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

All right. Good afternoon, everybody. My name is Simon Flannery. I'm the telecom services and communications infrastructure analyst at Morgan Stanley. Welcome you all. It's great to be in person for New York Nareit. Again, my great pleasure to welcome Dan Schlanger, the CFO of Crown Castle. Welcome, Dan.

Thanks, Simon. Thanks for being here. Thanks, everybody, for coming.

Great. So let's start off, Dan. I think one of the unique things about the tower business and Crown Castle is the visibility that you have into the future, and you have this model of growing your dividend per share 7% to 8% over an extended period of time. You've been growing it faster than that recently. But perhaps help us with understand the drivers that give you that confidence and what visibility you have into your future growth today?

Sure. I agree. It's one of the key attributes of the tower model is that we understand where our growth is coming from because we basically are tied to the underlying demand for wireless data in the U.S. That means you watching videos on your phones more in essence. And over the last several years, call it, decade, that growth has been in the neighborhood of 30% per year, and that's what it's projected to be at for the next 5 to 10 years when you look at industry estimates. That 30% or so growth year-over-year means our customers who are the 3 large wireless carriers in the U.S., Verizon, AT&T and T-Mobile, are our largest customers need to spend money on putting additional equipment up to push more data wirelessly to us. We own the asset that they put that equipment on. And every time they put more equipment on it, we get more money. That's the basis of our business model. And because we have such a healthy growth rate in the U.S., that doesn't seem like it's slowing down for any reasons that we can see, and healthy customers who are spending in the neighborhood of $30 billion to $40 billion a year, improving their network quality. We have a very large or very long-term visibility into our revenues going forward. And that's underpinned by long-term contracts we have with each of those customers plus a fourth customer that is building a network in DISH networks. So those are the 4 largest customers we have. We have what we call master lease agreements with each of them for between 10 and 15 years. And right now, we have contracted revenues going forward of $40 billion -- a little over $40 billion. So we have in the neighborhood of $6 billion a year of revenue. So we're talking about 7 years of contracted revenue as we sit today. It's not exactly how it works because those contracts do go out longer, but it is equivalent of 7 years. And that gives us a tremendous amount of confidence in our ability to see what's coming through the next, call it, medium to long term, regardless of what the economic cycle is, because the utilization of phones to conduct whatever part of your life you're trying to conduct does not stop in a recessionary environment. We've seen that in the past through all the other recessions we've participated in over the last 20 years or so. Our revenues and EBITDA grow through that recessionary period. And on some level, it's slightly countercyclical where people actually use their phones more in recessions because they have more time. So it's not something we wish for. It's not something we want, but it does happen. What we want is a healthy environment where we all like to use our phones, and we don't see any reason why that's going to change any time now. So that's kind of the base level of what our revenue forecast and our growth looks is based on is that 7% to 8% dividend per share growth rate per year is based on having that visibility into the revenue stream and the investment that our customers make in the networks.

Great. And we'll get an update on a dividend decision in October.

Yes, that's our plan. That's typically when we do it. Yes.

'23 guidance, great. So let's dive into the U.S. macro tower business a little bit more, which is your largest business line. 5G is all the buzz here and you talked about the growth rates you're seeing. I think you're looking at organic tower growth of about 6% this year, which is the highest in the industry. Help us understand what is driving that. And particularly, what inning are we in is how does '22 compare to the capital plans that the carriers have for '23 and '24 and beyond?

