Recommendation – TWER provides broadband internet access to business customers in 13 U.S. cities.  They own and operate their own network, which utilizes high-capacity microwave backhaul to wirelessly connect the rooftop of each customer location to the network core. TWER’s presence on thousands of rooftops has opened up a second business opportunity; leveraging these rooftop locations to offer Wi-Fi offload to wireless carriers.  Mobile data traffic in major cities is overwhelming the carriers’ networks and Wi-Fi offload has emerged as the leading method to alleviate this congestion. TWER simply installs a carrier grade Wi-Fi radio on their customer rooftop, and they can seamlessly offload mobile data traffic from the surrounding neighborhood to their network. Two national wireless carriers have already signed up this service, with several more expected to follow.  Because TWER utilizes their core ISP business to bring broadband capacity to the site, they eliminate the need to pay a 3^rdparty for backhaul.  This significantly lowers their cost structure and increases network reliability.

The spectacular growth in mobile data usage has been well documented; with Cisco estimating 90% annualized growth in mobile data traffic through 2016.  Smarthphones and tablet users are clogging up mobile networks and exhausting the capacity of the carriers’ spectrum holdings.  The much publicized move to 4G LTE technology will improve network efficiency, but those improvements will be quickly swamped by the deluge of data usage in urban markets.   There are only 2 cost effective solutions to the spectrum crunch: Wi-Fi offload and small cells.  Wi-Fi offload takes data traffic off cellular networks to alleviate congestions, while small cells allow carriers to decrease the number of users accessing each tower to improve performance.  TWER is ideally positioned to be the leading player in each of these solutions with their rooftop tower locations in the most congested data markets in the country.    

 

The Core Business - TWER has spent 10 years building up their ISP business through organic growth and strategic acquisitions.  In each city, TWER secures long-term leases for rooftop access on 10-15 of the tallest buildings in town.  These locations are referred to as Points of Presence (PoPs), and have a fiber optic line delivering broadband internet access to the rooftop.  Because the PoPs are on the tallest buildings in each market, they have a line of sight to nearly every rooftop in each city.  Using microwave radios, TWER can then deliver a high capacity internet connection to any building in town.  When a customer signs up for TWER broadband, a technician installs a small microwave radio on the customer’s rooftop that makes a connection with the nearest PoP.  This brings the broadband signal to the customer’s rooftop, and to their office by running a cable down from the roof. 

This network design has several unique advantages over broadband offerings from the cable companies and telcos.  TWER owns its own network, so they don’t have to pay any leasing fees for internet access.  Plus, the capital costs to add new users are extremely low, so they can offer significantly lower prices than the competition.  Much of the cost savings is the result of using microwave radios to connect customer locations to PoPs.  Microwave is far cheaper than bringing a fiber line to each site, it can be installed in one day, and it offers scalable capacity if a customer wants a bandwidth upgrade.  It has also proven to be more reliable than cable or fiber access.  If a fiber line breaks, or is cut, there is no backup.  TWER connects each location to several PoPs, and the PoPs are then interconnected.  This mesh architecture means that the network can survive if any single PoP goes off line.  Hurricane Irene hit New York and Boston in 2011, and TWER never lost service to any of their locations.  This was in stark contrast to Verizon and AT&T, who had major outages from the storm.

 

Core Business Economics - The core business generates run-rate revenue of $31M, and is growing at a 25% rate.  EBITDA is $6M and will grow faster than revenue given the operating leverage in the model.  Revenue growth has been lumpy since the company decided to emphasize acquisitions over organic growth.  There are dozens of single market ISP’s struggling to gain enough scale to overcome their fixed costs.  TWER has acquired five of these players to expand their presence in Boston, Chicago, and Los Angeles; and to make their entry into the Las Vegas and Houston markets.  These deals were done at very attractive prices, generally reflecting only the book value of the network assets… so TWER got the customers for free.  Most importantly, TWER picked up a number of new PoPs in each acquisition, which gives them a huge advantage over any competitors in their Wi-Fi offload build-out. 

While we’re not recommending TWER based on the strength of its ISP business, it should be noted that this business has significant growth potential… if the company chooses to increase their sales efforts.  TWER currently has about 3,600 broadband subscribers, with an average of just over 1 subscriber per building.  Because the rooftop equipment is already in place to service the first customer in each building… any additional customers offer nearly 100% incremental margins.  While this growth is tempting, it requires a dedicated sales team, with a long sales cycle.  The additional capital required to pursue these sales can be put to better use developing rooftop nodes for Wi-Fi offload, and pursuing acquisitions that expand TWER’s network footprint.

