American Tower's fourth-quarter results had few surprises, but the 2023 outlook is better than we expected and surpassed those of United States peers. Internationally, many moving parts—notably inflation, market consolidation, and one carrier’s financial difficulties—led to volatility in 2022 results and the 2023 outlook. Long term, we still like American Tower’s international diversification, and current U.S. strength only enhances its standing as our favorite U.S. tower company. We’re raising our fair value estimate to $220 from $210.

For most of 2022, American Tower’s results were weaker than peers’ in North America due to Sprint contracts that expired in the fourth quarter of 2021, resulting in heightened churn and flat organic tenant billings. After now lapping the initial cancellation, American Tower’s fourth-quarter North American organic tenant billings growth moved back up to 4%. We expect lower Sprint churn over the next two years before it is completely cleared by 2025. American Tower’s peers have most of their Sprint churn in front of them, but American Tower is also the only of the three big U.S. tower companies anticipating colocation and amendment growth acceleration in 2023. While we expect collective carrier capital spending in the U.S. to fall in 2023, we attribute American Tower’s ability to buck that headwind to its master lease agreements that lock in and even out spending as well as idiosyncratic differences between companies regarding carrier exposure and tower location. Considering its less urban footprint and lower Sprint churn, believe American Tower’s domestic outperformance can continue over the next few years.

In the international markets, organic tenant billings growth was 5.6% in the fourth quarter, the weakest quarter of the year. While lower escalators, which are tied to inflation in most international markets, were partly to blame, higher churn and lower colocation and amendment spending by carriers were also factors.

We think American Tower's strategy to diversify its tower portfolio globally leaves it best positioned among the three U.S. tower companies, as it is primed to benefit from the continually increasing demand in mobile data worldwide. However, we don't think veering into the data center business, which it did with its acquisition of CoreSite, will pay off, and it distracts from the tower focus we liked for American Tower.

The tower business is very attractive. We don’t think there will be any change to how critical they are to powering wireless networks; annual escalators provide a minimal level of stable revenue growth, and towers have significant operating leverage.

For the past several years, higher exposure to the U.S. was optimal for tower companies, but we think more international exposure will be preferable over the next few years. In the U.S., we think growth will stay below levels that towers achieved toward the end of last decade and the beginning of the 2020s. After multiple major U.S. spectrum auctions in that time period, we now think carriers have deployed most of the spectrum they won. We don’t anticipate additional auctions for big spectrum blocks near term and don’t expect deployment of already-controlled spectrum on additional towers will be a major catalyst.

American Tower’s international growth was depressed while the U.S. was outperforming, but we believe headwinds in India are largely past and the firm’s emerging markets—especially Africa and India—are poised to embark on the long-term network buildouts we think are necessary there. Many international markets are a decade behind the U.S. and in building 4G and 5G networks, and the countries don’t have the breadth of coverage we think is necessary for their huge populations, especially as wireless connections often provide the only connection to the internet.

American Tower acquired CoreSite to give it a greater presence in edge computing, but we don’t believe material synergies exist between towers and traditional data centers. We think CoreSite is a fantastic stand-alone company, but in our view American Tower overpaid for it and will not be able to make up for that difference through synergies.

We assign American Tower a narrow economic moat due to the efficient scale that underlies the tower industry and switching costs that dissuade tenants from seeking alternative providers once they have installed their equipment on towers. American Tower’s returns returns have averaged about 10% over the last 10 years, above the 7% weighted average cost of capital we estimate for the firm. Given the critical nature towers play in allowing the public access to mobile data, the lack of near-term substitutes to towers, and the barriers to alternative tower providers, we expect excess returns to continue for the next decade as well, resulting in our narrow moat rating.

The efficient scale present for major tower providers is enhanced by the extreme operating leverage associated with individual towers and the limited number of potential customers. Economic returns on towers are typically not good until the tower provider can secure multiple tenants on the tower, and the pool of sizable customers in any area is limited to the number of wireless carriers operating networks. These factors should make it unlikely that new competitors could profitably build a large portfolio of towers in areas that already have quality wireless network coverage.

