Description

Summary

Cellnex is the largest independent telecom tower operator in Europe. The business was last written up on VIC on March 29, 2020 near the COVID bottom and today trades for a lower share price, after declining more than 40% from its August 2021 highs. While this type of trading history is not unique in the current market, especially for a perceived “bond proxy”, at the current share price I see Cellnex being a very attractive risk/reward.

Pro forma the build-out of new contracted towers, an uptick in co-tenancy of Cellnex’s existing towers, and the redeployment of Cellnex’s excess capital following a March 2021 rights offering, I see Cellnex’s levered free cash flow per share approaching €3. Non-coincidently, €3 is management’s 2024 FCF per share target required to achieve a maximum payout under their new long-term incentive plan. At today’s €36 / share trading price, CLNX is trading for a normalized 12x FCF.  This valuation is attractive not only to where Cellnex has traded historically but also to where US peers are currently trading. Well know US tower operators are currently trading for >20x normalized FCF. Therefore, I don’t think 20x is an unreasonable valuation for Cellnex as there is precedent in the current market. 20x FCF x €3 in FCF gets me to €60 / share or ~70% upside from here.  

I think Cellnex’s attractive valuation will be more apparent to the market once it redeploys its excess capital. The company currently has ~€5.5 billion in funded excess capital and management believes it can redeploy ~€8 billion in capital without any impact on its split credit ratings (BBB- from Fitch, BB+ from S&P). The company has committed to redeploying this capital by October of this year. This is one of the few management teams in Europe that understands capital allocation and is incentivized to create shareholder value. I expect this capital to be deployed in an FCF accretive manner. Moreover, if for whatever reason the company can not redeploy this capital into a value-creating tower acquisition, management has made it clear on its Q1 conference call that they will return all excess capital through share repurchases. At the current normalized valuation, I believe share repurchases are attractive.

Cellnex’s shares have fallen along with other interest-rate-sensitive peers, following a sharp rise in rates. However, I do believe viewing Cellnex as a bond proxy is discounted at this point. The majority of Cellnex’s contracts are linked to CPI and the operating expense base is very well managed. Cellnex’s financial leverage profile is largely fixed (~86% of debt). Cellnex’s debt has no covenants, no pledges and no guarantees. The company has no debt maturing until 2024 and its most recent 2022 maturity was refinanced at a lower coupon than what prevailed.

Cellnex can grow under any operating environment and its growth accelerates in an inflationary environment. Consider the following bridge from its Q1-22 results. Cellnex’s Q1-22 YoY FCF grew 25%, in which 10% was from new towers built, 5% from increased colocations on existing towers, 8% from inflation and 3% from efficiencies. Growth in Cellnex’s tower pipeline and new colocations has some tailwinds which I address in the report below. Therefore, even before crediting for inflation, Cellnex should be able to grow low-teen for the foreseeable future.  

All-in-all, I believe Cellnex is an attractive risk/reward. You get an attractively priced, growing, inflation-protected, non-cyclical business at a normalized high-single-digit free cash flow yield. This valuation should be apparent once the company executes redeploying its excess capital. If the company fails to redeploy this capital into another transformative tower acquisition, then the company will aggressively return capital to shareholders at an attractive valuation.

History and Overview

Cellnex is the largest independent telecom tower operator in Europe with nearly ~100,000 sites. The Barcelona listed company was spun out of Abertis in 2015 with the rationale of creating a singularly focused tower operator to be the preferred partner for European telecoms. The European telecom industry is less consolidated than the North American industry, resulting in European telcos to earn lower returns on capital than international peers. In turn, European telcos trade at relatively low valuations, creating an opportunity for a company like Cellnex to help European telecoms surface value and more efficiently invest. Since Cellnex’s inception as a standalone public company, Cellnex has been successful in capitalizing on this opportunity, more than increasing its tower sites by 10x through over 25 acquisitions. Cellnex expects to continue on this path and has €7.8bn of excess capital (>25% of its current market cap) to redeploy into acquisitions. The company expects to redeploy this capital by October of this year.

What does the business do and how does it make money?

The business model of a tower operator is very straightforward. Tower operators lease strategically located land, upon which a tower is erected for the purpose of hosting transmission equipment for telecoms. The tower operator owns only the basic tower structure, equipment shelter, cables, and base stations. Telecoms lease the vertical space on the tower, for which they engage in long-term contracts with the tower operator. The tower operator then installs the telecoms transmission equipment.

