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

All right. Good afternoon, everybody. I'm Simon Flannery, Telco Services and Comm Infrastructure Analyst at Morgan Stanley. And it's my great pleasure to welcome Dan Schlanger, CFO at Crown Castle. Welcome, Dan.

Thanks. Thanks for doing this.

Before we get started, please note, we have disclosures at morganstanley.com/researchdisclosures.

So Dan, thanks for your time today. The tower industry is somewhat unique within the overall REIT universe. So perhaps just lay out for those who are not so familiar with it, some of the key drivers that make you so confident about the sustainable organic growth over the years.

Sure. I think it is a bit of a unique place across most businesses. Our business is the ownership and lease of vertical infrastructure to wireless carriers in the U.S., the vast majority of our revenues come from AT&T, Verizon and T-Mobile with a bit more from DISH recently. And we own the tower and lease out space on the tower on a long-term basis. Our contracts are typically between 10 and 15 years. Typically, those contracts have built-in escalators that are in the neighborhood of 3%. And we experienced in the neighborhood of 1% to 2% revenue churn per year. So our escalators more than make up for the churn that we may see. So we have a growing business just based on the contracts. And that's generally because it's very difficult to build towers in addition to the ones that already exists in the U.S. We, at Crown Castle, own about 40,000 towers. Our 2 large publicly traded tower peers, American Tower and SBA, American Tower owns about 40,000, SBA owns about 20,000 towers. And we make up the majority of the towers owned in the U.S. It's hard to build more because nobody wants them. They're ugly. And they're -- most people look at them and say, I don't want that anywhere near me. It's not in my backyard issue that most things like this are infrastructure as that negative to it. But if somebody already owns the infrastructure, that's a huge positive. And so it's difficult to build because municipalities don't want additional towers. And we have long-term contracts, like I said, because our customers understand how important it is to have low-cost infrastructure on which they can provide their own network service to all of us as consumers. Because we reduced the overall cost of operation and ownership, we're the most cost-effective way. The third party is the most cost-effective way to own tower infrastructure in the U.S., which is why all of the major carriers have sold towers to us and our peers and lease them back because the economics just make them more profitable. The underlying driver of growth is not just the escalator, though, it really is that all of us continue to use our phones more and more every day. The continual -- the underpinning of all of our growth is the amount of wireless data demand in the U.S. And that data demand is growing in the neighborhood of 20% to 30% every year because we all use our phones 20% to 30% more every year than we did the year before. Most people like me, at least, because I'm relatively old, look at that and say, "No way I do that. I think there's no way I use my phone 20% more now than I did last year." But you do, everybody does because everything we do on our phone expands over time. And one way I think about it is, I would historically never watch anything on my phone and now I do, and historically, when I pulled up even the Wall Street Journal, I would never see an ad that was running, but it does. And all of that is just more data that is coming to your phone. So you don't have to do anything to use more data every day. And that underlying driver doesn't look like it's slowing down anytime soon. If anything, it looks like it's speeding up of just more data demand -- wireless data demand in the U.S. And that underlying driver is what drives incremental revenue for us because as our customers get more traffic on their network, we use our phones more, they have to put more equipment on our towers and our peers' towers. So we grow according to the amount of data demand not as fast, typically, we do grow somewhere in the 5% revenue line per year. In 2024, we expect -- when we gave guidance, we expected that to be more than the 4.5%, but -- organically. So we just leave it. It runs that way. Our business runs that way and we generally get more business over time because we all use our phones more over time. So we have a very stable, very predictable growing revenue stream from very high-quality customers. that we think is perfect for a REIT investment because it kicks off a lot of cash flow, and it's very stable and growing. And that's been the core of our business since we have been a company 25, 30 years now. More recently, we've gone into other businesses that are just towers on a smaller level that we would call small cells. So towers typically are 50 to 300 feet tall. A small cell is typically on already existing street infrastructure like lampposts or street lights that are 25, 30 feet tall. The necessity of those smaller towers is because it's really hard to build towers, like I said, and these small cells enable this crush of demand to be satisfied by our customers. And the densification of our network to smaller and smaller areas of operation is what's happened over time and small cell is just another example of just densifying the network and we've seen good demand for our small cells, which I'm sure we'll get into in this conversation that's given us another avenue for growth in the U.S. that's been attractive for us. So just generally speaking, it's a good business, lots of visibility, lots of stability, long-term cash flows that are underpinned by very good contracts.

