The Great 5G Network Buildout: Current Status And Potential Winners (NYSE:CCI)

The excitement surrounding 5G

5G has been often touted as the next revolution that will impact the world as we know it. With its higher speeds, longer range, low latency, high reliability, ability to maintain a large number of supported devices, and low device energy consumption (figure 1), it will enhance video streaming, 3-D navigation, gaming, AR/VR (augmented reality and virtual reality) applications. It is also expected to be the platform for revolutionary applications that most of us cannot even conceive today, and will transform just about every industry – it will enable level 5 autonomous cars, revolutionize industrial automation, and enable the use of IoT (internet of things) in manufacturing, construction/mining, agriculture, supply chain, healthcare, energy, and security applications.

Figure 1: A comparison of 5G to other wireless technologies

There is a lot riding on the American rollout of 5G networks, especially as other nations such as China and South Korea get a head start on the technology. The US Chamber of Commerce sees 5G as vital for U.S. economic growth over the next few years, and projects that wireless technology has the potential to stimulate $275 billion in investment and could lead to three million new jobs.

US wireless telcos

The three main US wireless telcos (telecommunications providers) – AT&T (T), T-Mobile (TMUS), and Verizon (VZ) – have spent eye-popping amounts in the recent FCC spectrum auctions and are marketing themselves to the public as leading and reliable 5G providers with large coverage areas (figures 2, 3, 4).

Figure 2: Recent AT&T 5G advertisement

Figure 3: Recent Verizon 5G advertisement

Figure 4: recent T-Mobile 5G advertisement

However, there have also been controversies around the wireless telcos’ 5G advertising practices: AT&T was accused of promoting its 5G Evolution product which, according to the Verge, is simply a modified and in some cases slightly faster version of the 4G LTE standard, but which comes nowhere close to the speeds specified in the actual 5G specification finalized by the international cellular standards group 3GPP. T-Mobile was blocked from advertising its 5G network as the “most reliable” in the US by the Better Business Bureau, while Verizon was similarly asked to stop making claims that it is delivering “the most powerful 5G experience for America.

We are still in very early innings of the 5G buildout

According to a report by McKinsey and Company, although various use cases for 5G are emerging, few are compelling enough to generate strong demand. McKinsey writes:

“As with the transition from 3G to 4G, advanced electronics companies and industrial players are still uncertain about the benefits of the new technology. Where is the value coming from, and who is going to capture it? What are the use cases where 5G performance enhancements will generate most value and demand? Which applications will most benefit from 5G? Many companies did not ask such questions when 4G emerged and only achieved subpar returns. The danger exists that this scenario could repeat with 5G.”

This is a catch-22 situation: telcos have little incentive to fully fund expensive 5G buildouts until there are “killer apps” that enable customers to justify paying up for full 5G capabilities. Conversely, it is hard for developers to roll out their killer apps until the 5G networks are functional.

In the short term, the higher speeds of 5G will enhance existing apps for video streaming, 3D navigation, gaming, and AR/VR (augmented reality and virtual reality). It will also break the monopoly of cable and fiber to homes and business premises, as T-Mobile is doing with its home internet offering as it expands its 5G footprint.

5G technology excels in situations where there is a need to reliably transfer large amounts of data at high speeds (figure 5, y-axis) with high mobility (x-axis) and low latency. Even though society will benefit when it provides incrementally faster speeds for existing applications or breaks the monopoly of cable companies, 5G will create the most value for society and shareholders when it supports new apps where existing networking platforms are inadequate.

Figure 5: 5G excels where high speed, bandwidth and mobility are required

I have no doubt that many revolutionary, game changing applications (with the impact of the likes of Netflix (NASDAQ:NFLX), Uber (NYSE:UBER), YouTube (NASDAQ:GOOG) (NASDAQ:GOOGL)) will be built on 5G. It is really a question of which will come first–the apps or the 5G network, or at what point will the 5G network be sufficiently built-up for 5G apps to operate, grow, and achieve takeoff velocity.

Firms have been disciplined with their short term capital spending

It has been difficult to get precise information on the state or extent of the 5G buildout to date. However, I examine several reasonable proxies, including:

• Wireless telco capital expenditures,
• tower company growth, and
• radio access network equipment revenue growth.

Wireless telco 5G spending

In the 2020 and 2022 FCC spectrum auctions, the wireless telcos bid aggressively for the mid-band (2.7-2.98 GHZ) spectrum that is most attractive for building 5G networks, which demonstrates strong commitment and conviction in the long-term future of 5G. However, they have been more measured on their capital spending for the physical infrastructure buildout.

