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

Yes. If you step back and think big picture, where we're positioned in the market, by far, we've established ourselves as the largest third-party provider of small cells in the U.S. A significant portion of the other part of the market has, as you noted, been supplied by self-perform from certain of our customers, not all of our customers but some have been focused on self-perform. And that hasn't surprised us. I think from the early days of getting into this business, that's part of the opportunity. We expect that there would be a healthy level of self-perform for a variety of reasons, not the least of which was informed by our historical experience back in the early days of [ auto car ] business where, as you recall, if you go back to the early days, the vast majority of towers in the U.S. were built and operated on a self-perform basis. And then ultimately, the value proposition that came with letting third-party operators like ourselves and others own and operate those assets and then, again, share those costs across multiple customers, that value resonated over time as we prove that out and increase confidence for our customers that they'd be able to have the access and, ultimately, the control of their network that they required given how core it is to their business. And so we see a lot of those parallels playing out to the small cell business. Obviously, where we are today with towers is a much more developed business in industry than where we are with small cells. But what we're seeing today in terms of the mix of kind of third-party independent providers like ourselves as well as a meaningful portion of activity to date being self-performed, that's very reminiscent of the early days on the tower side. And -- we think that's a good kind of framework to think about in terms of how it's likely to evolve over time. We do think as we continue and others continue to prove out the value of a neutral host, third-party solution -- we think, over time, more of that activity will likely be outsourced as opposed to self-perform. I'm excited -- as we talked a lot about earlier this year, we had our single largest small cell award with the contract that we announced earlier this year with Verizon. I think that's a clear testament to the value that they see that we bring to the table. And we're going to focus on delivering on what we've committed to as part of that and continue to prove out the value that comes with our shared infrastructure offering and hopefully chip away and earn the opportunity to win more business over time. So I think we're seeing some of that evolve and shift over time, and there's more work to be done.

All right. One of the long-term impact of the pandemic is many people are moving out of city centers and into more suburban, rural environments that are traditionally optimal for the use of macro towers. Now are you seeing any shift in the carriers' deployment in reaction to the shift in population? And do you think that this could impact the long-term demand for small cells?

Yes. The short answer is no. The pandemic hasn't changed how we think about the long-term demand for our assets across towers, small cells and fiber. As we talked about earlier in this discussion, we've been very intentional in focusing our investment in the top markets. And when we talk about investing in the top markets, it's in addition to the suburban core around the central business districts as well. So I don't want to leave anyone with the impression that when you say top 30 markets, it means just the central business district, those top 30 markets. It's really where the population centers are, which is ultimately where we think we'll see the most demand from our customers as they continue to build out their networks and add density and new cell sites. We'll obviously let our customers speak to how they think about long-term planning for their network investments. But it's worth noting that what we're currently experiencing in terms of the broad-based upgrade activity across existing tower sites is very similar to what we've seen as part of prior upgrade cycle. So I think that's another indicator that it's probably more similar than different in terms of where we are today, even on the heels of kind of going through the last 18 months.

All right. So now I want to shift and pivot to what I consider to be the million-dollar question related to small cells. And I've been asking plenty of people here, just curious to get your take. What do you think the ultimate catalyst will be for driving that hockey stick inflection in small cell installations? And along those lines, I mean, how much visibility do you have into the timing of it? When do you think this comes?