Value proposition

The main value proposition of a tower operator is that they allow telecoms to build out their network more efficiently with a lower overall cost of ownership. This is achieved through the sharing of infrastructure amongst competing telecoms.

Prior to 4G technology, the needs of a tower operator were relatively limited as power needs and tower needs were relatively static. However, 4G and now 5G have changed this demand as cellular technologies moved to higher frequencies. In general, higher frequency waves travel shorter distances than lower frequency waves. This migration to higher frequencies requires additional towers, placing a strain on mobile operators' capex. 

Wireless technology is a never-ending upgrade cycle, requiring telcos to constantly upgrade their equipment to support the likes of radios, antennas and MIMO units. The core business of a telecom is maximizing the return on its sophisticated equipment, not the deployment and maintenance of an asset. While operating a tower is a straightforward business, there is still a significant amount of work required to maintain the equipment. With telecoms having equipment dispersed across tens of thousands of towers, telecom operators find it very difficult to maintain and install additional equipment on every site. Maintaining the structure, stability, power requirements, and environmental concerns is outside of a telecom’s core competency and is better offloaded to a third party like Cellnex.

Is this a good business?

Being a tower operator is a good business with several attractive attributes:

Recurring long-term revenues

·        Anchor contracts with telcos are typically non-cancellable, with a 10-20 year initial term plus renewal clauses

·        Long-term contracts include an “all or nothing” renewal clause. Telecom operators are not able to cherry pick certain towers and migrate partially to nearby competitors where it makes economic sense

·        Cellnex operates in only the utmost stable geographies in Western Europe (no Ukraine / Russia exposure) – 80% of Cellnex’s towers are located in A-rated or better sovereigns

·        Portfolio is largely comprised of blue-chip tenants like Arqiva, Orange, Bouygues, Iliad, Salt and Telefonica and are primarily investment grade

Strong underlying growth

·        Increasing mobile data usage will be a major growth driver for Cellnex. According to Ericsson, mobile data consumption in Western Europe is forecasted to grow over 20% per year for the next 5-years. More data, requires more equipment, which requires more towers and more tenants per tower

·        Cellnex is currently benefiting from regulatory changes. Several European countries are adopting rural coverage obligations. Greater coverage, requires more equipment, which requires more towers and more tenants per tower

·        Cellnex is also benefiting from the continual migration to higher frequencies. Higher frequency waves, like those embedded in 4 and 5G technologies, travel shorter distances than lower frequency waves. Higher frequencies, requires more equipment, which requires more towers and more tenants per tower

High incremental returns from co-tenancy

·        Cellnex’s existing tower network is estimated to be ~70% utilized

·        Incremental revenues from tenants looking to secure additional points of presence (PoPs) have an estimated ~90% incremental margins, with minimal incremental capex

Inflation beneficiary

·        65% of Cellnex’s revenues are linked to inflation (albeit with caps and zero percent floors), with the remaining 35% linked to fixed escalators

·        The combination of inflation linked revenues, largely fixed operating expenditures and long-term fixed-rate debt translates into a sensitivity whereby each 1% growth in inflation results in a greater than 1% growth in levered free cash flow

What’s the idea?

The thesis in Cellnex at its current valuation of ~€36 / share is as follows:

1.  Pro-forma all recent M&A transactions, Cellnex is trading at a reasonable value

2.  A large build-to-suit pipeline, additional lease capacity on the existing tower network, and CPI linked rental contracts provides Cellnex with strong visibility into organic growth

3.  Post a 2021 recent rights offering, Cellnex has ~€7bn in excess capital that it intends to redeploy over the next four months

Pro-forma recent M&A transactions, Cellnex is trading at a reasonable value

In 2021, Cellnex successfully closed €18.8bn in M&A transactions. In particular, seven of these transactions will be material contributors to Cellnex’s 2022-2023 earnings power.

€2.8bn of pro forma adjusted EBITDA translates into 2022 FCF of €1.4bn and normalized FCF of €1.5bn.

When we compare this in-place earnings power to CLNX’s fully diluted market value, we see CLNX is trading for ~18x FCF. In the context of the market for an asset of this quality, this is a reasonable value.

A large build-to-suit pipeline, additional lease capacity of existing tower network, and CPI linked rental contracts provides Cellnex with strong visibility into organic growth

Build-to-suit (“BTS”)

Cellnex has a build-to-suit (“BTS”) pipeline of €7.4bn through 2030. This pipeline provides strong visibility into incremental growth for Cellnex into the next decade.