Correct. And you've had a lot of activity here at the company recently, including appointing a new CEO, Steven Moskowitz with a lot of experience in the industry. Perhaps just give us some sense of his priorities and some of the early weeks of his time with the company.

Steven started with us about 6, 7 weeks ago. His background is from towers through his career as well as small cells throughout his career. So he's been somebody with a very good history of understanding our business, the value drivers in our business and what we think we need to do going forward to drive even more value. His focus has been getting his arms around things. Obviously, you would imagine, somebody coming in to a job like that, he needs to spend time just understanding where we are, what we're doing. He also participated and we recently went through a proxy fight, so he was participating in that, and we are undergoing a strategic review. So he's getting up to speed on all of those things. But his focus has really been a little different than our historical CEOs. The last 2 CEOs in our company were promoted from CFO to be CEO, and we're looking -- I think the Board was looking for something slightly different this time around somebody who had more of an operational background. And Steven has come mostly from operations. And he is very focused on how we can improve the efficiency and effectiveness of our operations, particularly on the tower side because that's where most of his background is, but across our businesses and looking to try to drive efficiency, however, we can find it. And that's a focus that I think has been valuable for our company and will drive value going forward and something that we'll continue to report on.

All right. And you referenced a strategic review. Can you just recap for those who're not familiar, what you're looking at and the -- where the things stand today?

Late last year, we started a what we call the fiber review committee on our Board to look at the small cell business that I spoke of earlier as well as the associated fiber that we own because all those small cells needs to be -- need to be connected via fiber optic cable in order to work and get the information from the airwaves into the system into the network itself. So we own a bunch of fiber, 90,000 miles of fiber throughout the major metropolitan areas in the U.S. as well as the small cells I talked about. And the fiber review committee has undertaken a strategic and operating review of our businesses related to that fiber. We call it fiber because our fiber segment include small cells and fiber, to see if those businesses really are best suited for Crown Castle or best suited for another owner. So we're looking into that right now. We are currently in the midst of that strategic review. Most of the operating review has already taken place. We are going to utilize the information we've received in that operating review and garnered from our own information analysis to try to address the first thing you asked about Steven's priorities, how do we get more efficient both from a capital and operating expense perspective. And from a strategic review that is ongoing. But looking, like I said, what is the best ownership structure for those assets, whether they're within Crown Castle or not?

So you talked about the strong underlying demand for mobile communications infrastructure, strong secular growth. The reported results are lumpy from a couple of perspectives, one being carrier consolidation. The industry has got to a pretty healthy place. We're seeing wireless price increases and so forth, but there's also been churn related to that. And then you also have the stop-start nature of their CapEx to some extent. So let's start with the Sprint and any other churn. I think you talked about your growth troughing in the first half of this year and then reaccelerating Help us understand when do we kind of get through all of the noise and all of that and then come -- get to a true kind of -- where the reported results really start to reflect the organic trends better?

As -- Simon I just mentioned, one of the things that has happened in our business over a long period of time is the number of wireless carriers in the U.S. has decreased via consolidation. So it used to be a relatively fragmented industry, and now we're down to -- in essence, 3 major national players at this point: Verizon, AT&T and T-Mobile. Through that consolidation, there has been rationalization of the networks because when 2 customers come together, they don't need all of the equipment to do everything that they did separately. So there's consolidation and rationalization of our network. That most recently has happened as T-Mobile has consolidated their purchase of Sprint, which happened a few years back. As part of that consolidation, we negotiated an outcome with Sprint -- with T-Mobile, where all of the churn of our towers, all of the revenue reduction of our towers, they would get through rationalizing their network footprint would happen at the beginning of 2025. So we expect about $200 million of revenue to decrease to come off our books in the beginning of 2025. When we're done with that, we don't see any other additional consolidation churn that's anything meaningful nor do we think that there will likely be any further consolidation because the U.S. government has said pretty clearly, they do not anticipate being -- allowing any additional consolidation. In fact, one more competitor in the market, which is why they've tried to allow DISH to become a nationwide competitor to directly compete with the 3 large providers. So we believe that once we get through 2025 and actually at the very beginning of 2025, that consolidation churn will be done and we will then have growth going forward, which we expect exclusive of that $200 million reduction in revenue. We believe our growth through 2027 will be about 5%, as I mentioned before. About 75% is already contracted. So we really think that we're in a good spot. The consolidation churn is always a little difficult for us because it's an episodic event. It doesn't happen very often, and it kind of gets in the way of our reported results. But the underlying business continues to grow very well. We just haven't -- we haven't seen it because we've had this churn event coming. But we do see that as we go into 2025 and beyond, we can continue the growth trajectory that we've seen in our business and get back to growing our cash flows and dividends.