 

The Tower Land Grab - TWER has a phenomenal opportunity to develop wireless towers in the nation’s most data-congested cities.  By leveraging the network assets used in their ISP business, TWER is building rooftop wireless towers at a far lower cost than any carrier or conventional tower company.  Currently, these towers are used to offer WI-Fi offload, the most cost effective way to transport mobile data traffic.  Starting in 2013, additional space on these towers will be leased to carriers to install their own cellular antennas.  Securing rooftop leases in the best locations has become a land grab, and TWER has a huge head start over their rivals.

Carrier class Wi-Fi offload is an industrial strength version of the technology most consumers use when they arrive at home or the office; their mobile device seamlessly accesses a pre-selected Wi-Fi network.  Accessing your local Wi-Fi device prevents costly overage charges on your mobile data plan, and usually offers much faster download speeds than the carrier’s cellular network.  TWER’s network blankets the nation’s most data clogged cities with high-speed, high-capacity, outdoor Wi-Fi access.  Carriers have contracted with TWER to have their customers seamlessly switched to the TWER network when they’re within range.  The users never know this switch has taken place because the authentication is handled between the carrier and TWER.  Customers get much faster download speeds, and carriers reduce traffic on their core networks while still keeping the customer “in-network” for billing purposes.

 

Aren’t the carriers already doing Wi-Fi offload with McDonalds and Starbucks? - If you’re an AT&T customer, you can access Wi-Fi for free at these locations… but what happens when you step outside?  The signal is lost and you’re back on the overloaded AT&T cellular network.  Even when you’re inside Starbucks, the Wi-Fi signal is no better than what you get at home.  It’s just a basic Wi-Fi antenna, backhauled with a copper phone line.  This set-up works fine for 3 or 4 users, but it gets easily overloaded with more demand for bandwidth.  A copper line can only reach 1.5 Mbps, compared to TWER’s microwave backhaul that can easily reach 200 Mbps of download speed.  Besides speed, TWER’s other big advantage is its transparent network that allows carriers to monitor (and monetize) user activity while on the Wi-Fi network.  When an AT&T customer jumps onto a Starbucks hotspot, their activity becomes invisible to AT&T.  This has been the major roadblock preventing carriers from utilizing Wi-Fi offload… it doesn’t allow them to charge customers for data use.  TWER’s carrier class Wi-Fi network operates as an extension of each carrier’s own network… allowing them to monitor each user’s activity, and tailor billing plans to monetize that data consumption.

 

How profitable is Wi-Fi offload? - TWER has already signed W-Fi offload contracts with 2 carriers, with several more contracts expected in the next 6 months.  TWER is under strict non-disclosure rules that prevent them from revealing the details of the contracts, or even the names of carriers that signed the deals.  Management has discussed a few metrics that help us frame the Wi-Fi opportunity.  The pricing will be based on flat fee per tower location, with unlimited usage.  In numerous presentations, TWER management has guided to monthly revenue of $200 - $1,000 per tower.  We have used $500 as a conservative estimate.  TWER has about 3,000 Wi-Fi nodes today, with 5,000 nodes planned by Q1’13.  If their carrier contracts cover all 5,000 nodes, revenue will be $30M per carrier ($500 * 12 months * 5,000 nodes).  With 2 carriers already signed up, and several more in advanced talks with TWER, the revenue potential could easily reach $120M.  We estimate EBITDA margins around 50%, but this could be conservative once they add additional carriers to the network.  Management has suggested that gross margins could be as high as 90%... and EBITDA margins in the 60%-70% range. 

 

The Wi-Fi Offload Opportunity

	Nodes	Customers	Rent	Utilization	Annual Revenue Run-Rate
Apr. 2013	5,000	2	$500	80%	$48M
Dec. 2013	10,000	2	$500	80%	$96M
Dec. 2014	15,000	3	$500	80%	$216M
Dec. 2015	20,000	4	$500	80%	$384M

How do we know the carriers will lease access to all 5,000 nodes?  - Most likely, each carrier will not lease access to all 5,000 nodes.  But, we believe the utilization rate will be above 80%.  When TWER first discussed the Wi-Fi offload opportunity several years ago, it centered on using their existing ISP customer rooftops to locate their Wi-Fi nodes.  This was an elegant model, but it didn’t account for the fact that TWER’s customer locations didn’t always match up with all the locations where the carriers required coverage.  Today, TWER is adding most of their new nodes on rooftops where they do not have an existing presence.  While this adds some costs, it allows them to build a network that is designed to the precise geographic needs of the carriers.  This customized build-out plan leads us to believe that carrier utilization rate will be above 80%. 

