Global tower companies including American Tower, Crown Castle, and Cellnex Telecom are often considered to be a proxy for bonds given their long-term contracts, inflation protection due to fixed or CPI-linked revenue escalators, and the inherent structural demand drivers for tower infrastructure from wireless data traffic growth on smartphones. In turn, these characteristics have justified the strong valuations placed on the long-term cash flows of tower companies.
However, there have been periods of time, such as in early 2021, where increased inflation (or perceptions thereof) have negatively impacted valuations of tower companies. Indeed, the notion that higher inflation should always benefit the business of tower companies is actually more nuanced.
For 2022, a persistent rise in inflation has become a significant cause for concern – both from a macroeconomic perspective and from a micro-focused lens on its impacts to tower companies. In the United States, as of November 2021, the consumer price index (CPI) rose 6.8% year-over-year and is estimated to remain elevated at 4%+ for 2022. While in Europe, as of November 2021, Eurozone inflation reached 4.9% year-over-year and is forecasted to be 2.2% in 2022, exceeding the European Central Bank’s target of 2.0%.
With this background, Dgtl Infra reviews how persistently higher rates of inflation could impact the businesses and valuations of global tower companies. Specifically, this overview includes the following implications of inflation on tower companies:
- Revenue: variability in the long-term contracts and particularly, revenue escalators within tower contracts
- Expenses: operating expenses most affected by increases in inflation (e.g., ground leases)
- Construction: material and labor costs to build new towers, which inflation influences
- Emerging Markets: foreign currency exchange rates, which country-specific inflation pressures
- Valuation: towers are long-duration assets, making the implications of inflation on cost of capital more acute
Long-Term Contracts with Revenue Escalators
Tower companies generate revenues on long-term contracts with built-in escalators which are typically fixed at 3% for U.S. towers and linked to local inflation / indexed to CPI for international towers. As such, these fixed and inflation-linked rental revenue escalators protect the profitability of tower companies from inflation in their expense base. To this end, historical inflation rates in the U.S. have been below 3% (i.e., a typical fixed escalator) since 2012.
Another nuance of tower company contracts is that revenue escalators are normally applied on an annual basis to revenue for the subsequent 12-month period. In turn, this creates a timing lag, whereby tower companies may be subject to periods during a year when their underlying costs increase, but their contractual revenues do not rise in a corresponding manner. Indeed, this problem is particularly critical when inflation rises rapidly, as it has done in 2021.
United States – American Tower, Crown Castle, SBA Communications
Historically, U.S. tower companies have not structured their ~3% fixed escalators to align with inflation, but rather to mimic the long-term growth in ground lease payments for the real estate underneath their towers. This is because ground leases are the largest operating cost of a tower company (see next section).
Given this dynamic, U.S. inflation rates that exceed the ~3% fixed escalator of American Tower, Crown Castle, or SBA Communications’ contracts, would adversely affect their U.S. businesses. Particularly, this is because site leasing revenues are structured via long-term contracts with pre-determined pricing. Therefore, these tower companies would not be able to increase their existing contract pricing, in response to a rise in inflation. However, from a revenue perspective, U.S. tower companies would be able to partially mitigate inflation by increasing pricing on new lease and amendment signings.
At the same time, U.S. tower companies have been extending the duration of their long-term master lease agreements (MLAs) with wireless carriers, hence increasing their sensitivity to inflation. Specifically, new tower lease contracts have recently been signed on terms of 15 years, replacing the typical 10-year length:
- American Tower: in September 2020, signed a 15-year lease with T-Mobile US
- Crown Castle: in November 2020, signed a 15-year lease with DISH Network
International Markets – Cellnex Telecom, Vantage Towers
Generally, long-term tower contracts in international markets, such as Europe, Latin America, and Africa, are linked to local inflation / indexed to CPI. One notable exception is India, where the market utilizes fixed escalators of 2% to 3%, which historically have been well below inflation rates in India. Notably, American Tower has 75.7k sites in India, which do not index to inflation.
Even in established tower markets like Europe, CPI-indexation is not consistent throughout all tower contracts between wireless carriers and tower companies. Particularly, this is shown through the contract details of Europe’s two largest tower companies – Cellnex Telecom and Vantage Towers.
Cellnex Telecom – Europe
Cellnex Telecom, the largest tower company in Europe, has made its view on inflation clear, with a graphic in its 2020 full-year results presentation depicting the phrase: “I Love Inflation”.
