American Tower (NYSE:AMT) is one of the most-watched telecom stocks today. That’s not surprising considering its average daily volume is 3.4 million shares. It’s a popular stock, indeed. Analysts love it, too, giving it a mean target price of $61.53, which is well above where it’s currently trading.
For this reason and a whole lot more, I’m recommending the opposite. I think you should sell. Here’s why.
In May, American Tower announced it was applying to the Securities and Exchange Commission to convert from a regular corporation to a real estate investment trust. At the time, its CEO said, “Our board and management team believe that converting to a REIT structure is the optimal cash distribution and tax strategy given the nature of our assets and business.”
On one hand, I can see where it’s coming from. This is a real estate business with stable rental payments from companies like AT&T (NYSE:T), Sprint Nextel (NYSE:S), Verizon (NYSE:VZ) and T-Mobile, which AT&T is looking to buy for $39 billion.
However, if the deal gets regulatory approval, American Tower will get more than half its revenue from just three companies. The odds of any of them facing severe difficulties are remote, but whatever happened to not putting all your eggs in one basket? REITs must pay out 90% of their taxable income, and if one of these firms were to have an unexpected crisis, the whole point of converting goes out the window.
According to American Tower’s 10K, its loan agreement allows total debt that is six times adjusted EBITDA. Right now, that multiple sits at 4.2. This means it can pack on another $2.5 billion before breaking its agreement with its bankers.
Since 2005, American Tower has grown total debt from $3.6 billion to $5.6 billion in 2010. That’s a compound annual growth rate of 9.2%. In its August 2011 corporate presentation, it highlights its 14% CAGR for both revenue and adjusted EBITDA. The two numbers tell me that it needs to keep borrowing to keep growing.
I’d be more impressed with American Tower’s REIT status if it didn’t rely on debt so much. At some point, it’s going to have to stop borrowing, and when it does, the growth comes to a grinding halt. Free cash flow by traditional definition is cash from operations less capital expenditures. In the past five years, AMT has averaged $224 million annually in spending, producing average free cash flow of $566 million. That’s good — until you realize its growth came mostly from acquisitions in both the U.S. and elsewhere.
Subtract the average annual spending on acquisitions in the same period — $259 million — and adjusted free cash is 46% less than advertised; and remember, it borrowed for most of those acquisitions. I just don’t see it ever getting to the point where it can generate enough cash, especially if it’s a REIT, to self-fund its global expansion.
The Simple Way
Ben Graham did an interview for an article in 1976 titled The Simplest Way to Select Bargain Stocks. The father of value investing explained how he reduced his stock selection criteria down to two things: earnings yield and financial leverage. Graham believed the earnings yield should be double the 20-year AAA bond yield (right now around 5%), and total assets should be less than two times shareholder equity. If a stock didn’t meet both criteria, he wasn’t buying.
American Tower’s current earnings yield is 1.9%, and its total assets are 3.1 times shareholder equity. Neither is anywhere close to what Graham would have found acceptable. Growth investors won’t care about stuff like this, but value investors do — and I’m one of them.
Bloomberg ran a short piece Aug. 11 that said UBS AG’s U.S. clients have become net buyers of telecom stocks. Warren Buffett says you have to go against the herd to make money investing. If they’re buying, I’m selling.