Description

Spectrasite operates and owns wireless cell phone towers. The majority of its revenue is from the major wireless carriers. It rents out space on its towers to the major wireless carriers and other smaller providers who place equipment on the towers that provide coverage for service.

Investment opportunity:
While an outright investment in the old bonds of SITE appears attractive, I believe an even more attractive opportunity exists in the old common stock. At $0.048, you can effectively buy warrants in the reorganized company at $5.95 a piece. Standard warrant valuation analysis would conservatively indicate a value of $10.2 per warrant or almost 71% above thee current trading price. In addition, I believe the valuation of the equity is attractive at current bond prices. Current bond prices place the reorganized equity at around $25 / share. Given the debt and equity valuations of SITE’s piers, applying similar multiples to SITE’s EBITDA would produce a stock price north of $40 /share. At $40 / share the warrant should conservatively trade at $21 / warrant or 352% above the current warrant price.

Through the bonds the company trades at around 8.8x Est. 2003 EBITDA of $146M and 10x LQA EBITDA of $129M. AMT and CCI both trade at around 12x-14x ’03 est. EBITDA. At 12x SITE’s ’03 Est. EBITDA of $146, the stock would trade at around $40.

Deal Summary
Spectrasite filed a pre-arranged ch. 11 bankruptcy on 11/15/02. The bankruptcy process will cleanse the company of around $1.7B in bond debt. The old bondholders will receive 100% of the reorganized equity as the form of their recovery or 23.5M shares. Around $730M of mostly bank debt will be reinstated. Net debt will be around $685M. The old common equity will be eliminated but will receive warrants to purchase 1.25M shares. The warrants will expire 7 years from the date of issuance and will have a strike price of $32.00 per share. Management will receive options equal to 10% of the fully diluted shares outstanding. These options will vest over time based on meeting certain performance criteria.


The current Capital Structure:

Bank Debt $725M
Bonds 1,700
Old Equity 155M Shares

The bonds are currently quoted in the 33-35 range for the fully accreted issues. 35% implies a reorganized fully diluted equity market cap of $696M [(0.35*1700)/(0.854)]
85.4% is the fully diluted equity ownership of the bonds after taking into account the warrants and management options. The fully diluted number of shares is 27.5M. This implies a fully diluted pro forma share price of $25.3. The strike of $32 is a 26% premium to the this pro forma stock price. Using a standard option calculator with these assumptions and a 40 volatility indicates a value of $10.2 per warrant. Since 1.25M warrants will be issued to the existing 155M shares, ~124 shares will get you one warrant. 124 *0.048 = $5.95. I believe 40 volatility is conservative.

Long dated options of CCI (a SITE comp) trades at 70+ vol. Stage Stores (STGS) warrants trade at around 40 volatility as well.

Here are warrant valuations based on various volatility assumptions at the current implied equity price of $25:

20% Vol: $5.3
30%: Vol: 7.8
40%Vol: 10.2
50% Vol: 12.4
60% Vol: 14.4


Business Summary
Similar to many other leveraged telecom companies, SITE has been forced to deal with its debt issues in bankruptcy court. Overly optimistic projections of cell site additions have not been achieved and left the company with a balance sheet that is not supported by its operations.

SITE will be the first major wireless tower company to reorganize and emerge from bankruptcy. As a result, it will be the least leveraged tower operator with only bank debt and its associated low level of interest expense. There has been a lot of speculation about consolidation among the major wireless carriers. I do believe this will happen within the next five years. I also believe there will be similar consolidation in the tower industry. SITE’s competitors like SBAC, AMT and CCI are all very leveraged and would find it hard to make significant acquisitions in the near future.

SITE’s cleaner balance sheet will allow it to begin consolidation in the industry at least among the various mom and pop operators that exist and possibly with the larger guys once their finances have stabilized. Consolidation can produce significant operating efficiencies as each new dollar of lease revenue falls almost entirely to cash flow. Sales, accounting and administrative departments can be consolidated.

Tower leasing is a great business with gross margins in excess of 65% and EBITDA margins in the 55% range. In contrast to the top line of many telecom companies, tower operators have experienced growing revenue and EBITDA streams. As additional sites are collocated on existing towers, the incremental lease revenue incurs little new operational expense. As a result, Tower operators have experienced increasing EBITDA and Tower Cash Flow margins. This trend will continue into the future even if collocations are at lower rates than in the past.

Free cash flow has always been negative historically due to the tremendous amount of cash the various operators used to buy and build towers to expand their operations. All of the major players understand now that cash flow is king and that growth capex is not needed. The next few years will highlight the cash flow generation ability of the major operators as they dramatically decrease their capex budgets for new towers and spend only maintenance levels of capex. Maintenance capex is around $1000 - $2500 per tower per year depending on the age and size of the tower or around $16M in the case of SITE.

Towers are valuable assets that are needed by the carriers to conduct their business. The leases are generally 5 years in length and carry annual rent escalators of around 2-3% / year. Towers are unique in that if AWE leases space on towers in the L.A it does not do anything to their 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.

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. Given the contractual nature of the lease revenues, the high EBITDA and cash flow margins with low levels of maintenance capex, I believe that the towers should be valued more like REITS. REITS generally trade for around 10-13x EBITDA. One could argue that the multiples should be even higher due to the rent escalation provisions in the contracts and the ability of the operators to add more sites to existing towers. Apartment REITS, for example, cannot build more apartments on an existing building without significant capital expenditures.

As wireless subscribers continue to grow and users spend more minutes on the phone, carrier networks are becoming increasingly strained. Over utilized networks result in dropped calls which make consumers upset and contribute to churn among the carriers. Carriers satisfy this demand by adding more sites onto their network which is why the tower operators have increased their lease revenues consistently and their lease cash flows at an even faster rate.

Catalyst

1.) Emergence from bankruptcy, equity investors will be able to purchase a tower operator with a good balance sheet
2.) Attractive valuation of company relative to piers. 8.8x vs. 12x-14x for comps
3.) More transparent trading of warrants – trading up to at least fair value
4.) Consolidation among operators