 10,000 small cells per year. And we would anticipate that over a period of time, I don't know what it is. It will be significantly more than that to keep up with the demand that is coming for small cells. But like I said, I can't pinpoint when that inflection will happen because it's hard to predict when our customers turn their focus from towers to small cells and to densifying that network. It's always been hard to -- even in our tower business, it's been hard to predict when inflection points would happen or when not even inflection point, when accelerations or decelerations of any nature will happen because it's so idiosyncratic to how each carrier looks at their network and where they want to spend how much money. And so we can't pinpoint when that will be, but we feel really comfortable and confident that it will happen, that acceleration in small cell demand will happen. And I think that there's a tremendous opportunity ahead of us. But with what the customers are saying, it does look like they're going to focus on towers in the near term, which is great for us, which is at the beginning part of this conversation, why our tower business is growing as much as it is this year, but you don't really see a reason why it would start to slow down at any point in the near term. So we feel good about that. And when the switch happens to small cells, we feel like we're uniquely positioned because we're the only tower company in the U.S. of size to have a small cell business upsized as well. And when you add those 2 things together, we believe that we have the ability to converse with our customers in a way that is more solution-based than product-based, which we think really adds to the conversation very positively.

And how does an inflationary environment affect the business model? Whether it's the average escalator that you were referencing earlier, the way you price services and your costs to run the business?

Yes. So from a revenue perspective, like I said, we -- the 2 drivers of revenue on the power business or the new leasing activity, which is not really impacted by inflation. And our escalators which averaged in the neighborhood of 3%, but that our -- we have about 15% of our escalators that are tied to the CPI. So as CPI increases, the escalator increases a bit. That's -- the reason that we have that 3% escalator in our contracts is because the vast majority of our cost structure is in the ground lease underneath our towers that we don't own. And those ground leases are long-term leases that also had escalators in them most of which are not tied to CPI, most of which are fixed escalators. So the vast majority of our cost structure is fixed, and we don't see that increase. So we don't have a huge impact from inflation on the business. There's a little increase in the revenue side. And there's some increase, obviously, in the people side of our business, which is a line item. But like I said, the vast majority of our cost structure is fixed because it's the land lease under our towers. Where inflation, I think, impacts us the most is in the cost of capital as the cost of capital changes because of inflation. So if interest rates change because of inflation, that may have an impact on us, although we've done a very good job over the last several years trying to fix that as well, to where more than 90% of our debt is fixed rate debt, we have an average tenure of our debt that's out to 10 years. So we've really tried to mitigate even the inflationary impact from interest rates. Now -- so there's not a huge impact for our business for inflation.

In our final few minutes, you mentioned the tower model, fiber, small cells, what are the opportunities for Crown Castle to ridge all of these assets and try to introduce new products or new revenue opportunities such as the Far Edge data center concept or other ideas that the company might be contemplating?

Sure. First of all, we're really excited with the portfolio that we've put together to date. The combination of towers, fiber and small cells, we believe we'll meet the demands of the network over the medium to long term. Because as that density I keep speaking about occurs, it will rely on fiber and small cells. And like I said before, we are the only major significant large tower company to have an investment in tower -- in fiber and small cells. So we're really excited about where we've already positioned ourself. What it also has the benefit of, though, is to allow for edge data centers within that network. Edge data centers are computing power and storage at the edge of the network to reduce the time it takes for a consumer or a some sort of application to reach data. And those edge data centers will be necessary as we consume more and more data and produce more and more data to be able to make decisions about that data fast enough, we will need edge computing, some sort of data center at the edge of the network. And our ability to combine the space under our towers where we can put the data center and the fiber that we already own to connect them to the network, we think will be a unique opportunity for us as the only company that has that -- those 2 things at scale to attract those edge data centers to our sites. And that's one of the things that we are focused on for the future growth of the business over and above what we've already discussed with towers and small cells and fiber.

In our final 30 seconds, Dan, anything else that you want to share with our audience today that they should be mindful of with respect to Crown Castle?

Just that -- like I said, we think we're well positioned, growing our dividend at 7% to 8% a year is our target. We think that generates a really good total return for the stability of our cash flows in the business that we're in. And we have a tremendous growth opportunity with small cells and fiber that we've invested in that really hasn't driven a lot of that growth to date. And we see that coming over the next 1, 3, 5, 10-plus years and something that is unique to us and should drive outsized returns, and we're really excited about that position that we are in. So that's what I would leave you with, and I appreciate all the questions and the time, Mike.

Dan, thank you for joining us. I want to thank our audience for joining us. And hope everyone stays well. Thank you.

Thank you very much.