As of September 30, 2021, Cellnex’s revenues were ~65% linked to CPI/inflation, with the remaining ~35% governed by fixed escalators between 1% and 2%. Specifically, through the following tower contracts, Cellnex has only secured fixed escalators:
- Salt: 1% fixed escalator on 2.8k sites in Switzerland
- Iliad: 1% fixed escalator on 7.9k sites in France and Italy
- Bouygues: 2% fixed escalator on fiber-to-the-tower (FTTT) roll-out in France
- SFR/Altice: 2% fixed escalator on 10.5k sites in France
Additionally, three of Cellnex’s CPI-linked contracts have inflation caps of 2.25% or less. Particularly, these contracts are with OMTEL in Portugal (2.0%), NOS in Portugal (2.0%), and CK Hutchison across Europe (2.25%).
Vantage Towers – Europe
Vantage Towers, the second-largest tower company in Europe, generates 83.5% of its revenue from its anchor tenant, wireless carrier Vodafone. At the same time, Vodafone’s master service agreement (MSA) with Vantage Towers has a duration of 8 years, including 3 automatic renewals, effectively extending the agreement for a total of 32 years.
Generally, Vantage Towers’ MSA has 2% inflation caps across its European countries of operation, including in its two largest markets, Germany and Spain, which comprise 65%+ of its consolidated revenue. The company’s only exceptions are in the UK (a 50% joint venture) and Hungary, where its inflation caps are 3%. In summary, through its MSA with Vodafone, Vantage Towers has low inflation caps under a very long-duration contract.
Inflation Impacts – Cellnex and Vantage
Overall, Cellnex and Vantage’s operating results could be negatively impacted by high rates of inflation that exceed their fixed escalators of 1% to 2% or inflation caps of 2.0% to 2.25%. Under these scenarios, operating expenses would increase at a greater rate than revenue, leading to pressure on profitability and margins.
Next, we discuss the specific components of these operating expenses which could negatively impact the profitability of tower companies.
Operating Expense Inflation – Tower Companies
Tower companies generally have a fixed cost profile, with their largest direct costs of operations being ground leases, monitoring, insurance, real estate taxes, utilities, and site maintenance. Notably, in international markets, tower companies can often pass through a portion of these operating expenses to tenants, such as ground leases and power & fuel costs.
Ground Leases
A tower company’s largest direct cost, often comprising ~70% of operating expenses, are the ground leases for land under their towers or rooftop sites.
In the United States, ground lease expenses are primarily fixed under long-term, renewable lease agreements, of 5 to 10 years, with annual cost escalations of ~3%. As such, the impact from inflation is insignificant on ground lease expenses, and, in turn, the majority of a U.S. tower company’s operating expense base is fixed.
However, in Europe, ground leases are often linked to inflation and only recognize a portion of the previous year’s inflation. Therefore, with higher inflation, revenue would increase at a faster rate than expenses, demonstrating the operating leverage of towers.
Radius Global Infrastructure – Example
As a reference point, Radius Global Infrastructure, a ground lease aggregator, operates a ground lease portfolio with a weighted average escalator of 3.2% year-over-year. Further, the company’s annual rental escalator is ~80% tied to inflation, meaning a consumer price index (CPI) or subject to open market valuation (OMV), with the remaining ~20% linked to a fixed rate, typically between 2% and 3%.
Radius Global Infrastructure’s high weighting of inflation-linked rental escalators is due to the geographic composition of its portfolio, with its in-place rents more skewed towards Europe.
Variable Operating Expenses
Variable operating expenses of tower companies, which are most susceptible to inflation, represent the remaining ~30% of operating expenses such as monitoring, insurance, real estate taxes, utilities, and site maintenance. For example, site maintenance costs, which require labor, include ensuring the physical tower does not have rust and cutting the grass on-site. Additionally, utility costs comprise electricity in the United States, while diesel fuel is a significant operating expense in emerging markets.
Diesel Fuel Prices
In emerging markets, particularly Africa, one of a tower company’s primary operating expenses is diesel fuel, which they use in substantial quantities to power tower site generators. This is because of the intermittent and unreliable grid availability in certain African countries (e.g., Nigeria).