So let me just start with the underlying business itself. So again, we own a tower, we lease that space on that tower to these customers who put antennas on that tower. Those antenna take data from there to your phone. When we structure our agreements, we structure them as long-term agreements where we get an underlying revenue increase every year of 3% per year. And we have decommissioning of sites where they don't need that tower -- that antenna on that tower of about 1% -- 1% to 2% of our revenue every year. So just in a structural term, we have more escalator than we typically have any type of reduction in our revenue under those agreements. So that gets us to about 2% growth on a year-over-year basis. The remaining growth is just more activity, adding more equipment to the assets that we already own. And that is happening because of what I just talked about, the increase in demand for data in the U.S. drives the requirement for our customers to put more antennas up, which pays us more money. That is the remaining 4%. That comes in 2 ways. It comes where they put additional equipment on a tower they already have equipment on or they actually go on a tower they don't have any equipment on, and those 2 things happen all the time. The reasons for those are just the more we use our phones, the more network needs to be deployed. If you think about that in kind of historical terms 20, 25 years ago, when we were using our phones to make phone calls, the best thing to do with the tower was on a 300-foot tower, put an antenna on the top of that 300-foot tower and push the signal as far as you could, 5 miles. But as people started using their phones for more than calling, they started texting each other. That uses more data than the voice does, then the radius that, that tower could cover could still be 5 miles, but only people in the first 2.5 miles got any of it because it's like a pipeline. Once it's full, it's full. So it filled up and the people who -- it's actually a good example, a good way to think about it is a garden hose. You have a garden hose. It can take the water from 1 side to the next, but if you start poking holes in it, it leaks out. And by the time you get to the end, there's no more. That's what the equipment does that we have. It sends out the signal, but if people utilize that signal within the first portion of the radius, you need more of it. So you then build another, you have another tower, you put more equipment on 1 that's close by. Now they cover 2.5 miles. And that has happened so often that now we are at a point in most cities in the U.S. that there's as many towers as there can be. They start to interfere with each other. They're actually signed ways in essence, and they start to cancel each other out if they get too close. So right now, we've gotten to the point where most towers are in the neighborhood of 0.25 to 0.5 mile apart. And it's as much as we can have in most cities. So we're not building more. We're just adding equipment to the ones we already have. That structure, where I talked about 3% escalator, 1% churn and then the growth from all of this additional equipment is exactly what makes it such a good business model because those things are pretty well known, and we can project out for a pretty long time what's going to happen. What Simon is talking about with 5G is just the next generational upgrade of moving with a wireless signal and the cellular network. 3G to 4G, if you want to think of it, was kind of you could be on the internet in 3G, but 4G was really made video available. And because of that, it opened up all sorts of different use cases for us as consumers. We went from periodically checking stock prices in 3G to doing our banking online because it was convenient and available. And that's because the generational upgrade of the amount of data and how quick it moved was that much more, so we got more used to it. We started using Uber and Waze. Amazon went from doing it sitting at your computer to always being on your phone. That's the evolution of the business that we're in. That's driven a tremendous amount of growth for us. The next step of that is what 5G is. And we believe that our 7% to 8% growth rate is predicated more like on the 4G use cases, just continuing to do more of what we already do. And if 5G opens up like 4G did, additional use cases, we think we could grow much faster. That's a possibility, but we don't know what that looks like yet, so we're not convinced it's going to happen in the time frame that we would be willing to say our 7% to 8% growth rate is something we need to change. So trying to pull that all back together, we are -- to get to 7% to 8%, we don't need any significant improvement from where we are. And we believe the 5G use case that you were asking about, when is this peak going to happen, it's going to take a long time to implement and it's going to take a lot more equipment, and we believe it's going to be maybe a decades long type of investment cycle. So we're in the very early stages of that now, probably started last year in earnest, and then we're going to move through probably the next 5 to 10 years of a pretty substantial investment from our customers.

And T-Mobile was saying last week their usage on 5G phones is 2 to 3x the 4G phones, and they're just getting that started. You mentioned the 3% escalators. It's been a huge part of the story the last few years, and it's been above inflation the last few years, not so much today, but you're still talking to the same sort of profitability. So can you talk through your cost exposure, your long-term ground leases and how you feel confident about managing any kind of input inflation?

Yes. So the reason the 3% escalator became industry norm was that the biggest cost item that we have as a business is we lease land under our towers for a long period of time. The average lease terms are 36 years right now for the land under our towers. That's the largest. It's in the neighborhood of 70% of our cost is that land lease. And those land leases came with about a 3% escalator associated with them. So when we negotiated way back when we started this business, 20, 25 years ago with our tenants, the carriers, we said, look, we have this big cost. We don't need to pass that on to you because whether you own it or we own it, you would have to bear the brunt of it anyway. So we get 3% cost revenue escalators to offset that 3% cost escalator. But embedded in that right now is like Simon you said, is we have 3% escalators. It's not tied to CPI. They do adjust the 3%, but the majority of our costs accrete at 3%, too. So we don't get squeezed at all. And in fact, we make marginally more dollars because revenues are -- we have about a 70% gross margin. So revenues are significantly higher than cost. So on a nominal basis, revenues grow more than costs do, and we make a little bit more money every year based on 3% escalators on cost and revenue at all times. And those are contractual. So we feel really good that we're not going to get squeezed from a gross margin perspective because of inflation and that we have the right protections in place to have our control of those assets for a very long time. And in the way that going back to kind of the ultimate business model, one of the things I think is great about the tower business is that when you start thinking about the perpetuity growth of the business, there is a pretty consistent -- you can look to a pretty consistent revenue, pretty consistent cost, and you know the pretty consistent churn on the asset. So you can look out and say, we're going to grow into the future without having to spend money. And that's, I think, a relatively unique place to be when you think about perpetuity growth and long-term viability of a business and cash flow.

