One month on from China Tower Corporation’s (CTC’s) IPO, TowerXchange reflect on the valuation, future risks and opportunities for the world’s largest towerco. Speaking to financial commentators and analysts, while enthusiasm remains intact that the towerco business model has been successfully introduced into China, critical differences in CTC’s pricing models and cash flows, and uncertainty surrounding how 5G will be deployed in China, have combined to suppress valuation – at least for now.
China Tower Corporation was listed on the Hong Kong stock exchange in August 2018, selling 25% of their enlarged share capital for US$6.9bn (at HK$1.26 per share), valuing the company at HK217bn (US$27.6bn), representing a multiple of 7.1x their adjusted EBITDA for 2018.
TowerXchange spoke to multiple financial sources, learning that this was CTC’s third attempt at going public. Their first attempt was at a valuation multiple of 15x EBITDA. “This was an unrealistic ratio to expect,” commented Malcolm Rogers, Telecom Markets Analyst at leading data and analytics company GlobalData. “CTC operates in a mature industry and mostly mature Chinese telecom market, and while growth prospects are solid, they won’t be turning any heads. Further, there is some risk aversion in Asia markets with investors uncertain over Trump’s trade policies. Further CTC generates revenue in RMB, while it trades on the HKSE, adding another level of uncertainty (future RMB to HKD to USD rates),” added Rogers.
After a subsequent attempt at 10-12x attracted insufficient interest, now priced at 7-8x the view of most of investors is that China Tower Corporation (CTC) is too cheap to ignore.
The CTC IPO was the beneficiary of a big push from China, Inc., which wanted it to attract as broad participation as Xiaomi. Managers of Chinese capital had to participate, although commentators were impressed that cornerstone investors did not need to take more than 20% of the total placement, while investors with discretionary capital found it too cheap to ignore.
Sources TowerXchange spoke to suggested two factors suppressed CTC’s valuation, the first being that nobody knows whether there will be one, two or three 5G networks built in China. This question is critical to the long-term amendment revenue potential of CTC’s towers (amendment revenue is where an existing tenant pays a supplementary lease to overlay an additional network technology, e.g. adding 5G to a 3G/4G site).
The second factor suppressing CTC’s valuation is that their lease expirations are all due in 2022-23, and there has been no clear indication of how long that renewal will be and at what rate. That is detrimental to CTC’s valuation, especially given their lack of bargaining power over their primary tenants, which still own the majority of CTC.
“China Tower Corp, currently is owned by the three MNOs in China, (China Mobile, China Telecom and China Unicom). Opening up the company to an IPO has put more scrutiny on its operations and mean less direct control for the operators, with the trade-off being an injection of fresh capital for the business,” said GlobalData’s Malcolm Rogers.
“The stock priced exactly where we thought it would,” said Spencer Kurn, one of the Founding Partners at New Street Research. “China Tower remains attractive due to its sheer scale.”
“CTC trades at a lower multiple than their peers in the U.S., Europe and LatAm because CTC’s economics are inferior as function of pricing regime they’ve implemented, and because of their ownership structure. Additionally, a potential merger between China Unicom and China Telecom could further depress returns for China Tower relative to tower peers globally. Returns on invested capital range from 3-9% depending on the level of lease up,” continued Kurn. “This is lower than we typically see for other tower companies, but we anticipate returns expanding – it’s still a solid business. And large institutions can only find scale in so many places in China.”
Key differences between CTC cash flows and their international peers
“There are simple differences: an American towerco charges around US$2,000 per month for a new lease, CTC charges less than US$400,” said New Street’s Kurn. “Costs per tower are a lot lower in China than in the U.S, but not by enough to maintain the margin. The other difference is that in the U.S. when an incremental co-location is added, the towerco doubles its revenue. In China there’s a healthy discount to the lease when a second tenant joins: we think revenue goes from something like US$400 to US$550 instead of US$400 to US$800 when you add a second tenant, and with the third tenant only taking it to about US$700.” The co-location discount in China is greater than you would find anywhere in the world, including in India.
Costs per tower are a lot lower in China than in the U.S, but not by enough to maintain the margin. The other difference is that in the U.S. when an incremental co-location is added, the towercos doubles its revenue. In China there’s a healthy discount to the lease when a second tenant joins – Spencer Kurn, New Street Research
New Street’s Spencer Kurn continued: “The co-location potential is what you’re playing for, and the U.S. and LatAm has more favourable co-location economics than China. The economics of towercos are a function of how each market developed: U.S. towercos developed independently from the operators. In Europe, or in this case China, where towercos developed out of MNOs divesting as a means of cost savings, you tend to see less favorable economics – lower escalators and discounts when co-locating.”
Operator-led towercos like Bharti Infratel are a better comparison than the U.S. towerco REITs
“We thought this business looked a lot more like Bharti Infratel than a U.S. towerco – the multiples CTC initially sought were thus pretty frothy,” said New Street’s Kurn.