Diesel power generation expense is a variable cost, which is typically paid in local currency, but linked to the U.S. dollar through the international price of oil. Indeed, this variable diesel cost can leave a tower company’s financial performance exposed to fluctuations in oil prices over the duration of its leases/contracts. As such, recent increases in global oil prices have negatively impacted the financial results of tower companies in Africa, such as IHS Holding.
Construction Cost Inflation – Tower Companies
Globally, tower companies including American Tower, Cellnex Telecom, and Vantage Towers, intend to construct 70k+ towers over the next several years. Therefore, inflation in construction costs, both materials and labor, could significantly influence the economics of ongoing build-to-suit (BTS) programs of tower companies like American Tower. Below are further details on the plans of the largest tower developers, American Tower, Cellnex Telecom, and Vantage Towers:
- American Tower: in 2021, anticipates building a total of 6.5k to 7.5k tower sites globally, including 4.5k sites in India and 1.3k sites in Africa. Additionally, American Tower has set a long-term goal of constructing 40k to 50k communications sites globally, over the next 5 years – making long-term inflation a relevant consideration
- Cellnex Telecom: through 2030, Cellnex has committed build-to-suit (BTS) programs to construct ~20k incremental towers across Europe. Specifically, Cellnex will construct these BTS sites in countries including Poland (5.9k sites), France (4.7k sites), and Italy (2.7k sites)
- Vantage Towers: through FY 2026, Vantage Towers will construct a total of 7.1k new sites through a BTS program with Vodafone. Of this total, Vantage Towers will build 5.5k sites (77% of total) in Germany
As a reference point, Cellnex notes in its Q3 2021 earnings presentation that, with regards to raw materials, “only c.1/3 of BTS Capex [is] associated with constructions costs”. Nevertheless, inflation in both materials and labor still poses a risk to tower developers as follows:
Material Prices
As a result of the ambitious build plans of these tower companies, key construction materials such as galvanized steel and reinforced concrete will remain in high-demand from tower companies. In turn, cost inflation due to higher commodity prices in steel and concrete impact the total cost of building a tower structure. For example, U.S. spot steel prices reached an all-time high in September 2021, up 200%+ year-over-year.
Labor Inflation
Beyond construction materials, tighter labor markets, which ultimately lead to wage inflation, would also impact the construction costs of towers.
Foreign Currency Exchange Rates
Certain tower companies, including American Tower, SBA Communications, IHS Holding, and Helios Towers have sizable operations in emerging markets like Africa, Latin America, and India. These emerging markets are susceptible to currency devaluations as a result of sharp increases in local inflation. For example, below are key emerging markets countries (all markets of American Tower) and their latest corresponding inflation rates:
- India: annual inflation rate in India stood at 4.9% as of November 2021
- Brazil: annual inflation rate in Brazil increased to 10.7% in November 2021
- Nigeria: annual inflation rate in Nigeria was 15.4% in November 2021
- South Africa: annual inflation rate in South Africa grew to 5.5% in November 2021
As a result of inflation-led currency devaluations, tower companies like American Tower could be impacted by the foreign currency translation of their financial results into U.S. Dollars for reporting purposes.
Cost of Capital and Valuation
Crown Castle highlighted during its Q3 2021 earnings call that its “business and balance sheet are well-positioned to support consistent AFFO growth through various economic cycles, including during periods of higher inflation and interest rates”. Indeed, as discussed in the prior sections above, Crown Castle’s assertion on the business implications of inflation on tower companies has merit. Particularly, this is the case as Crown Castle is solely focused on the U.S. towers market and has a limited pipeline of tower development projects – reducing its exposure to inflation.
However, equally important are the consequences of inflation to a tower company’s cost of capital and thus valuation, particularly given the long duration nature of tower assets. Specifically, higher inflation could lead to an increase in the cost of equity of tower companies driven by i) a higher risk-free rate as easing of monetary policy subsides and ii) an elevated market risk premium from a more cyclical economic environment.
In isolation, a higher cost of equity and thus cost of capital would negatively impact tower company valuations. Additionally, given the vast majority of a tower company’s worth is derived from its terminal value, the sensitivity of its valuation to changes in its discount rate/cost of capital is very high. Finally, tower companies are highly-levered, magnifying these valuation changes. As such, should inflation raise the cost of capital of tower companies, the negative impact to their valuations could be exacerbated.
Overall, while various permutations of inflation may or may not have a material impact on the business of tower companies, the risks to their valuations may become more relevant in 2022.