Yes. It's a great question. And obviously, we're very focused on it and think about it a lot. There's no question that small cells will be critical for supplying the demand that's coming with 5G. I think when -- again, when you think about the compounding growth from mobile data demand, that's showing no signs of slowing down. When you roll that forward over the next several years and new use cases ultimately get developed with 5G, that's going to drive additional demand. There's no doubt that spectrum alone won't solve kind of the constraints that are going to come with that growth in demand. As we've talked about, the spectrum will continue to get deployed. But ultimately, as we've seen over the last several decades, adding more cell sites to the network is critical for our customers to be able to continue to keep pace with that demand. And given the data demand density that's coming with 5G, combined with the spectrum that's available today and that will be available to address that demand in the future. Unlike prior kind of upgrade cycles, even through 4G, where small cells started to emerge as a really important tool for our customers. We think it will be a more critical component of that densification that is going to come in future phases of the 5G upgrade cycle. Again, right now, we're kind of in the early days of it. And it's driving a tremendous amount of activity on the tower side, which is great. We're obviously well positioned to benefit from that activity, as you can see with the 12% growth that we're guiding to for the full year. And then in future phases, as densification becomes more of the focus and the pendulum naturally swings a little bit, as you talked about a couple of times, more balanced between towers and small cells, we're going to be in a great position to benefit from that. We already have today nearly 30,000 small cells contracted in our backlog. And so we'll work through that over time. And those haven't gone away despite the increased focus on towers for now. And we think there'll be increased demand well beyond that as the focus shifts away from just the initial upgrade. This dynamic won't change and only become more acute with 5G when you look at, again, the data demand projections and the need for additional cell sites. But I think the reality is trying to predict specifically where those inflection points are. That's always been challenging in the business. I think, again, thinking back to the early days of the tower business over time, we and others got really, really good at predicting where carriers would need additional infrastructure in proximity to existing tower sites. And we'll be able to kind of paint a pretty good demand picture around our assets. But one of the things that was always challenging to do is to pinpoint exactly when those sites would be prioritized over others, which ultimately comes to the root of your question around trying to pinpoint as you talked about a hockey stick or inflection point and really be specific around predicting the timing around when that demand is going to materialize. What's really important for our business given the long-term nature of it is to make sure we have assets in the right location that over a reasonable planning horizon, we're going to see the demand that we've underwritten. It's ultimately going to help us achieve the targeted returns that we're pursuing. And we're confident that we have the right assets in the right location. But predicting the exact timing of when all that's going to come together has always been challenging. And that's not unique to the small cell business. That's always been the case for the tower business as well. But we're confident that, that small cell demand will meaningfully increase with future phases of the 5G build-out. And so we're squarely in the when, not if category in terms of that materializing. And we think we're in the best position to benefit from that future demand with the combination of the assets and the capabilities that we've developed.

All right. So let's pivot and talk about your fiber business, and more specifically, CapEx. So your updated 2021 fiber CapEx guidance was reduced to $1.3 billion from $1.5 billion prior to reflect the lower small cell installation guidance. That actually seemed like a relatively small cut given the reduction in installations not just for this year but also for next year. Can you give us some more color on where the $1.3 billion is being spent?

Sure. Yes, happy to. And you're right with the numbers. So we did reduce our CapEx expectations by about $200 million to $1.3 billion on a gross basis. Within that, we expect to invest about $900 million in our fiber business this year. So that would include the investments we're making both in small cells and to support the growth on the fiber solutions side as well. When you look at it on a net basis, so when we talk about unit economics and returns, we get down to a recurring cash margin as a percent of net invested capital, so net of any prepaid rent and capital contributions that we get from our customers as we're building out these networks. That $900 million is actually closer to, call it, $650 million or so, plus or minus, on a net basis. And again, that would cover both small cell activity as well as fiber solutions. When you take a step back and think about kind of the trend in CapEx over a multiyear basis, look at how that $650-or-so million compares to where we were only a couple of years ago, obviously, when activity levels were higher than 5,000 that we're now expecting this year into next year. That's down significantly over the last couple of years, where only 2 years ago, is north of $1 billion on a net basis. And so I think that tracks a little bit more with how you think that relationship would hold. There's always going to be some timing ebbs and flows in terms of the activity and when the spend occurs ahead of it. So the timing of no deployments and then the trajectory of capital may not perfectly be aligned 1:1. But as you look out over, again, kind of more of a rolling 12 to 24 months' time frame, that relationship is holding as you'd expect.