Great. And just on DISH, we're at about 2% of service work, of tower leasing revenues is that what...

It's a little bit more than that, it's 3% to 4%, candidly speaking.

And then the other part of this is the 5G CapEx cycle by the carriers. So we had these -- the merger, we have the C-band auction. We have this explosion in CapEx. And then almost this time last year, it seemed like all at the same time, the carriers kind of pull back. But it does seem like the commentary from you and others has been that we sort of hit bottom and things are starting to pick up again. So help us with both what you're seeing today, but also where the carriers are and the amount of work you know that they still need to do to build out 5G because it's far from done, it may be in New York City, but there's a lot of work to do.

The way our business generally works, like I talked about, is as our customers need to put more equipment on towers to withstand demand of the network from us, we get paid more. And one of the times that, that is most concentrated is when there's an upgrade in the underlying technology of what the network is. So there was 1G to 2G, 2G to 3G, 3G to 4G, now 4G to 5G. Each of those generational upgrades has provided more service to us as consumers. And we get the benefit. We get a better network that's faster. It can carry more data. It is more stable. You get everything you need. And we generally haven't paid much more for it as consumers. But throughout those generational upgrades, there's a significant amount of equipment that needs to go on towers in order to make that upgrade happen. And what we've traditionally seen through the cycles is that at the very beginning of those upgrades cycles, there's a significant increase in the amount of CapEx from our customers as they want to push a lot of equipment out very quickly. So that we, as consumers, can get a new little GE symbol on our phone and we get more speed and we feel better about how well the network is operating and everything is good. And that happened in 4G, and you see a significant spike. And then after that spike, generally speaking, there's a lull, there's some return to normal. And then there's a long period of pretty consistent spending from our customers. So if you think through -- a cycle is generally somewhere between 10 and 15 years, the first couple of 3 years is a lot, comes down for a little bit, and then it evens out -- that spending evens out over a very long period of time, the next 5 to 10 years. We are experiencing that in the 5G upgrade as well from 2020 to 2022, there was a significant amount of capital spend from our customers that resulted in us growing more than what we generally think, 5%. Our growth rate is more 6%, 6.5% a year and that was helpful. That's really good for us. We like that. But we always knew that activity levels have to drop after that initial surge happens, and that initial surge stopped about the second quarter of 2023. And that stopping was for our world, pretty dramatic. So as you can tell, we don't grow that much, but we don't -- [ not ] grow that much either. So I'm talking about differences of 4.5% and 6.5% growth being substantial in our business because it is substantial. It's a very long-term business, and that being able to grow more is always better or usually better, particularly in our business it doesn't take capital to grow. It's just additional equipment on existing infrastructure. So we get -- what we saw was more incremental growth in the beginning part of the 5G upgrade cycle. We are in kind of the downward portion of that and then the long tail is what we see coming. What we believe and what we said when we gave guidance last in the first quarter was we believe our tower business will grow around 4.5% this year. That was basically what we grew in the first quarter and that we believe that our initial guidance, which we gave in October of 2023, 2024 year, will remain consistent with what we thought in that range. We don't see anything yet that changes our view of 2024, but we also believe that that's a -- like I said, through 2027, we will get more growth than what we're seeing this year. So we do anticipate more growth going forward, just not yet this year, as we go back from that surge lull in more maintenance period going forward. And we see the same general pattern is happening that has happened historically. And what's great about our business, like I said, is that it really doesn't take a lot from us on the tower side to have -- to withstand that growth. We don't spend any more money. There's a space on our tower. When I talk about space, what I mean, like I said, it's a vertical piece of infrastructure, somewhere between 50 and 300 feet high. There is space in terms of just physical amount of space, but there's also the weight at the top of the tower, it can't fall over. And there's wind loading. So these things are really big antennas that catch wind, so they're like sails, and so with enough wind, we don't want them to fall over either. So there's structural capacity of the tower. We generally have lots of structural capacity on our towers to the extent that we don't, and a customer wants to add additional equipment, Generally speaking, our customer pays for it. So we don't put a lot of extra capital in to get the incremental growth. So the incremental returns on our business on the tower side are really, really high. And so there's not much incremental operating cost, almost 0. There's not much incremental CapEx, almost 0. So we just continue to generate better and better returns over time. And we think that's part of the reason it's such a good business model.