Spectrum license spending

Wireless telcos have invested over $120 billion to acquire spectrum auctions (figure 6). Between the FCC spectrum auctions 107 and 110 in 2020 and 2022, Verizon and AT&T spent over $60 billion and $32 billion, representing about 44% and 17% of 2019 revenues respectively. In contrast, T-Mobile has bid less aggressively in the auctions as it has the necessary spectrum it acquired from both its merger with Sprint in 2020 and as part of the termination fee it earned because of the blocked acquisition by AT&T in 2011.

Figure 6: Amounts paid in the 2020 and 2022 FCC auctions

Sources:

– Company 10K and 10Q filings with the SEC and www.fcc.gov

– www.lightreading.com: Shocker! Verizon was the big spender in FCC’s 5G mmWave auction

– Seeking Alpha: AT&T, Dish bid most in FCC’s latest 5G airwaves auction, while Verizon skips

Capex spending

Even though the wireless telcos bid aggressively for spectrum licenses, their capital expenditure spending has been more measured. AT&T has spent less on capital expenditures over the last two years compared to the prior 4 years (figure 7, although we need to keep in mind that its capex includes spending for its Time Warner and other subsidiaries), while Verizon increased its capital expenditures at just a 6.3% annualized rate from 2018-20 after 4 years of spending at around the $17 billion level (figure 8).

Figure 7: AT&T capital expenditures

Source: company public 10-K filings with the SEC

Figure 8: Verizon capital expenditures

Note 1: this excludes ~$13 billion in future incentive payments to the FCC

Source: company public 10-K filings with the SEC

Interestingly, T-Mobile’s capital expenditures doubled from $6 billion in 2019 to $12 billion in 2021 (figure 9) but remains well below the spend of both AT&T and Verizon. (Industry commentators note that T-Mobile’s spectrum license purchases have been lower than AT&T and Verizon’s as it has sufficient high-quality spectrum).

Figure 9: T-Mobile capital expenditures

Source: company public 10-K filings with the SEC

I take the controlled capex spend as an indication that telco management is intent on avoiding the same “build it and they will come” mistake made during the 4G roll-out that resulted in subpar returns. Indeed, Verizon stated in its 2021 10-K filing: “[we] have significant discretion over amount and timing of capex… and not subject to any agreement that would require significant capex on a designated schedule or occurrence of designated events”. Similarly, AT&T wrote in its 2020 10-K filing: “The amount of capital expenditures is influenced by demand for services and products, capacity needs and network enhancements.”

Radio Access Network Equipment revenue growth

5G networks require installation of or upgrades to 5G radio transmitters. As such, the sales of radio access network equipment manufacturers can be another good proxy indicator of the pace of upgrades. (Sales of network core equipment manufacturers such as Cisco (CSCO) and Juniper (JNPR) are less useful indicators as network core upgrades reflect growth in overall network traffic, as opposed to the 5G growth we are attempting to measure).

There are currently 3 major 5G radio access network vendors each with just under 25% of the market (Huawei, Ericsson, and Nokia, figure 10). NEC, Samsung, ZTE, and other smaller players account for the remaining ~30% share. With US government regulations enacted under the Trump administration that ban the use of 5G networking equipment manufactured by Huawei and other Chinese 5G vendors, US wireless telcos are generally limited to Ericsson (ERIC) and Nokia (NOK) radio access network equipment.

Figure 10: 5G radio access network market share by vendor

Source: Strategy Analytics Unveils 2023 5G Global Market RAN Forecast | Light Reading

Ericsson’s Network Segment

Ericsson’s 4Q 2021 earnings release showed that its network segment grew by 3% for the quarter on a comparable unit and constant currency basis, and 7% for the fiscal year 2021 (figure 11). In the commentary, management noted that sales for the fourth quarter grew “double-digits” in North America, Europe, Latin America, and Northeast Asia, which it attributed to “high 5G demand”, but was offset by a decline in Mainland China which accounted to 3% decline in overall segment sales. The company further stated that it was able to navigate a challenging global supply chain situation due to continued investments to ensure supply chain resilience.

For the year, gross margins expanded 47.0% in 2021 compared to 43.8% in 2020, while EBIT margins expanded to 22.4% in 2021 compared to 19.0% in 2020 (both measures exclude restructuring charges), which indicates that revenue gains were not fueled by price cuts.