Great. Well, let's pivot to the small cell business. So I think it's one of the unique parts of the Crown Castle story, and you see the opportunity to leverage this growth in data traffic, 4G and then 5G. So perhaps a little kind of small cell 101 and then into what your expectations are for the -- as the initial 5G macro builds are kind of concluding or stabilizing that you see the small cell accelerating?

Okay. Going back to my example of years ago, you wanted to be on a really 300-foot tower as tall as you could be. And now it's kind of a quarter or a half mile radius. That also came with coming down the tower because if you're at 300 feet, a lot of the wavelength is just getting down to the ground level. So you might as well come down if you're not going to go so far out. And so now what has happened because we've gotten so concentrated as an industry of towers are where they are, they're close enough, they're as close together as they can be because they do, like I said, interfere with each other, if they get too close. There's a next evolution which is what we call small cells, which is putting an antenna on top of already existing street infrastructure, a lamppost or a traffic light and connecting those to fiber optic cable and taking them back to the network. So that instead of using a tower that's 50-foot tall, you now come to something that's 25-foot tall and you put a lot of them really close together.

Is there an example in Times Square area or somewhere in New York?

Yes, they're all over, but I guarantee you've walked by 1 today, probably 40 of them today. You just don't notice them because that's on purpose. We don't want people to notice them. One of the great things about the tower is nobody wants one in your backyard, so you don't build anymore. It is really nice. But the small cell is just a continuation of the trends of moving down and closer together. So instead of having a 300-foot tower, you have a 25-foot tower instead of being 5 miles apart, now you're talking about hundreds of feet apart or 1,000 feet apart. And it's necessary to drive these 5G use cases that I think people are talking about around autonomous driving or virtual reality or augmented reality because it can't take that long. If there's any latency, if there's any delay in the time that the signal goes from whatever is creating it back into the network and back, if that's a car driving around, it's an accident or if it's augmented reality, it's somebody getting motion sick because if there's any more than 10 or 15 milliseconds of latency when you turn your head and when your visual cues hit in, you get seasick. So these use cases require such low latency in such a vast amount of data that small cells are going to be required to augment what we already have in the network in terms of towers. So our business about 10, 15 years ago, we started investing heavily in small cells because we saw it as the next iteration of growth for the industry and that it was physically required by means of physics required that these are the only way that it's going to reach the latency and the density of the demand that is coming with 5G. And that investment is very much akin to what the tower investment is. It's the same thing. It's 1 asset, you put multiple customers on the same asset. We lower the cost for every 1 customer because they don't have to build it themselves, and we make money because we're, in essence, the developer, and we get enough occupancy to make money. The contract terms are the same, 10 years, same customers, same wireless carriers. So we thought about it as very similar. And then the returns that we get out of this business are very good. We start with an initial return when we build these things from scratch, a greenfield project of 6% to 7% cash flow -- annual cash flow divided by the capital we've put in at the very beginning. So our initial cash flow yields are 6% to 7%. Those grow to about 10% to 12% when we add a second tenant to that same system, and they grow to 15% to 18% or so when we had a third tenant. Our cost of capital being somewhere in the mid to high single digits. That to our view, doing 2 to 3x our cost of capital in a business like ours that has such low risk is something that we think generates a tremendous amount of long-term shareholder return.

Great. And you're doing about 5,000 nodes this year and you expect that to double next year. Is that right?

