Description

The bonds of SBAC are attractively priced and provide investors with the opportunity to capture at least 20%+ annualized returns over the next several years and possibly much higher should the situation develop as I believe it will.

SBAC is a national wireless tower company. SBAC primarily leases out space on its towers to the various national cell phone carriers. The equipment the carriers place on the towers establishes the network that allows them to provide service across the country. You may say that this does not sound like a particularly sexy business especially given the recent turmoil in the wireless / telecom arena. I would reply that you are correct but it is the mundane nature of the business that makes it so darn attractive.

Capital Structure
Bank Debt ($300 facility) $255
10.25% ’09 bonds $500
12% ’08 bonds $269
Cash $62

The 10.25% 2/1/09 bonds of SBAC trade at around 65% which is roughly a 20% YTM. Through the bonds of SBAC, you are purchasing the company at around 8.4x run rate EBITDA. This is an attractive valuation for a company with SBAC’s cash flow generating ability. The fact that most of SBAC’s cash flow is generated from business that is under contract and insulated from competition makes these cash flows even more valuable.

Based on my liquidity model, SBAC will have no problem meeting its interest obligations through at least 2005 by which time you would have pocketed around 20 points in coupon payments. Meaningful amounts of bank amortizations ratchet up in 2005. Even if this forces a bankruptcy, which I don’t think it will, you as a bondholder would be owning the equity at an attractive 8.4x ’02 run rate EBITDA or around a 10% FCF yield to the new reorganized equity. In 2005, these metrics will be even more attractive as the company’s leasing base increases through additional tenants/amendments and contractual rent escalators as it has historically. Applying a conservative 11x multiple to unlevered free cash flow in 2005 would result in a 90-95% recovery on the bonds. This result would provide the investor with a total return in excess of 20% annualized. Of course, I believe this valuation will be achieved earlier as people realize that liquidity is sufficient and that at 3.1x gross leverage the banks are adequately secured and will at worst be refinanced if any issues arise. Any earlier revaluation would only increase the IRR on the investment.

I believe that the economics of the tower business is similar to most REITS but with several more attractive attributes. SBAC should be valued at least as highly as a REIT and certainly could be reasonably argued to command a higher valuation than a REIT. Part of the value mispricing is due to the hangover of the massive telecom bubble collapse. Many telecom companies are down significantly from their highs and they have brought down many others with them. As time passes and people begin to recognize the tower operators for what they are and see the cash flow that is generated, the tower operators will garner the valuations they deserve. Lucky for us, the tower operators are under appreciated, especially SBAC, and that creates the opportunity that is available to us now.

I believe this opportunity exists because the company is in an in between state. It is not bankrupt or nearly bankrupt where valuation is the primary determination of price that is usually determined by the buying and selling of distressed investors. On the other hand, SBAC does not have gobs of liquidity (although it does have $62M cash and $45M available under its credit facility which I believe is quite significant) and command some spread to treasury. In addition, I believe HY investors are weary of holding bonds in a company where the underlying assets are telecom related and not easily understood after a cursory glance. They probably say something like – “look at all that leverage and its telecom – no way”. Investors also look at the vast amounts of capex that has consumed cash historically and conclude that the end is near. SBAC did spend hundreds of millions of dollars historically on capex to build and acquire the towers in their portfolio. They probably overpaid for most of them during the height of the bubble. This capex is a thing of the past, though. After 2003, SBAC’s capex will be reduced dramatically, out of necessity, to a maintenance level of about $10-$15M / year. This will have dramatic cash flow implications and cannot be appreciated after a quick glance of the historical financials.

SBAC is a highly leveraged company but at current prices you are buying into the company at a very attractive valuation. In addition, as a bond investor you will be collecting large coupons that represent a 15 – 16% current yield.

Tower operators essentially collect rent. SBAC rents out space on one of its ~3,800 towers, to Nextel for instance, and receives monthly rental payments in return. Rentals spaces vary in price based on location and size and amount of equipment placed on the tower but they average around $1,500 per month per tenant or $18,000 per year. Most of SBAC’s towers can accommodate as many as 4 tenants or so and average more than 2 currently.

Once the tower is built, SBAC has to spend very little to satisfy its obligations to the carrier. Workers generally monitor the tower for repairs and maintenance. Tower maintenance capex runs at about $1,000-$2,000 / tower. All this translates into incredibly strong operating statistics. SBAC delivers leasing gross margins in the 60% range and leasing EBITDA margins in the 40 – 50% range at least.