Figure 11: Ericsson network segment 2021 results

Nokia Mobile’s network segment

In its 4Q 2021 earnings report, Nokia estimated that the mobile networks addressable market, excluding China, grew by 5% on a constant currency basis, and expects the market to grow by about 3% in 2022.

Surprisingly, Nokia’s Mobile Networks sales decreased by 5% for the year and was down 16% for the quarter on a constant currency basis, a decline management attributed to the impact of lower net sales in radio access products and supply chain constraints.

For the quarter, management noted that North America and Asia Pacific sales declined due to both price erosion and market share loss but was offset by 5G deployment growth in Europe. Comparable gross margin declined by 190 bps to 37.6% while operating margins declined by 320bp to 9.8%. For the year, gross margins expanded by 150bps to 37.4% while operating margins was unchanged at 7.9%.

This contrasts with Ericsson’s sales and margins that expanded for both the quarter and year and which experienced double-digit sales due to 5G demand. I will be watching the results of both companies closely to see if this divergent trend continues into 2022.

Figure 12: Nokia mobile network segment 2021 results

Tower Company buildouts

The three main tower companies – American Tower (AMT), Crown Castle (CCI), and SBA Communications (SBAC) – have shown different growth profiles.

Crown Castle

Crown Castle, whose tower and small cell node business and accounts for 66% of total revenues in 2020, has high exposure to big cities (56% and 71% of its towers are in the 50 and 100 largest US basic trading areas).

The company has experienced strong growth. Even though the number of towers has remained around 40,000 since 2016, Crown Castle’s small cell nodes have increased significantly. In its 4Q2021 earnings release, Crown Castle noted that it received new commitments for 50,000 small cell nodes over the last twelve months, which is equivalent to 70% of total small cells booked in its history prior to 2021. Furthermore, the company’s recently signed twelve year agreement with T-Mobile to continue its nationwide network expansion indicates that resources are being strategically deployed in areas with dense population, which plays to Crown Castle’s strength.

The company also operates a fiber segment which has grown route miles from 26,500 in 2016 to over 80,000 in 2021. Fiber site rental revenues make up 34% of Crown Castle’s total revenues in 2020.

American Tower

American Tower has a mix of urban, sub-urban, and rural towers both in the North America (~56% of revenues) and internationally (44% of revenues). The company typically adds 300-600 news sites a year (or less than 1% of total towers) in North America through acquisitions and new construction. Even though its North American tower count remained relatively static around 40,000 between 2015 and 2019 (figure 13, red line), operating profit has increased at an annualized rate of 8.2% over the same period (figure 13) with the growth in the number of transmitters and tenants on each tower as well as the contractual price escalators.

The number of towers grew 5.4% to 42,698 in 2020 through the acquisition of towers from InSite Wireless Group and new sites, and stands at a total of 42,840 as of September 30, 2020.

Figure 13: American Tower North American tower count and operating profit

SBA Communications

SBA’s US domestic tower count has grown more quickly in the last nine months, confirming a pick-up in its customers’ 5G buildout (figure 14).

Figure 14: SBA US domestic tower count

Source: SBA Communications earnings releases

In its 3Q 2021 earnings release, Jeffrey Stoops, President and CEO noted: “US wireless carrier activity continued at materially higher levels compared to the beginning of the year. Domestically, we produced record services revenue, surpassing our second quarter record, and our leasing and services backlogs reached new multi-year highs at quarter-end”. Indeed, 3Q2021 domestic revenue growth accelerated to 9.4% (figure 15), compared to 6.2% for the 6-month period ended June 30, 2021 and 4.8% year-over-year growth from the fiscal year 2019 to 2020.

Figure 15: SBA Communications US site leasing key financials

Taking a longer-term perspective

I performed a high level survey of each of the segments discussed above to identify individual companies that can potentially benefit from the 5G rollout.

Wireless Telcos

I examined the wireless telcos from the perspectives of the quality of spectrum owned and their financials.

Quality of spectrum owned

Wireless telcos operate by propagating radio signals on electromagnetic spectrum which they are licensed to use. Lower-frequency spectrum (<2GHz) is generally attractive because it provides a larger coverage area and better in-building penetration, which enables the telco to provide the same service with fewer cell sites. However, the download speeds are slower compared to high frequency spectrum (>28GHz), but the latter cover shorter distances, have poorer in-building penetration, and thus require more cell sites to achieve the same coverage footprint (figure 16).