We believe TWER’s Wi-Fi offload initiative will generate revenue of $57M is 2013 revenue, growing to $129M in 2014.  The company plans build 2,000 additional nodes by Q1’13… extending their Wi-Fi network in New York City and San Francisco, and building in Chicago, Philadelphia and Miami in 2012 and 2013.  Each node costs about $5,000 to build… or $10M for all 2,000 nodes.  TWER has $31M in cash, which should be more than enough to cover the build-out. Plus, cash flow from 2 current offload contracts will likely begin in late 2012.  The next stage of the build-out will likely focus on cities like Los Angeles, Boston and Houston where TWER already has an extensive network of PoPs.  It’s these PoPs that allow TWER to build additional nodes for only $5,000… because they don’t have to bring a fiber line to the rooftop.  Other companies would have to pay upwards of $100,000 to bring a fiber line to the site, and incur substantial delays getting easements and permits.

 

What about the cable guys? – The cable companies have made a major push to offer Wi-Fi hotspot access to their subscribers.  Comcast, Time Warner Cable, Cablevision, Cox, and Bright House each contributed their own hotspot networks to a joint venture called CableWiFi.  Subscribers to any one the cable companies can access the shared network on their mobile device.  With internet usage increasingly going mobile, the cable companies want to extend their ISP service outside the home.  It’s relatively easy to hang a Wi-Fi antenna from a pole mounted cable line, which is common in suburban areas.  It becomes much more challenging and expensive to set up an outdoor Wi-Fi network in urban areas where cable lines are often underground. 

http://timewarnercable.cellmaps.com/WiFi.html - /

A quick look at the coverage map for CableWiFi shows virtually zero coverage in Manhattan, San Francisco, and many other big cities where mobile data traffic is heaviest.  These are the exact areas where TWER has built their Wi-Fi network.  Management stated that they have had talks with cable companies, and we expect a Wi-Fi access deal to follow shortly.

 

Small Cells - In addition to Wi-Fi offload, carriers are exploring the use of small cells to expand the capacity of their limited spectrum holdings. By replacing one larger macro cell tower with several smaller locations, the same spectrum can support more data traffic. The catch is, these small cells have to be lower power and closer to the ground, while still maintaining a high capacity backhaul connection to the core network. New small cell designs are the size of a grapefruit, and can easily bolt onto TWER’s existing rooftop infrastructure.  Because TWER already has a power supply and backhaul on each rooftop, it offers carriers a way to use their spectrum more efficiently in the most congested locations.  

The addition of small cell leases makes TWER a very attractive acquisition candidate for the major tower companies. 10 years ago, CCI, AMT, and SBAC went on a spending spree to lock down all the best locations for traditional, macro-cell towers. They spent massive amounts of money on this land grab, knowing that once these leases were locked in, they would produce decades of ever increasing cash flows. Wall Street completely misunderstood this strategy, and assumed that the spending would continue indefinitely.  The three main tower companies saw their share prices driven below $1.00, offering savvy investors a tremendous buying opportunity. Simply put, there were only a limited number of prime tower locations and once they were taken, the spending would slow down, and free cash flow would increase dramatically.

Today, there’s a new wireless tower land grab, but this time its on rooftops in big cities. Wireless carriers need to add thousands of small cell locations, but don’t want the hassle and capital expenditure required to build out these sites.  The tower companies were slow to understand this dynamic and have been scrambling to expand their urban rooftop portfolios. Crown Castle recently purchased NextG Networks, an owner of Distributed Antenna Systems (DAS), for $1 billion, or $120,000 per node.  The economics of a DAS network are very similar to TWER’s nodes, giving us a private market value of $120,000 for each of TWER’s 5,000 nodes, or $10 per share. 

We haven’t included small cell co-location in our model, but consider it a very attractive opportunity going forward.  The wireless industry will have to add 120,000 – 200,000 new small cell sites over the next few years to alleviate overloaded macro cells.  TWER can offer thousands of ideally placed rooftop tower locations for carriers to install their own antennas.  Rent for small cell towers has ranged from $1,000 - $1,500 per month.  Much like a traditional tower company, TWER would only have to provide structural support and a power supply; hence cap-ex would be minimal.  Unlike a traditional tower model, TWER can also offer backhaul service for an additional monthly fee.  In situations where the carrier is also the dominant local telco (Verizon in NYC) that carrier would likely provide their own backhaul, since they probably have a fiber line in close proximity.  Other carriers located on the same tower could lease backhaul capacity from TWER, which would likely add another $1,000 - $1,500 of monthly revenue per tower.  This would also require minimal additional cap-ex since TWER already has substantial excess backhaul capacity at each site.  If we conservatively assume TWER will only lease to one carrier on 2,000 of their sites, revenue would be $30M.  Adding backhaul on half of those sites will bring in another $15M.  Most importantly, all of TWER’s rooftop leases allow small cell installations… although management hasn’t disclosed the associated rent expense.  We haven’t included any small cell revenue in our model since it probably won’t arrive until late 2013 and management hasn’t given enough guidance to properly frame the opportunity. 