Great. And I guess the flip side of that big spike initially in macro towers was there was a lull on the small cell side. So they're a little bit yin and yang. But you've guided and have started to see a reacceleration. You've always had a big small cell backlog. So just help us understand where you are on that reacceleration in small cell node construction?

Yes. As part of the network architecture, the best way to cover all of our usage of phones by our customers, the wireless carriers is to use towers. It is the cheapest and fastest way of increasing the amount of capacity in the network because they know already what the tower is. They know where their capacity constraints are. They know what those -- what adding equipment to that tower will do to those capacity constraints. And the first time they get more spectrum, which is just radio waves that carry data, that those radio waves need to come from an antenna, they add those antennas to towers first because they cover a broader swath of population and they're the cheapest way of covering that population. However, over time, those towers, at some point, you can't add any more without the signals interfering with each other, or it actually does max out the capacity of a tower. And to get more density in the network, we need as an industry to move to shorter towers, again, we call small cells. And therefore, when we saw the big increase in activity from our customers from 2020 to 2022, they were really focused on towers. Therefore, our tower growth went up and they reduced their focus on small cells. And so our small cell growth went down in those periods. Now that we're on the other side of that big influx of activity, we're seeing more focus from our customers on densification in really big areas like New York City or L.A., big metropolitan areas, where we know and our customers know, they need more capacity, but can't get any towers closer together than they are so they need to go into the small cell world where we participate. So what we've seen is a significant increase in the amount of small cells we believe that we will generate revenue. In 2023, incremental new revenue-generating nodes is what we call a small cell -- every small cell. We did 8,000 of them in 2023. We believe that we'll do 16,000 in 2024. So it's a significant increase over year-over-year. And it's likely because the cycle generally is our customers go on towers first and then they densify with small cells. They did a lot of that tower work. Now they need the densification work and therefore, our small cell business is picking up in revenue growth. And that's part of why we're in the business is -- we have had a belief over time that densification is going to be required. Small cells are going to be required, and they are a bit of an offset to the tower dynamics in the U.S.

And on those 16,000 I think one of the things that the tower model is great at is those incremental economics that you talked about. And I think you've believed, I would have said that this will play out as well in the small cell market, but it's you measure it more like maybe nodes per mile or something like that. So perhaps give us an update on how that's progressing?

Just like in our tower business, our small cell business is a shared infrastructure model. So we put infrastructure in place. We lease that infrastructure back to the wireless carriers. They pay us less than it would cost them if they built it themselves. And if we get enough customers, enough tenants as we would call them, because we believe them -- we think of them as tenants just like most real estate companies would. As we get more of that tenancy, our returns go up. No different than an office building, just a significantly different underlying demand. An office building is, how many people are working in a central business district. For us, it's how many people are using their phones. For me, I'd rather bet on the fact that people use their phones more than people work in offices. So I think we're in a pretty good business. And we see the same dynamic in the small cell business. We build a piece of infrastructure, and as we put more tenants on that infrastructure, our returns go up. Historically, we had targeted returns of an anchor build. We don't build speculatively to where we have a small cell build that doesn't have an anchored tenant. So we always have a contract before we start spending money. We generally were building to 6% to 7% initial returns, yields, cash-on-cash returns in the first year. And those returns would go up. As incremental tenants were added, they get added at high double digits to low 20s and higher incremental returns, which gets us somewhere in the kind of low double-digit returns with 2 tenants and then up from there. So what we see is basically the same dynamic where the first tenant is not yet profitable for us, but the second tenant is. Those -- therefore, the colocation is very important to us. And the timing of that colocation is very important. The colocation being adding another tenant to an already existing piece of infrastructure. And we're seeing a lot of that colocation happening with the majority of the small cells we're putting on air in 2024, being colocation small cells where we are adding equipment to already existing sites. And that's something that has been a goal of ours to try to get to the point where we're seeing a lot of that colocation and a lot of the incremental economics, that's coming true in 2024. And we believe that as we look forward through our backlog, A lot -- most of our -- the majority of our backlog is colocation at this point. So we're going to see incremental returns that we think are higher than what we've seen historically.