Mid-frequency spectrum (2.5 GHz to just under 6 GHz) is considered ideal for 5G networks as these frequencies have a good combination of speed and coverage. (As a note, it was the mid-frequency C-Band spectrums of 2.7-2.98 GHz which fetched record setting prices in the 2020 and 2022 FCC auctions).

(For a more detailed discussion on spectrum, please refer to T-Mobile’s paper on The State of 5G)

Figure 16: Spectrum characteristics

All three wireless telcos have been building out 5G networks in more densely populated urban areas using high band spectrum, driving a significant increase in new commitments for small cell nodes over the last twelve months for Crown Castle (figure 17). AT&T and T-Mobile have deployed 5G networks in sub-urban and less densely populated areas using lower (800 MHz and 600 MHz) frequency spectrum without the need to aggressively add new cellular towers.

In its 2020 merger with Sprint, T-Mobile obtained Sprint’s 2.5GHz mid band spectrum (figure 17, orange block), which gave it a head start in building a mid-frequency band-based 5G network in the US. In contrast, AT&T and Verizon had to procure mid-band spectrum in the 2020 and 2022 FCC auctions before they could begin building competing 5G networks.

Figure 17: Spectrum licensed to each wireless telco

Key:

Green square = Confirmed for 5G;

Dark gray square in Mid-Band: planned for 5G networks

Light gray square in Low Band: existing for 2G/3G/4G networks

T-Mobile’s head start puts it in an advantageous competitive position vis a vis its two larger competitors. In its 4Q 2021 investor earnings presentation, T-Mobile claims to have 5x more 5G geographical coverage than Verizon and nearly 2x more coverage than AT&T (figure 18).

Figure 18: T-Mobile’s coverage compared to AT&T and Verizon

Wireless Telco Financials

Verizon’s TTM revenues have not grown significantly since 2016 (figure 19, green line). AT&T’s revenues have grown over the same period, largely due to the acquisitions of DirecTV and Leap Wireless in 2015, and Time Warner in 2019 (blue line). In contrast, T-Mobile’s TTM revenues have grown steadily since 2016 and was boosted in 2020 by the spectrum it obtained through acquisition of Sprint, which gave it a head start in the buildout of its 5G network (orange line).

Figure 19: TTM revenues for the wireless telcos

Even though T-Mobile issued over 40% of additional shares in the Sprint acquisition (figure 20, orange line), the acquisition was still accretive, with per share TTM revenues (figure 21, orange line) growing significantly more than Verizon or AT&T’s (green and blue line respectively).

(as a note, Verizon issued 1.27 billion shares in 2014 for the acquisition of Vodafone Group Plc’s indirect interest in Verizon Wireless, which increased its shares outstanding by ~40% (figure 20, green line)).

Figure 20: Fully diluted share count for the wireless telcos

Figure 21: Per Share TTM revenues for the wireless telcos, indexed to December 31, 2017

AT&T and Verizon’s EBITDA margins have been flat since 2016 (figure 22). In contrast, T-Mobile’s EBITDA margins have expanded from ~23% to over 30% due to operating leverage as the company scaled up.

Figure 22: Wireless telco EBITDA margins

AT&T and Verizon’s trade at undemanding price-earnings valuation multiples of 8.7x and 10x respectively (figure 23), likely due to the lackluster growth, and in AT&T’s case, the noise surrounding AT&T’s plans to merge its Time Warner division into Discovery Communications (DISCA). T-Mobile’s price-earnings multiple of 50.6x likely reflects both its higher growth and head-start in its mid-band 5G network buildout.

Figure 23: Wireless telco PE multiples

On an enterprise value to EBITDA basis, AT&T, Verizon, and T-Mobile trade at multiples of 7.2x, 8.2x, and 9.7x (figure 24), which are relatively undemanding.

Figure 24: Wireless telco EBITDA multiples

T-Mobile is well-positioned to capitalize on its head-start in the 5G buildout, particularly if demand for 5G usage picks up quickly. However, AT&T and Verizon are formidable competitors that will undoubtedly catch up over time.

Radio access network equipment providers

It is necessary for wireless telcos to install or upgrade their radio access network transmission equipment to provide 5G service to its customers.