Much like apartment REITS, towers generate recurring contractual revenue. REITS are valued highly for this stable high margin revenue stream as they command EBITDA multiples in the 9-11x range. Towers exhibit several traits that make them as attractive as REITS and several more that make them more attractive than REITS.

*Contractual Rent w/ Escalators

SBAC leases out space on its towers for 5 year lease terms. Either through the renewal clauses or through the terms of existing leases, the leases escalate at around 2-3% / year. So not only is the existing revenue base stable, contractual in fact, but it is growing.

*Scalability

SBAC can add up to four tenants per tower which makes the economics on each tower extremely attractive as each new lease paying customer’s revenue is converted into almost pure FCF. This feature makes each existing tower extremely valuable. REITS do not share this same ability. If an apartment building in NYC has 250 units, it has no means to increase revenue other than through rent increases. Very rarely do I see additions to apartment or office buildings to add more rental space. This would be very expensive and probably prohibited by various zoning laws. SBAC, in essence, can add another floor to its apartment buildings and lease out this newfound space. Furthermore, SBAC can create this new space for almost nothing in the way of incremental capex. If apartment or office buildings could add new floors to its most sought after buildings and do it for free, they would be scary valuable and even more highly prized by investors.

*Low Level of Maintenance Capex

Once a tower is constructed little capex is needed to maintain the tower. SBAC estimates its maintenance capex a ~$2,000 / tower or even lower which would be roughly 5% of a tower’s revenue assuming 2 tenants at $1,500 / month. ($2,000) / ($1,500*12*2) As more tenants are added and rents escalate this % will decrease further.

*Unique Asset / Monopoly Like Characteristics / Barriers to Entry

Towers are unique in that if NXTL leases space on towers in the
L.A area it does not do anything to NXTL’s coverage in Syracuse NY. Each tower fills in holes in the coverage of the network of each carrier. Unless there is another tower
very close by to another, the carrier has little choice but to lease space on the
tower or put up with poor coverage in that location. Poor coverage or low quality reception is a leading cause of churn among the wireless carriers.

Due to this unique demand characteristic and the fact that it is generally
uneconomical for the carrier to cancel leases or rip down sites from the towers, there is
very little churn. Any churn that has been experienced is usually from paging
companies that represent less than 5% of revenues on average.

At several hundred thousand dollars a pop, towers are rather expensive to build. Few entities, especially carriers, would find it appealing or economical to build a new tower close by to a competing one. In addition, local communities are getting increasingly restless about the ever-increasing eyesores like towers or radio antennas that appear in their back yard - NIMBY. Getting zoning approval for a new tower site would prove to be very challenging.

*Attractive Consolidation Opportunities

While chatter swirls regarding wireless carrier consolidation, consolidation among the major tower operators is highly likely and extremely compelling. Consolidation would enable operators to reduce large amounts of redundant G&A costs further enhancing the already attractive operating statistics. A number of events have transpired recently that create interesting consolidation possibilities. Major operators like AMT have returned from the brink as it now carries a billion dollar equity market cap. Spectrasite has emerged from its bankruptcy reorganization as the least levered tower operator with significant equity stakes owned by major financial players. I believe that either of these two companies or CCI will take advantage of the significant opportunities in consolidation. SBAC is an attractive target due to its relatively small size (3,800 towers vs 14,000 for AMT and 7,500 for Spectrasite) and portfolio of younger low maintenance towers.

Private equity investors have been swirling around all the major tower operators. A financial investor may choose to make an investment in SBAC to ensure the continuation of the public equity for management, identifying the attractive investment opportunity on its own or use SBAC as a platform for consolidation of smaller operators.

*Attractive Valuation

At 65% a purchaser of the SBAC bonds is buying into the entity at around 8.4x run rate EBITDA and $178,000 per tower.

Through the equity, comparable companies like AMT and CCI trade at around 11-12x est. ’03 EBITDA and AMT is valued at approximately $315,000 / tower. Spectrasite trades at around 10x est. ’03 EBITDA and $190,000 / tower.

Catalyst

Consolidation
Quarterly results demonstrating liquidity and cash flow generation
Receipt of coupons