Description

China Tower

China Tower is the cheapest tower company in the world, trading at a 18% maintenance FCF yield and 6.6x EV/EBITDA (vs. peers as high as 24-28x). This is despite its massive scale, virtual monopoly in China, and huge tailwinds in the form of Chinese Government initiatives in 5G deployment and infrastructure development.  We believe that the stock suffers from having no natural shareholder base – Chinese investors have limited experience with the tower business model that has created enormous wealth in the US (see AMT, SBAC, CCI) and Europe (CLNX, INW), while the western investor tends to overstate government and contract renewal risk.  While there will likely be per-unit pricing concessions as its customers plow billions in network capex, we view it as inevitable that China Tower is bigger, better, and more profitable in the future in spite of its rock-bottom valuation.

We believe the stock can return >100% as 5G builds momentum, contract worries are revealed to be misplaced, and the company is understood over the next few years.

Business description

Towers are fantastic businesses.  The business is primarily ownership and rental of only the steel structures that hoist mobile network operator’s (“MNO”) network equipment high enough to create effective line-of-sight to consumers’ mobile phones.  This is a simple commercial real estate model; revenues are contractually recurring and costs are minimal – capital expenditures in network technology and associated risks are born entirely by their customers, providing towers with a predictable and exceedingly high-margin business that can prudently sustain very high levels of leverage.  In addition, these are almost universally growth businesses – mobile data consumption is growing 40% y/y driven by widespread adoption of mobile video apps and innovation around short-form-video (in both China and the rest of the world), forcing mobile network operators to place more and more network equipment onto towers each year, often with no incremental expense or capex to the tower company. 

China Tower is the monopoly tower owner in China with 1.9m towers.  It was created as a JV between China’s 3 leading MNOs (China Mobile, China Unicom, China Telecom) in 2015 to enhance efficiency through infrastructure sharing – these 3 majority state-owned enterprises continue to own 69% of the company and follow policy set by the Chinese government.  The current contract structure was created in 2018 prior to the introduction of outside shareholders later that year and shares efficiencies between tower company and tenants (somewhat similar to European tower companies); addition of a second macro tenant changes rental rates to 65% (first tenant) + 70% (second tenant) = 135% of the original base rent, while addition of a third macro tenant changes it to 55% + 60% + 60% = 175%.  The company will also “build-to-suit” new towers at their customers’ behest.  Tenancy ratio currently stands at 1.6x.  In 2019, total tenants grew by 8% y/y and EBITDA by 6% (excluding the impact of IFRS16).

After its IPO in 2018, the company has slowly ramped up investor relations efforts, though has been hindered by the lack of a natural shareholder base and poor US-China relations.  According to IR, 65% of investors are US-based, and Chinese Telecom executives are now afraid to travel to North America to conduct investor relations due to the (potentially politically motivated?) arrest of Huawei’s CFO in Dec ’18. 

“5G” and government initiatives

Whether or not you believe the hype, 5G is coming to China.  Already a top priority and focal point of the country’s global ambitions, the Politburo Standing Committee (中国共产党中央政治局常务委员会) announced in March that the country would further accelerate construction of “new infrastructure” projects such as 5G networks.  And what Xi Jinping says, the country does – 21 of 23 provinces have now put 5G network construction in their government work reports, and mobile operators China Mobile, China Unicom, and China Telecom are collectively projecting 550k new 5G base stations to be completed in 2020.  Broad expectations are this number goes to 3m through 2025 (~$150-180bn capex) and 5m through 2030 – big numbers for a country that currently only has 3m base stations (or any country really).

While in the rest of the world much of the 5G deployment will fall to local city infrastructure (light poles and traffic lights), it appears that China Tower will be the main beneficiary in China due to higher starting density of towers (~750k citizens / tower vs. more than double that in the US and RoW) and agreements with local governments.  Management currently expects 600k new tenancies in 2020, including 100k 4G macro sites.  In addition, the company is already seeing success in its Distributed Antenna System (“DAS”) business, essentially providing 5G service indoors – think subways, airports, malls, stadiums, tunnels, etc.  DAS revenue grew +46% y/y in 2019 and +39%  y/y in 20Q1 with a good amount of white space to continue growing; the company covers 5.3 km of railway tunnels, 2,570m m² of buildings, and 3.4 km of subways vs. addressable markets of 16,331 km of railway tunnels, 3,982m m² of sports venues/stadiums alone (not to mention other types of buildings), and 5.2 km of subways throughout the country.