2022 is expected to be one of the largest spend years, which creates strong visibility into the growth for 2023. Cellnex is forecasting ~€1.4bn in spending for 2022. Based on my analysis of the returns on historical transactions and discussions with management, I estimate Cellnex will earn a ~6% post-tax ROA on BTS. This implies Cellnex’s BTS initiatives alone should drive an incremental ~€85mm to 2023 FCF. BTS alone represents a ~5% increase to our pro forma free cash flow forecast of ~€1.5bn.

Co-tenancy growth

Cellnex is expected to experience co-tenancy growth driven by operator sharing and 5G densification. European telecom spending is lagging US telecom spending and European towers are relatively underutilized. As a result, Cellnex’s average co-tenancy is 1.4x (i.e. one anchor tenant and 0.4 secondary tenants), versus U.S. Towers which have a co-tenancy of 2.5x.

Historically, co-tenancy growth has driven 2-4% organic growth for Cellnex. This growth is expected to continue and potentially overshoot if European telcos aggressively invest in their 5G networks. If we assume 3% growth from co-tenancy (or 0.04x increase co-tenancy per tower), we see an incremental ~€90 million in FCF, representing a 6% increase to our pro forma free cash flow forecast.

Inflation linked contracts

Cellnex is an inflation beneficiary and rising CPI across Europe will have a positive net impact to Cellnex’s financials. 65% of Cellnex’s revenues are CPI linked, albeit have a blended cap of ~3.5% (e.g. some leases have no caps, other have caps at 2.0%). The remaining 35% of contracts have a blended escalator of 1.25%. Therefore, if we assume CPI is 3.5% or greater, which is a possibility for 2022/2023, then Cellnex’s revenues should increase by €95 million.

Given that the majority of Cellnex’s operating costs are fixed, combined with the large efficiencies to be extracted from its M&A program, Cellnex expects to keep like-for-like operating expenses unchanged. In turn, a €95 million increase in revenue should fall ~100% to EBITDA.

The only item that would likely be materially impacted if the current inflationary environment is sustained, is interest expense. Fortunately, >85% of Cellnex’s debt is fixed. If we assume a sustained 3.5% increase in CPI would drive a 2% increase in interest rates, then we would see interest expense increase by €55 million. Therefore, Cellnex still benefits in an inflationary environment and should see €40 million in net benefit. This represents a 3.5% increase in free cash flow, which is commensurate with inflation.

All-in-all, I expect the culmination of BTS growth, co-tenancy growth and net inflation growth to drive ~15% YoY growth, propelling normalized 2023e FCF towards €1.7bn. This translates to Cellnex trading for 16x 2023e FCF.

Post a 2021 recent rights offering, Cellnex has >€7bn in excess capital that it intends to redeploy this year

I expect Cellnex to redeploy its >€7 billion in latent balance sheet capacity this year. Cellnex has several incremental channels to redeploy this capital with sell-side analysts estimating certain projects can generate ROAs above 10%. I won’t rehash how the redeployment of this capital can look under various scenarios assuming differing valuations and financing conditions as the exercise is all very theoretical. However, if we just assume that Cellnex redeploys its current, in-place, excess capital, which I see being €5.5bn, Cellnex will be able to shrink its share count by ~20%. This accretion, net of the incremental interest expense will allow Cellnex to earn €2.60 per share and implies that Cellnex is trading for 14x FCF.

I would think of this share repurchase scenario as illustrative to provide context into a base level of earnings power. I do expect Cellnex will be able to redeploy into projects that are more attractive than share repurchases. In addition, I also believe Cellnex will be able to deploy more than €5.5 billion in value-creating projects by the end of this year. If we combine the likely scenario of higher returns from capital redeployment and roll forward organic growth from Cellnex’s three main drivers – i) BTS; ii) colocations; and iii) inflation, it’s not hard to see FCF per share of €3 by 2024. Non-coincidently, €3 is management’s 2024 FCF per share target required to achieve a maximum payout under their new long-term incentive plan. €3 x 20x FCF gets me to €60 per share. US tower operators trade above this valuation on two-year forward estimates. Therefore, I see Cellnex representing ~70% upside, which is very attractive for a defensive business with strong long-term growth prospects and balance sheet optionality. I believe this opportunity will be more apparent once Cellnex has redeployed its excess capital. Management expects the balance sheet to be redeployed by October of this year.

Catalyst

Capital redeployment