Great. And then on your fiber solutions business, again, looking for reacceleration there. Can you update us on what you're seeing there and what the drivers are of that?

Yes, our fiber solutions business, so as I spoke to earlier, small cells require fiber optic cables to connect the actual antenna back into the network. And the way that, that connection is made is through fiber optic cable that we own. That is the shared infrastructure -- part of the shared infrastructure model of small cells. We also own a business and run a business that, because we own that fiber in dense metro markets, we own fiber in 48 of the top 50 markets in the U.S. We pass a whole bunch of buildings. And therefore, we sell access to the network to those enterprises in those buildings. The majority of our sales efforts are focused on government agencies, educational, medical, finance -- financial firms, large customers with various sophisticated needs. And that business is generally driven by increasing demand for data for organizations, people using more data, sending it to the cloud, coming back from the cloud. That's what our business then provides connectivity to. And what we're seeing now is, as Simon pointed out, was there had been some reduction in activity going into the back half of last year. And as we see incremental demand coming, we think that, that activity is going to reaccelerate or what we said was it would really accelerate when we gave -- when we updated our guidance in the first quarter, we accelerate to about 3% growth per year. And that's just based on more data demand in the U.S. Again, similar dynamics as to what drives our wireless business. People just use more data over time, and we believe that there's lots of drivers of that demand going forward as well.

Great. And in the last couple of minutes, we have, Dan, could we just review balance sheet and capital allocation. You like a lot of REITs. Obviously benefited from the favorable rate environment. You've pushed out a lot of your maturities here. But help us with target leverage and upcoming maturities and how you're thinking about refi-ing and so forth? And then anything you can give us on the dividend policy?

We -- our target leverage is about 5x debt to EBITDA. We think we can maintain a solid investment grade profile with that leverage. We're a little higher than that right now, given that we have been building a lot of these small cells over time. So we're about 5.5x, give or take. We think organically, just as we grow revenue and EBITDA, we will be able to pull that leverage back down to our target leverage over time. We have very little maturities through '25. We have purposely managed our balance sheet to give us a lot of leeway. We also have a large revolver that gives us a significant amount of capacity and availability of capital. So we look out over the course of the next 18 months or more. And we don't need to access the public markets. We have plenty of liquidity with our revolver in order to take care of any CapEx or refinancing needs of which there are very few because we've purposely pushed out the maturity towers to try to match more the long-term nature of our assets. So our average maturity of our debt is around 8 years right now. And it's something that we keep in mind all the time, is how do we try to match the liability with the asset. We have these long-term assets. We want long-term liabilities. And during the period of time where the interest rates were very low, it was our view instead of trying to maximize the savings we can get and go short term or floating rate debt at the time. We actually went the other way and tried to push as much term into our balance sheet as possible. So we did a lot of 30-year debt to try to take advantage of the very low cost of capital at the time. That turned out to be a good decision, although at the time, it didn't feel great because our borrowing costs were higher than our peers. But I think at this point, it's coming back to be a good decision and the length of our balance sheet, the lack of maturities and liquidity we have, we feel really good about. And it's a very purposeful endeavor that we went down. In terms of dividend policy, we pay out our -- the cash generated from our operations as a dividend, and then we fund incremental growth through incremental debt at whatever the prevailing the rate is. As we have done our modeling, we've always anticipated higher long-term cost of debt than what we had seen in kind of the low interest rate environment. What we're seeing today is much more akin to what we would have in our modeling for long-term cost of debt for us. So we feel like we've done a good job of matching the availability and cost of our capital to what we think long term -- will be required of us to continue to add our assets and grow our business.

Great. Dan, thank you for your time today. I really appreciate it.

Thanks. I appreciate the time.