Yes. So the growth associated with our small cell business we believe will be higher than the growth associated with the tower business because it's such a small business now, it's a nascent business. There's probably in the neighborhood of 150,000 towers in the U.S., maybe 175,000 towers in the U.S. There's probably 150,000 small cells as well. Each one of them is smaller and generates less money for us just because the capital is less for each specific one. But going forward, we think that that's going to increase substantially. And right now, we have built 55,000, 60,000 small cells that we have built. We have another 55,000 under contract. So we believe that we will double the size of our business over the next several years because we have as many orders in hand in essence or close enough to it as we have put on-air already. And we believe that that's going to go from 5,000 that we put on-air in '22 to 10,000 or more in '23, and we think that trend can continue going on beyond that because we are just at the start of both the investment in 5G that our customers are making and at the implementation of small cells as network architecture to carry the -- what I was talking about, the density of demand that's coming with that 5G investment.

And presumably, something like fixed wireless is probably pretty good for the tower and small cell business.

Yes. So 2 of our customers, T-Mobile and Verizon are talking a lot about fixed wireless, which is a replacement for cable coming into your home. It's just wireless provision of data and internet services and cable to your home. That fixed wireless asset goes over the same networks, the same towers and small cells. But a typical home typically consumes around 400 gigabytes a month of data and a typical user generates about 10. So a home is about 40x what a typical user is, which means any one home takes up a lot of capacity. And in order for us as an industry to serve that capacity, we need small cells. And that has not yet been a driver of our business because it's too early on in the uptake of fixed wireless from a commercial standpoint, from a consumer standpoint, but we believe that, that could be a significant driver of investment into the network to drive incremental revenues for Verizon, T-Mobile and the other carriers that are typically our customers.

So you alluded to one of the things that I think is really attractive about the tower business, which is the moat, the NIMBY aspect to it. And I think the data shows there's -- the majority of towers have no competing structure within half a mile or a mile or whatever and probably not going to get built. What's the moat around the small cell business. You're one of the scale players in there? How do you think about competition?

So you're exactly right on the tower business. Part of the great reason the tower business has such low churn and good escalators and all of those other things we talked about is because it's really hard to build 1 next to 1 that already exists. Now regulatory-wise, most municipalities don't allow 1 to be built if there's a structure already available because nobody wants a tower, like it's just -- they're too ugly, which is great for us. But 20 years ago, there weren't that many towers and the moat that was built was because of an economic reason. Why would you build a tower here next to this tower and then take the risk of having to split up all the lease up and everything else because at the time, we were making 2% or 3% on our money, and you needed to assume that you were going to get 2 or 3 more customers on that specific tab. So why would you build 1 next to 1 that already existed if you take that risk and increase the risk when there's this whole table to cover I'll just go down there. I'll go 5 miles away. And that's happened over the course of our industry over time as even as we've densified. There's no reason to build right next to 1 that's already there. So there's a huge first-mover advantage. And then once you own it, and that's where somebody needs to be, then they're going to go there. It turned into the municipalities regulating the ability to build towers out because nobody wants them in their backyard. But the original moat was an economic one. We are in the stage now with small cells that, that economic moat is the 1 that is in play. Once we build a system, there's no reason for somebody to build 1 right there also because then you take too much economic risk in order to fight to have the lease up and in order to fight to potentially steal our customer, you would have to lower rents and that doesn't make any sense. Why not just build when there's nothing?

And the permitting is really tough.

And permitting is tough. It takes somewhere between 18 and 36 months to build one of these things. Most of that time is just getting through the permitting and zoning process. So when you add all that together, there's economic reasons and operational reasons that make it very difficult to build where we already have a system. And because we are, by far, the largest third-party provider of these, we think we are in the best position because again, the first mover advantage really matters. And we think we've put ourselves in that first mover position in most of the top markets in the U.S. So 28 of the top 30 markets in the U.S. we have covered. We think we'll continue to build in those markets and expand beyond that as our customers want to expand. But we think, like I said before, the small cell business is a tremendous growth driver as we move into 5G and into the future. And our tower business now is a tremendous growth driver as our customers are trying to cover all of us using our phones more.

Great. Well, let's open it up to the audience, see if there's any questions folks have here. Yes?

When you do risk management assessment, what is the major reason that you [indiscernible]?

Shall I repeat the question?