Costs to the tower provider are mostly fixed per tower, meaning costs to operate a tower are virtually the same whether a tower has one tenant or several tenants. American Tower states that an average U.S. tower costs about $275,000 to build; rents for the initial tenant are about $20,000 per year; and the company’s operating expenses with one tenant on the tower (consisting primarily of rent expense to lease the land, which is fixed) are $12,000, resulting in only a 3% return on the tower. By American Tower’s estimates, the return jumps to 13% once it has added the second tenant and can reach 24% with a third.

Consequently, even before considering other hurdles an upstart competitor would have to overcome to compete on American Tower’s turf, it would have to contemplate sinking tremendous amounts of capital into building towers, locking itself into $1,000 per month land lease payments over a term of 5-10 years, and, given a likely need to offer lower average prices to carriers to entice them to switch, would need to average close to two tenants per tower in hopes of generating a slim excess return on its capital.

We believe the limited number of potential tenants and switching costs that make taking those tenants away from rivals difficult will keep out new competitors. Most markets have only three or four major carriers that own wireless networks. In the U.S., for example, the big three wireless service providers generally make up about 90% of the geographic segment’s revenue. Customer concentration is similar throughout the industry, and it applies in American Tower’s other markets as well, though not to the same extent. Customer concentration levels in American Tower’s other geographies range between 60% and 80% and should increase as carrier consolidation in those markets continues.

Switching costs make it unlikely a tenant will vacate a tower if it wants to maintain a presence in the area. Carriers own and are responsible for the equipment they deploy at and on the towers, and they are responsible for removing it if their leases expire. Industry peer Crown Castle has stated that it costs carriers about $40,000 to remove equipment from a tower in the U.S. With American Tower’s U.S. tenants paying between $20,000 and $30,000 per year in rent, it means they would have to recoup one and a half to two years' worth of rent payments to break even. A rival would need to undercut American Tower’s prices by that much more to make up for the loss carriers would be facing in deciding to switch, further impeding a competitor’s prospects of generating excess returns. Yet direct costs are not the only switching costs carriers face. Carriers’ most valuable assets are their networks, and any disruption to the network, whether temporarily during a tower switch or more permanently as a result of a new setup and location, risks customer dissatisfaction with their service. Given the negligible switching costs to carriers’ customers, we don’t think network risk is one that carriers would take lightly or put in jeopardy for minimal cost savings, adding even more to the amount a rival would likely need undercut prices to coax carriers into making the gamble. History suggests that carriers hesitate to leave towers that they are on, as churn for American Tower is typically 1%-2%, inclusive of churn related to industry consolidation.

American Tower’s acquisition of CoreSite does not affect our moat rating or moat sources, because it will make up a small portion of American Tower’s total business. In its own right, we had similarly rated CoreSite as having a narrow moat, and we think its property portfolio had a strong competitive advantage. The network density of its data centers underpinned a network effect, and the firm also benefited from the switching costs inherent in data centers.

While we think barriers to competition for the existing public tower companies are overwhelming in the near term, a couple of factors reduce our visibility over a 20-year span, keeping us from labeling American Tower’s moat as wide. First, the tower companies typically lease significantly more land than they own. At the end of 2021, American Tower owned only about 10% of the land under its towers. Its leases typically have initial terms of five to 10 years and give it the option for at least one renewal period. Under existing leases, American Tower controls the land under more than 41% of its towers until 2031 or later, so we don’t think it is a significant near-term concern. However, as leases need to be renegotiated, we have less confidence that the tower companies have leverage over land owners or advantages versus other potential land tenants. We think competitors are unlikely to build competing towers in tower vicinities; we think their better competitive move would be to secure available land where towers already exist. While incumbents may be best positioned to hold on to their land, they may be forced to do it on less favorable terms, which could affect returns.

We are raising our fair value estimate for American Tower to $220 from $210, implying an EV/EBITDA multiple of 20 and P/AFFO multiple of 22 based on our 2023 forecasts.

We project revenue growth to average in the mid to high single digits annually over the next five years. We project total tenant billings growth in the U.S. to average 5% annually throughout our five-year forecast. We believe carriers will have to continue investing in their networks to accommodate greater data usage, leading to mid-single-digit annual long-term growth from co-locations and amendments, and escalators should hold steady at about 3% annually for the foreseeable future, as American Tower has agreements in place with all the major carriers.