As discussed in figure 10 above, there are currently 3 major 5G radio access network vendors – Huawei, Ericsson, and Nokia – each with just under 25% of the market, followed by NEC, Samsung, ZTE, and other smaller players vying for the remaining ~30% of the market. With US government regulations enacted under the Trump administration that ban the use of 5G networking equipment manufactured by Huawei and other Chinese 5G vendors, US wireless telcos are generally limited to radio access network equipment from Ericsson, Nokia, and the smaller players, which make the market for radio access network equipment effectively a duopoly in the US.

Revenues for both Ericsson and Nokia have been flat the last five years (figure 25). However, EBITDA margins for both have expanded since 2019 as wireless telcos in the US and around the world began rolling out 5G networks (figure 26). I expect radio access network equipment revenues to grow as AT&T and Verizon put to work the spectrum acquired in the 2020 and 2022 FCC auctions and T-Mobile further expands its network to maintain its lead.

Based on its market share of 5G equipment, pricing power, and supply chain management over the past year, Ericsson is the better managed of the two. Figure 25: Ericsson and Nokia trailing twelve-month revenues

Figure 26: Ericsson and Nokia EBITDA margins

Both Ericsson and Nokia trade at relatively undemanding price-earnings multiples of 16.8x and 17.5x respectively (figure 27).

Figure 27: Ericsson and Nokia price earnings multiples

Even though I believe Ericsson and Nokia will both grow as 5G networks are deployed around the world, I would place my bet on Ericsson.

Tower companies

Tower companies lease space on their towers to the wireless telcos to place their radio access network equipment. The tower business is highly attractive because of the contracts are long term, non-cancellable, and typically have built-in lease escalators and inflation protection. The towers are highly cash flow generative because of low ongoing capital requirements. Furthermore, as the incremental operating expenses for additional antennas or tenants is minimal, towers generate very high returns on investment when they sign-up multiple tenants (figure 28). It is economically unattractive for wireless telcos to build or operate their own towers as it is unlikely that they can defrays costs by leasing their tower space to competitors.

Figure 28: Tower economics and return on investment (for illustrative purposes)

As the wireless telcos build out their 5G networks, they will need more closely clustered towers and small cell nodes to accommodate the shorter coverage distances and poorer in-building penetration of the high-frequency 5G spectrum, particularly in urban and densely populated areas. They will also require more space on cellular towers to locate additional radio transmitters.

Over the last five years, the three large tower companies have all enjoyed strong revenue growth (figure 29), and margins for American Tower and Crown Castle have expanded (figure 30).

Figure 29: Tower company 5-year revenue growth

Figure 30: Tower company five-year EBITDA margins

However, the attractive economics and positive outlook of the tower business are priced in – American Tower, Crown Castle, and SBA Communications are trading at price earnings multiples of 45x, 68x, and 123x respectively (figure 31), while the forward price to FFO (funds from operations, based on data from Seeking Alpha) are 24.3x, 23.2x, and 36.6x respectively.

(as a note, these three companies have diversified outside the US tower space. American Tower and SBA derive 50% and 20% of their revenues internationally, and Crown Castle’s fiber solutions segment accounts for about 31% of its revenues. Crown Castle faced pressure from activist investor Elliott Management in 2020 to reduce its fiber investments to focus only the highest ROI opportunities).

Figure 31: Tower company price earnings multiples

In the last twelve months, Crown Castle has booked new commitments for its small cell nodes equivalent to 70% of total small cells booked in its history prior to 2021. I believe the company’s growth will continue with the expansion of high frequency 5G networks into second tier cities, which makes Crown Castle an attractive 5G play in the tower space.

Over the long term, wireless telcos will need to improve the speeds and capacity of their networks in less densely populated areas. These upgrades will require the use of higher frequency spectrum, which necessitates more tightly clustered towers that will benefit American Tower and SBA Communications, both of which have greater exposure to suburban and rural markets.

Summary

5G will be an important technology for the future, but the “killer app” has not emerged, and we are still in the early innings of the 5G network buildout.

Wireless telcos have spent very large amounts for the highly attractive mid-band spectrum in the 2020 and 2022 FCC auctions, but they have been disciplined on their capex spendings so far.

Valuations of a fully-built 5G world do not appear to be reflected in the stock prices of wireless telco or radio access network equipment manufacturers. Tower company valuations are high, but I believe they reflect the stability, strong cash flow, and high return on low incremental capital expenditures.

Based on my assessment of the wireless telco, tower, and radio access network provider sectors, I believe T-Mobile, Crown Castle, and Ericsson are attractive long term 5G plays, but it will take time for them to realize their full potential.