Yes. The question is, what are the major risks that we're afraid of. I would say that the growth of our business is the thing at risk. The underlying business itself, the cash flow we're generating now, we don't see a tremendous amount of risk to because they are necessary. Our assets are necessary. They're required to deliver all of the services that we get from our phones. I don't see a lot of risk to that going down. But in kind of the theoretical risk bucket, it would be -- is there a reason to think that the demand for wireless data in the U.S. is going to go down. We don't think so. I don't think there's any industry analyst that would think that. But that is a theoretical risk we think about, but there's not a lot we would do about it. I think that the risk to the growth profile of our business actually has more to do with the investment, the speed of investment from our customers because we would do more if our customers wanted more. So it's the demand side of the business and the growth in that demand. It's how healthy our customers are and how much of their cash that they want to allocate to increasing the quality of their network. And our customers go through periods where they put most of their focus on increasing quality of the network, some go through periods of paying down debt or paying dividends and those types of prioritizations are hard to do for every company. And I think that for us to get the most out of the asset base we have, it would take our customers generating incremental revenues from 5G that would make them speed up their incremental investment in the network architecture and speed up our growth. But even without that, we feel really good that our customers will have to continue to spend on their network and improving their network quality because they compete with each other on the quality of the network. If you're walking down the street with somebody and you're a Verizon customer and they're a T-Mobile customer, and T-Mobile's better, and you say hey, how come you get a signal? At some point, you switch, and they're trying to avoid that at all cost because that's a huge cost to them to switch customers. So there's a natural impetus for our customers to continue to spend on their network, which drives great visibility for us. But the increment, the speeding up of that investment, I think, is the biggest risk we have is where do they ultimately monetize all of that investment and how do they monetize that investment in a way that will allow us to build out faster.

You mentioned some of the cases for small cells. And so Thomas Garden and [indiscernible], are they using small cells right now? It is my understanding that there is [indiscernible] for driving [indiscernible] computer for autonomous driving.

So the question is with autonomous driving and AR and VR, are they using small cells or the wireless network now? The answer is no, you're right. On a car, typically speaking, an autonomous car now, there is an onboard computer. The vision that I think most of the car companies have, you can't have that be the only way you collect the data because the computers will have to be too big. They generate a tremendous -- they generate terabytes of data in a day. And they would -- so the computers get to be too big, they get to be too hot and you're actually going to be transporting people as opposed to now, they're just learning. The second part of it is, if you really want that system to work really well, autonomous driving, they need to talk to each other. They can't talk to each other with onboard computers. The onboard computer, basically, they go park, plug in, download, upload, go back. In order to make the system work, they're going to have to be mobile, truly mobile, and that's where the wireless network would have to come in. AR and VR is the same way. Right now, most AR and VR is done with a headset that you walk into your house and you put it on and you play a game or you do some sort of interactive experience. We believe that over time, that will become mobile, where it's not a big headset, it is some sort of interactive environment. I do not believe that we will all be in the Ready Player One environment where you go into a computer all the time. I do believe we will evolve past our phones just like we've evolved to our phones that we will have all passed our phones from where we episodically check something on the internet, and we ping it and then get information back that there will be a stream of information coming to us through something. I don't know what that is it's not my job. Somebody smarter than me knows. But when you're in a city you've never been in before and you want to go find a Starbucks and you say, hey I'd like a Starbucks and then a line appears on the sidewalk and you follow it. That takes a mobile network. You can't do that over WiFi. You can't do that sitting plugged-in somewhere because you're walking around. And that's where I think that the wireless communications will take over.

[indiscernible] Starlink?

So the question is do we have anything about Starlink, Starlink being a low earth orbit satellite network used to deploy and give wireless coverage in all of the use cases we talked about. We talked about getting closer to the ground, closer together, lower latency, and Starlink goes exactly the other way. We do not believe that it competes at all in a place where there's already coverage. We believe Starlink, and if you listen to what they say, they are talking about the same thing, Kiper as well. They're trying to provide coverage where there isn't any because they can't compete where we already have a terrestrial network.

Are you seeing any customer development at all [indiscernible]?

As the question is do we see internal development of small cell nodes from our customers, and the answer is yes. The biggest competition we have is our customers building their own small cells. But just like with towers where they built their own towers to begin with, small cells are cheaper to each customer if we build them and then have them each pay less to be a part of it. So economically, it doesn't make sense. We believe that in the beginning of their deployment of network, it likely means that they will build some of their own because they like control. But over time, economics wins. So we believe that over time, small cells will be built by third parties, and we are the predominant third-party right now and I believe we'll keep that. I'm sorry, we're out of time. We can come up later.

Thank you, Dan.

Thanks, Simon. Appreciate it. Thanks, everybody.