The Small Cell Opportunity

	Towers	Carriers per Tower	Small Cell Rent	Utilizaiton	Annual Revenue Run-Rate
Dec. 2013	10,000	1	$1,000	20%	$24M
Dec. 2014	15,000	2	$1,000	20%	$72M
Dec. 2015	20,000	3	$1,000	20%	$144M

The Backhaul Opportunity

	Towers	Backhaul Customers per Tower	Backhaul Rent	Utilizaiton	Annual Revenue Run-Rate
Dec. 2013	10,000	1	$1,000	10%	$12M
Dec. 2014	15,000	2	$1,000	10%	$36M
Dec. 2015	20,000	3	$1,000	10%	$72M

Won’t small cells cannibalize Wi-Fi offload? – Wi-Fi offload and small cell deployments will go a long way to easing mobile data congestion, but even with both technologies in use, the carrier networks will still be overburdened in the densest urban markets.  There is simply too much data being consumed in concentrated areas, at concentrated times of day.  Wi-Fi offload and small cells are ways to partially alleviate the two bottlenecks in urban mobile data networks… spectrum and backhaul.  Spectrum is naturally limited in supply and further constrained by government licensing restrictions.  Small cells extend the usefulness of the spectrum currently being used, but can’t create new supply.  Wi-Fi offload uses unlicensed spectrum, which requires lower signal strength and limits propagation.  TWER has shown that using a network based on packet microwave can affordably increase backhaul capacity, but the majority of carrier networks are focused on building out fiber-based backhaul.  Adding all this fiber will take several years, and billions in cap-ex.  TWER’s Wi-Fi offload and small cell offerings are the most cost effective methods to add capacity to urban networks, but neither one alone can meet the enormous demand for mobile data over the next decade. 

What is the bear case? – TWER management lost some credibility with the investor base by promising Wi-Fi offload deals in 2011.  When the carrier contracts didn’t come through as promised, the stock sold off considerably.  We thought the issue was put to rest when management announced their first 2 carrier contracts, with another engaged in a trial deal.  Now investors are worried because offload revenues won’t arrive until late 2012/early 2013.  The major carriers have never integrated an outside network into their own, nor have they used this caliber of Wi-Fi offload, so it’s understandable that the integration process takes time. 

There was also a poorly executed secondary offering in June 2011, at $4.00.  In hindsight, management was smart to raise cash when they did, even if better execution on the deal would have reduced dilution.  Currently, skeptical investors are questioning the de-emphasis on the core ISP business.  The debate boils down to where TWER should allocate their next dollar of spending.  We believe the opportunity to grab prime rooftop real estate at affordable pricing is limited and the company needs to act fast.  In contrast, growth in the core business is reliant on a dedicated sales effort that can be dialed up and down over time.  

 

The TWER Opportunity - We believe the market is substantially underestimating the earnings power of TWER’s Wi-Fi offload opportunity.  TWER’s market cap is $190M, with $31M in cash and no debt.  The ISP business will generate $34M in 2012 revenue… growing to $40M in 2013.  It is already earning run-rate EBITDA of $6M.  Wi-Fi offload will bring in $57M in 2013 revenue, and $129M in 2014.  EBITDA margins on this business will be above 50%.  In total, we expect TWER to earn EBITDA of $40M in 2013… and $91M in 2014.  Traditional tower companies (AMT, CCI, SBAC) consistently trade around 15x EBITDA due to their predictable earnings and low maintenance cap-ex requirements.  To be conservative, we bring this down to 10x to reach a target price of $16.50 in 2014.  We believe the downside is limited; especially once the offload revenue begins later this year.  Plus, our estimates don’t include any additional revenue from small cell co-location.  With nearly 400% upside to our target, and little downside, we believe TWER offers incredible value at the current price.

• Wi-Fi offload revenue starting in Q4’12, which will dramatically transform the earnings power of the business. Signing of a third and fourth carrier to utilize the offload network.  
• Signing of a third and fourth carrier to utilize the offload network.  
• Wi-Fi access deal with the CableWi-Fi consortium.
• Small cell co-location revenue beginning in 2013