We expect investment to stay elevated in American Tower’s international geographies. Apart from potential future acquisitions, we forecast the company to build about 5,000 new international towers annually. We expect collective international sales growth on existing towers to average about 7% annually from 2023-27, and we expect newly built towers to add a few percentage points worth of revenue growth each year, as American Tower takes advantage of the need in many developing markets to enable high-quality mobile broadband.

After the acquisitions of Telxius and CoreSite reset the firm’s adjusted EBITDA margin to 62% from 64% in the prior two years, we expect the trend of expansion to resume and for it to reach 65% by 2027. We expect margins to expand more in the U.S., where the firm will benefit from operating leverage on its stable portfolio of mature towers. Firmwide margin expansion will be limited by a higher revenue mix shift to the lower-margin international business and the significant international building of new towers, which start with fewer tenants and therefore lower margins. We project the U.S. tower business to drop from 53% of total sales in 2021 to about 40% by 2026.

Our Morningstar Uncertainty Rating for American Tower is Medium. We are confident towers will be integral to telecommunications throughout our forecast, and American Tower will thrive, but the stock's value is dependent on carriers needing to continue investing heavily in their macro towers. If there is ever an alternative to macro towers or the ability for carriers to rely on them less than they have historically, American Tower's growth will suffer.

Greater use of small cells by carriers, which will be more prevalent with 5G, could affect tower demand, as could other technological advances that require less tower density for carriers. We believe towers will continue to be carriers' most cost-effective option, especially in the ex-urban areas where American Tower more commonly resides, so we don’t think the risk is high. However, maturing 5G networks and less wireless spectrum for carriers to deploy should make high sales growth less reliable.

We think American Tower's recent acquisition of CoreSite increases risk and uncertainty, as it paid a big premium for a business where we see few synergies. We think CoreSite is an excellent business with valuable and unique properties, but we question whether investors will see adequate returns for the price American Tower paid.

We don't think American Tower has high ESG risk. Two potential ESG issues that American Tower's core business lends itself to are the risk of natural disasters, which have become worse with climate change, and the high level of business the firm does in more developing countries where the rule of law is not as strong. The acquisition of CoreSite brings about the ESG risks associated with data centers, namely their massive power consumption and housing of very sensitive data, making them prime targets for security breaches. CoreSite is working toward using renewable energy and becoming carbon neutral, though this also adds the risk of being able to procure enough green energy at reasonable prices.

Our capital allocation rating for American Tower is Standard. We’ve liked some of the strategic expansion decisions over the years, but many have yet to perform as we anticipated. The more consequential factor for our decision against an exemplary rating, however, is American Tower’s detour into the data center business. We believe the firm overpaid for in its acquisition of CoreSite, and we don’t believe there are substantial synergies between data centers and towers. While the firm mitigated some of the financial risk by selling a minority interest in its data center business, it has still brought financial leverage to higher levels than it has been historically and heightened its own risk.

American Tower’s strategy has historically been to focus exclusively on towers and expand its model throughout the world, including in many developing countries where we believe there is a path to follow a similar trajectory as the one the United States has experienced over the past decade. The focus on towers, international expansion, and moderate financial leverage led us to an exemplary rating prior to the CoreSite acquisition. Even as American Tower spent more aggressively on the international expansion in recent years—around $10 billion building and buying international towers during the last five years—and increased its financial leverage from historical levels, the firm continued to regularly achieve at least 10% returns on invested capital each year over the past decade. In our view, the CoreSite acquisition puts the firm’s ability to continue executing successfully at greater risk and brings financial leverage higher than we’re willing to give a pass on for company with exemplary capital allocation.

American Tower’s net debt/adjusted EBITDA was 5.5 at the end of 2022, but it has brought it down significantly through an equity raise following the CoreSite acquisition, and has improved its debt profile, in our opinion.

We think American Tower’s handling of shareholder distributions is appropriate. As a REIT, it must distribute at least 90% of REIT taxable income. As a percentage of free cash flow, the payout ratio has traditionally been around 50%, and the dividend averaged 20% growth each year since 2013. We expect those figures to deteriorate following the outlay for CoreSite, and with American Tower keen on keeping its investment-grade credit rating, we expect returns of capital to shareholders will be limited to what’s required to maintain REIT status.