Towering Valuation?

09/29/2010 4:35 pm EST


Jim Jubak

Founder and Editor,

There’s no doubt that American Tower (NYSE: AMT) is getting kind of pricey—even after it beat Wall Street expectations for second-quarter earnings.

On August 3, the company reported second-quarter earnings of 25 cents a share, five cents a share above Wall Street’s projections. Revenue climbed by 11% from the second quarter of 2009, coming in at $469.9 million—about 1% ahead of expectations.

But the key metric for American Tower is price to cash flow. The company takes its cash flow and uses it to buy more cell-phone towers (or to buy complete cell-phone tower competitors). That in turn produces more cash flow, which American Tower uses to buy more towers.

If you think that sounds like the financial model of a master limited partnership or a REIT (real estate investment trust), you’d be right. The company is thinking about putting some or all of its assets into a REIT structure, which passes most pre-tax earnings back to investors. The timing of such a move looks like 2011 or 2012, depending on how quickly the company can put its net operating losses to work against profits.

The current price-to-cash-flow ratio of 22.1x isn’t out of line with the company’s average over the last five years of 21x. (The industry average is just 10.7x, according to Morningstar.) But the ratio is moving towards the top of the range set at 25.8x in 2006 and 26.2x in 2007. In 2004, the ratio was just 19x, and in 2005, an even lower 17.5x.

At these levels, an investor is starting to price in much of the higher revenue growth that’s projected from the rollout of 4G cell-phone networks in 2010 and 2011. I think it’s reasonable to project that EBITDA (earnings before interest, taxes, depreciation, and amortization) margins will rise in 2010 and 2011 as network operators increase their need for space on existing towers. Standard & Poor’s forecasts that free cash flow will grow to $789 million in 2010 and $975 million in 2011. That would be up from $641 million in 2009.

The problem is that the stock’s price already anticipates much of that good news. On the better- than-expected results in the second quarter, I can get to a target price of $57 a share in 12 months, but that represents only a 10% gain in a year from Wednesday’s closing price just below $52.

That’s not a bad return for a risk-averse investor—and I don’t think this stock is very risky at this point in the industry cycle—but it wouldn’t be enough to lead me to put new money to work in these shares. (For more on the short-term prospects for stocks, see this post.)

As of September 29, I’m putting a price target of $57 a share by September 2011 on American Tower.

Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio.

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