While Indian towerco Bharti Infratel is clearly a strong comp for CTC, there are different trends in India to China – for example consolidation is a more immediate issue in India, as is the legality of some infrastructure, whereas it’s a much more orderly market in China. Towercos that are majority owned by their MNO clients (“operator-led towercos”) generally don’t attract the same valuation as pureplay independent towercos. Many analysts feel that operator-led towercos are often not properly geared, and need to take on more leverage to generate value.
Impact of State-Ownership
“China Mobile has a State-Owned Enterprise (SOE) discount of 60% to discounted cash flow fair value – China’s other two MNOs have 25% discounts,” said New Street’s Kurn. “The key risk is government interference at the expense of upside to shareholders.”
The risk of government interference in CTC that most concerns the financial commentators TowerXchange spoke to relates to the renewal of CTC’s leases in 2022-23, which will be a negotiation between SOE CTC and their three SOE customers/shareholders. CTC has already seen its lease rates discounted: as of January 2018 base price discounts for second tenants rose from 20% to 30%, and from 30% to 40% with the addition of a third tenant. In addition the anchor tenant base price discount was increased from 25% to 35% with the addition of a second tenant, rising to 45% with the third tenant. Had these same discounts been applied to CTC’s year ending December 31 2017, operating revenue would have been reduced by 6%.
The State will also have a significant say in whether China Telecom and China Unicom will merge, which would obviously significantly affect CTC’s tenancy ratio potential. “There are rumors that China Telecom and Unicom may merge, but I think the regulator may block this move,” said Malcolm Rogers of GlobalData. “You lose a lot of competition in the market even when dropping from three to two providers. If you look at Philippines, a market with only two mobile operators, they have some of the highest prices for mobile services relative to real income in Asia.”
There is a positive side to State-ownership. “Many of the headaches faced by tower companies revolve around securing land rights, adhering to local regulations, et cetera,” continued Rogers. “As an SOE, CTC can essentially build where it wants. Further China has done a lot in recent years to modernise its SOEs, restructuring them to have corporate governance to match private industry.”
As a legacy of the three parallel tower networks originally built by China Mobile, China Telecom and China Unicom, it remains common to see two to three adjacent towers in China – access to land and backhaul didn’t seem to be a problem, suggesting that the ability to establish the asset is simpler than in other countries.
What would CTC have to do to look more attractive to analysts and investors?
Analysts would like to see more metrics around tenancy ratios, expected tenants over a year, and average pricing – more granularity on par with what other listed towercos provide. CTC’s non-core initiatives are of interest too: analysts want more information in order to understand the capital intensity and returns of CTC’s forays into DAS, small cells, leasing up electricity transmission infrastructure, and their new ‘trans-sector site application and information’ (TSSAI) business, which combines ground based augmentation of satellite signals with CCTV, environmental, metereological and earthquake monitoring.
I think there is legitimate concern that CTC is treated as just an input for its parent companies’ main businesses, mobile services rather than a separate for profit business. Ensuring investors that CTC will be run as a separate entity charging appropriate profit making prices for its services should help - Malcolm Rogers, GlobalData
“It will be good to see continued growth from CTC’s small cell TSSAI businesses,” said GlobalData’s Rogers. “Both are new growth areas and have a lot potential for future 5G, IoT and smart city projects from operators, tech companies and governments in China. As part of its Smart City Industry Policy and Environment Program, the Central Government has committed RMB2tn (Approximately US$300bn) in smart city investments over2015-2025. Small Cells and TSSAI sites can be used to support these projects.”
“I think there is legitimate concern that CTC is treated as just an input for its parent companies’ main businesses, mobile services rather than a separate for profit business. Ensuring investors that CTC will be run as a separate entity charging appropriate profit making prices for its services should help,” concluded Rogers.
New Street’s Spencer Kurn summed up: “The bull case on CTC is growth: they’re baking in a healthy amount of growth but there is a runway for continuing growth in China, and expanding outside China is a big opportunity for them.”
“There is risk in 5G – it could be a boom or bust for CTC depending on the consolidation of MNOs and their capacity to invest in 2021 and 2022, which is also when CTC’s leases expire. Analysts are worried that represents an opportunity for the Chinese MNOs to secure a price cut. On the other hand, with peak 5G investment, CTC could grow revenue and EBITDA 13-14% annually.”
CTC and 5G
One consistent theme in TowerXchange’s conversation with the analysts: China needs a lot of capital to achieve their goal to set standards and lead in 5G, a goal supported by an industrial technology policy mandate, and the CTC IPO was a monetisation tool to fund 5G investment.
“There is good growth potential for investors as the company has a virtual monopoly in the Chinese Tower business and 5G could require a significant amount of additional sites in China. The higher frequency mobile spectrum bands required to support 5G services have a smaller coverage area per mobile base station compared with most of the traditional mobile spectrum used in networks today,” said GlobalData’s Malcom Rogers.