All right. So to that point, should we anticipate fiber CapEx remaining above $1 billion moving forward, even with that small cell installation continuing at 5,000 into next year?

Yes. So just -- I'll jump into the question more, but just to clarify, so we're actually expected to be less than $1 billion this year on the fiber side, right about $900 million. In terms of going forward, again, keep in mind, these are all discretionary investments that we're making. So we'll evaluate those opportunities as they arise and look at those and evaluate those investment opportunities with the same rigorous framework we've utilized to date. And so we'll see where the opportunities and ultimately the activity is moving forward. In terms of the trajectory of spend, that will largely be tied to the volume of activity. And then secondarily to that, not just kind of the headline number of how many small cells were actively constructing in any given period of time, but importantly, what is the mix and composition of that activity between what we talk about as anchor build or greenfield investments, where we've secured a small cell contract and award in an area where we don't have existing fiber to leverage. And therefore, we're building that system greenfield. Obviously, that comes with a different capital profile and return profile relative to more of the colocation opportunities, where we're able to lease up and add small cell customers to existing fiber networks. So in addition to the overall volume of nodes in any given period of time, the mix of that activity between anchor versus colocation will also be a key determining factor in terms of what the capital investment is needed to support that level of growth. Again, beyond '21, we'll be in a position in a couple of months to at least have a more specific conversation in terms of expectations beyond this year. But hopefully, that framework at a high level gives you enough to kind of work through over a long period of time.

One of the criticisms that Crown gets is that you include amortization of prepaid rent in your AFFO. I know this is not new but can you remind us why you do that?

Yes, absolutely. I think there are a couple of things to kind of parse apart here. So let's talk through the economics of why we're receiving prepaid rent from our customers. And then we can talk about more the accounting implications around it. So in terms of the 2 primary drivers of why we're receiving prepaid rent, the first would be what we were just talking about on the small cell build opportunity. As you know and we've consistently targeted now for a long period of time, when we're building a new greenfield small cell system, we're underwriting that investment typically to an initial 6% to 7% cash-on-cash yield. And so that metric that we're targeting is kind of simple check book math, thinking about the recurring cash margin at a project level relative to the net capital investment And so that would be net of any prepaid rent we get upfront. So as you can imagine, there are obviously 2 levers that we can pull there and work with our customer to ultimately achieve that -- those return targets: One is on the recurring rent side and the other is capital contributions upfront in the form of prepaid rent to effectively buy down our cost basis in the asset. As you know, our customers have operating and capital budgets that they have to manage as well. So the mix of where that return is coming from in terms of how much is coming from recurring cash margin versus upfront payments to, again, buy down the capital base, that will ebb and flow over time as our customers manage their own budgets and have preferences. But generally speaking, historically, we've gotten somewhere in the ballpark of about 1/3 of the capital kind of paid upfront, and you can see that in our financial results, which economically is a great outcome for us when we can achieve the returns that we're targeting. And then on a go-forward basis, we then have an asset in service that has a structurally lower cost basis relative to someone who would contemplate coming in and trying to compete for the next opportunity and proximity to that asset. In addition to the small cell side of the business, on the tower side, we also have instances where we collect prepaid rent. This is typically tied to us getting an application from a customer, which then will do a structural analysis of the site that they're looking to either add equipment on if they're already a tenant or if they're looking to come on as a new tenant. And to the extent that we don't have sufficient structural capacity to support that deployment and need to make some capital investments to reinforce the capacity, then it becomes a conversation with the customer in terms of understanding how much of that capital investment they're going to contribute to in the form of prepaid rent. So that's the economic side of it in terms of what's going on. Where you started with your question in terms of ultimately the punch line of amortization flowing through AFFO, a couple of things that I think are important to understand. From a GAAP accounting perspective, it requires us to recognize that prepaid rent as deferred revenue. That then gets amortized into site rental revenue over the corresponding lease and the life of that lease on a straight-line basis. And this is exactly consistent with what our peers do. So I don't want to leave anyone the impression that we -- where we have some treatment that's different relative to our peer set. It's the same approach in terms of amortizing net prepaid rent, starting at site rental revenue and then having that flow all the way through the AFFO. I think why it gets a little bit more focus and attention and questions for us is just given the fact that we both have prepaid rent on the tower side, it's very similar to our peers, but we have a small cell business that our peers are not in. That leads to a different amount of contribution there and activity, which is understandable given the fact that we have 2 businesses where that's a reality, not just one. The final piece I'd say -- and you alluded to it as saying this is not a new topic. This topic does have a long history, a long but distinguished history in terms of the conversation with investors, in terms of how various folks think about and treat the value there because there's real economic value that's happening in that -- with that prepaid rent. And so we provided very detailed disclosure on this, going back to at least 2014, that we provide an update every quarter in our supplement. So it's very easy to get the visibility required so that folks can look at it and make any adjustments they see fit. But I think at this point, it's pretty well understood by our investors.