China Tower also has significant option value in its Trans-sector Site Application and Information (“TSSAI”) business, which hosts non-telecom equipment on its towers: cameras for government surveillance, manhole cover theft/danger monitors (apparently actually a real issue in China), forest fire/earthquake prevention, smart tourism displays, etc.  These aren’t traditional businesses for tower companies to be in, but China is not a typical country.  TSSAI did 2bn RMB in revenue in 2019, +70% y/y, and grew 62% y/y in 20q1.

Contract renegotiations and Pricing

China Tower’s current contract with its customers expires and will be renegotiated before 2023, causing consternation amongst western investors used to staggered/individual site leases and not used to shareholders doubling as customers or government policy influencing contract negotiations.  We underwrite to the average price per tenancy declining only mildly (partially due to 5G equipment being smaller than 4G per unit); not nearly enough to counter the massive deployment tailwinds at China Tower’s back.

The new contract must continue to serve the interests of 3 parties: the Chinese government, the MNO customers/owners, and the minority shareholders.  Because all 3 (including the minority shareholders as a separate entity, led by Hillhouse, GIC, and Tiger Global) must independently agree to any new contract, the outcome is highly likely to be only a minor departure from the anchor set by the previous contract.  All 3 parties benefit from stable pricing at China Tower, while 2 of the 3 parties stand to lose from very weak pricing.

1. Minority shareholders: clearly want strong pricing to support margins, revenue, and cash flow.

2. Chinese government: priorities are social stability and continued capital investment in the country’s infrastructure.  Stable pricing enables both, while very weak pricing would undermine (a) China Tower’s own ability to invest in digital infrastructure as well as (b) capital markets’ willingness as a whole to fund investment in the country.

3. MNO customers: priorities are near-term consolidated earnings and the value of ownership in China Tower.  Again, stable-ish pricing supports both.  And while near-term consolidated earnings would benefit from very weak pricing, it would do so at the expense of China Tower’s market value.  As tower company EBITDA multiples are ~3x higher than legacy telcos (in China and elsewhere), MNOs actually create value by recognizing profit at the tower company rather than the parent.  This dynamic can be observed in public tower companies elsewhere in the world, with INWIT in Italy and Telesites in Mexico charging full rent to their customer-owners Telecom Italia and America Movil (same owner, not direct ownership) despite lower near-term consolidated earnings at the MNO.

Another interesting analogue may be Travelsky, the Chinese GDS monopoly also owned by its 3 state-owned-enterprise customers.  Since its 2001 IPO, the company has 10x’d revenues, 10x’d net income, and 10x’d stock price.  Naturally the path here will be different, but the example is inspiring.

Valuation

China Tower currently trades at 6.6x 2019 EV/EBITDA and a 9% “growth FCF” yield, by far the cheapest of all publicly traded tower companies globally (AMT trades at 24x!).  “Maintenance FCF” yield appears incredibly high at ~18% with maintenance capex / rev ~5% (western tower companies are typically ~3% but China Tower’s revenue/pricing structure is less aggressive relative to the cost of their towers).

We believe this low maintenance capital intensity is a point of misunderstanding in the Chinese investor community, having seen multiple reports comparing China Tower’s EV/EBITDA to other telecom players with much higher structural capital intensity such as China Mobile, China Telecom, and China Unicom.  To reiterate – China Tower only owns and maintains a large steel tower, whereas traditional telecom must continually upgrade sophisticated network equipment to keep up with changes in technology.  These are different business models and the tower company deserves a much higher EV/EBITDA.

This stock is priced for a massive decline in fundamentals, but in reality tailwinds will drive revenue, EBITDA, and free cash flow higher over the next 5+ years.  We project consolidated EBITDA to continue growing at ~6%/yr (5G and TSSAI) and for the multiple to expand aggressively as the company’s incredible business model and tailwinds become appreciated by the investor community.

Catalyst

Discovered by local and foreign investors

Growth continues, potentially accelerating with 5G deployment

New contract comes out similar to the last one, alleviating fears of potential impact