Analysis: Towers seen safer mobile bet than gadgets

NEW YORK (Reuters) - Betting on the next bestseller smartphone can be a bit of a gamble, so hedge funds have been seeking out surer ways to profit from the growing popularity of mobile web-surfing.

The neighbors may call them eyesores, but investors are hugely attracted to the low-risk, high-growth prospects of the gangly steel broadcast towers operated by American Tower Corp (AMT.N), Crown Castle International (CCI.N) and SBA Communications (SBAC.O).

As a result, several of the largest equity-oriented hedge funds, including Andreas Halvorsen's Viking Global Investors, Julian Robertson's Tiger Global Management, Steve Mandel's Lone Pine Capital and Domenic Ferrante of Brookside Capital Investors, boosted their positions in one or more of the stocks in the second quarter, according to a Thomson Reuters survey of regulatory filings.

In a nutshell, the popularity of devices like Apple Inc's (AAPL.O) iPad and iPhone means more mobile web-surfing, which puts more strain on wireless networks unless service providers boost their data capacity. But this requires renting more cell tower space to install new network equipment.

"Network demands are increasing at a very rapid pace and carriers will need a lot of added capacity," Benchmark Co analyst Clayton Moran said. "The only way to do it is with towers."

And regardless of what happens with the economy, analysts see the tower stocks rising further because consumers are upgrading to advanced devices faster than ever. Since carriers subsidize most of the up-front cost of a smart phone purchase, it remains one of the more affordable luxuries even in a down market.

Smartphones represented 42 percent of all U.S. handset sales in the second quarter, up from 28 percent a year earlier, according to market research firm NPD.

While it's hard to predict if, say, Motorola Inc MOT.N or HTC Corp (2498.TW) will have the hottest phone this holiday season, there's no question there will be demand for space on cell towers. As long as consumers keep turning to phones for everything from business to entertainment, operators will sign long-term leases for more cell tower space.

ESTIMATES GOING UP

Benchmark's Moran sees tower firms continuing their trend of several years for recurring free cash growth of 20 percent.

"The outlook is for a sustaining of that 20 percent growth rate annually for the next few years," he said.

And if carriers raise spending, which looks likely, Piper Jaffray analyst Christopher Larsen sees an even rosier 2011 tower revenue outlook.

"We're looking to see if there's room to raise our estimates for 2011. The rate of data adoption has accelerated ... This means the carriers will have to spend more," said Larsen. "If my numbers have to change they'll probably go up, not down."

While their growth is dependent on wireless, the tower business model is most often compared to Real Estate Investment Trusts (REITs) that rent space for firms hosting computers in data centers for clients like Internet companies.

Tower operators are more expensive than these REITs, with shares trading at roughly 17 times Moran's estimate for 2011 adjusted Funds From Operations (FFO) per share.

In comparison, data center REITs Digital Realty Trust Inc (DLR.N) and DuPont Fabros (DFT.N) have multiples of around 15, according to REIT analyst Robert Stevenson at Macquarie.

Moran said the tower industry's higher multiple is justified as competition is less intense there than in data centers, which do not need approvals such as roof rights.

There is some disagreement about which tower company represents the best choice from the three publicly traded U.S. operators.

MERGER POTENTIAL

Piper Jaffray's Larsen sees American Tower as the most attractive, as about 20 percent of its revenue is from outside the U.S. market in places like India, Brazil and Mexico.

"That's good because it's in higher-growth markets with higher returns on investment," Larsen said.

He estimated that a tower in a overseas market brings a return on capital investment of up to 19 percent, compared with up to 15 percent in the United States, a more mature market.

But because mobile markets like India are in a relatively early stage of development, Benchmark's Moran says it is not yet clear if eventual competition will drive down returns.

SBA is expanding internationally but still may be a more predictable bet, as the vast majority of its towers are in the

United States, where difficulties getting approval to build new towers ease worries about an overcrowded market.

"We like the domestic exposure," Moran said. "The U.S. market dynamics are much better known than a market like India or Chile or Brazil, so the risk is lower."

Moran hopes American Tower will eventually buy SBA to generate savings and make more use of debt markets. But recently American Tower has been placing its bets overseas.

"It would be a smart deal for AMT to buy SBA," Moran said. "American Tower should probably have more debt than it does to enhance potential returns. Buying SBA would achieve that, as well as adding an attractive domestic portfolio."

(Reporting by Sinead Carew; editing by Aaron Pressman and John Wallace)