All right. To your point, it's not a new topic, but there always seems to be a new flavor or a new angle. And along those lines, I would say pushback, right, is that it's viewed that this should be an offset to CapEx and shouldn't be flowed through AFFO at all, either as amortization or cash. I mean what's your response to that?

Well, again, there's the economic reality that whether you pick it up through amortization on the income statement or you just focus on the cash flow statement, you're going to see it in working capital. So if you're thinking about the valuation of the business and doing a discounted cash flow analysis, you can -- you're going to pick that up through working capital. So I think it just depends on how you want to look at it. From a CapEx perspective, though, we're required from an accounting perspective to report CapEx on a gross basis. That's what's ultimately going into the PP&E, into the asset base. And again, we want to make sure that we provide the appropriate visibility with our disclosure so that you or any investor that wants to think about it differently, they have all the pieces available and it's easy to get to that.

All right. For the second time, I'm just going to transition and talk about your fiber solutions really quickly. So you guide to organic fiber solutions [ SRR ] growth of approximately 3%, which is similar to what you did in 2020. Although Crown is primarily leveraging the fiber for small cells, do you believe there's an opportunity to accelerate that fiber solutions growth moving forward?

Yes. I mean fiber solutions is an important component of our overall strategy. Obviously, we're -- we've invested in the fiber assets because of the opportunity we see around small cells, and we think that's going to be the key driver of long-term value. But with that, we can complement and augment that return by thoughtfully growing the fiber solutions business. So we're absolutely focused on maximizing the long-term value of the investments we've made in fiber. And that includes driving as much profitable growth on the fiber solutions side of the business as we can. That will ultimately add value to what we're going to deliver with the small cell strategy. Based on where we're focused in the market, we're not going after every single opportunity in the broader fiber industry. But we're very focused on where we think we can compete effectively and differentiate ourselves. And based on where we're focused on the overall market dynamics, the output of that, we think, leads to a growth rate around 3%. Obviously, that could change. Dynamics could change over time. And to the extent that there's an opportunity to pursue additional growth that will be profitable and add to long-term returns, that's obviously the business we're in. I mean just like the tower business, once we have the asset in place, we want to sweat that asset as much as possible and add as much cash flow -- long-term cash flow as possible. And the fiber solutions market provides a large addressable opportunity beyond our small cell business to be able to add to those returns. And we'll continue to focus on that. But I think the appropriate expectation given our strategy, given where we're focused in those overall market dynamics, a 3% growth rate, we think, is the appropriate assumption at this point.

All right. Instead of jamming in another question, I think we'll end it here for the sake of time. Ben, thank you so much for being here with us today. We really appreciate it. And to the rest of you, enjoy the rest of your day in the conference.

Thanks a lot. Always great to participate. Talk to you soon.

All right. Take care, Ben.

Bye.

Bye.