(Editor's note: On Jan. 24, 2023, we republished this article, originally published on Jan. 18, to correct Helios' stand-alone credit profile in the second chart. A corrected version follows.)

This report does not constitute a rating action.

Infrastructure is expensive. Over time, many mobile network operators (MNOs) have sold their telecommunications towers, choosing instead to lease capacity from specialist tower companies. This has given rise to a strong subsector within telecoms. In exchange for taking on an asset-intensive and costly aspect of delivering mobile phone services, towercos gain stable, recurring revenue and low operating risk. The towerco subsector has a strong record of robust and resilient performance, which it has again demonstrated over the past three years, and it has consistently outperformed the wider telecommunications industry.

Because their business is capital-intensive, towercos often carry more debt than similarly rated companies in other sectors and frequently make debt-funded acquisitions. S&P Global Ratings' upgrade and downgrade triggers (the leverage band) can therefore include a cushion if a company’s financial policy or track record indicates that additional debt may be issued. That said, the sector's strong business fundamentals give it the capacity to manage relatively high levels of debt.

S&P Global Ratings recently reviewed its financial requirements for tower companies, in light of their relative strength. As a result, we expanded by 0.5x our leverage tolerance for four of the 13 towercos that we rate:

• Cellnex Telecom S.A. on Nov. 11, 2022,
• Crown Castle Inc. on Nov. 21, 2022,
• SBA Communications Corp. on Dec. 2, 2022, and
• Operadora de Sites Mexicanos S.A.B. de C.V. (Opsimex) on Nov. 25, 2022.

We allow these companies to operate with higher leverage than towerco peers at their rating levels because of their relative strength, and because they follow financial policies that do not require an additional leverage cushion. Here, we present frequently asked questions from investors about why we now tolerate more leverage at some rated towercos.

Frequently Asked Questions

Why do we consider that tower companies have stronger business profiles than the broader telecoms sector?

In our view, tower operations have proved to be the strongest of the telecom sector's major subsegments, and towercos have developed a stable, low-risk business model. The sector benefits from:

• Durable demand profile: Towers are passive, but critical, infrastructure on which MNOs deploy their equipment. Regardless of fluctuations in their subscriber bases, MNOs require access to a network of towers across their markets if they are to provide competitive coverage, and the high cost of switching is exacerbated by the potential for disruption to their own mobile network coverage.
• High barriers to entry: Tower locations are limited by site availability and zoning rules can obstruct construction. In some jurisdictions, regulators have also set limits on the emission of electromagnetic frequencies (EMF), which are amplified as the network becomes denser, particularly in urban areas and when using the faster 5G standard. Tower infrastructure is also asset-intensive, making it both costly and time-consuming to replicate.

• Predictable revenue and cash generation: Contracts for the use of towers typically average 10 years or more, ensuring that revenue is highly visible. In addition, operational risk has been relatively low given the passive nature of the assets, and many contracts include automatic or inflation-indexed lease escalators and energy cost pass-throughs. These support high margins and cash generation, and largely protect towercos from downside risks.
• High operating leverage: Like many other forms of infrastructure, tower assets have high operating leverage. Adding new tenants to a tower (colocation) carries few costs, but results in a significant increase in both revenue and EBITDA margins.

These attributes support solid business profiles; indeed, we generally assess towercos as having a stronger business profile than the MNOs they serve. The combination of low operational risk and revenue certainty from long-term contracts with built-in escalators, yields steady cash flows, robust growth, and higher valuation multiples than their MNO customers. The graphic below compares average business strength, excluding the influence of country risk, for our rated towercos against that of our rated telecom companies.

Nevertheless, business strength is only one element of our credit analysis. Our ratings on some towercos are constrained by their record of aggressive mergers and acquisitions (M&A) and market expansion. For example, Vantage Towers AG's dividend policy implies a willingness to increase its financial debt to fund shareholder returns. Given the likelihood that additional debt would reduce the company's headroom at the current rating, we chose not to loosen our leverage requirements. Conversely, Cellnex's decision to tighten its financial policy reduces the risk that it will engage in aggressive debt-funded M&A, which had carried a corresponding need for a larger leverage cushion, and contributed to our loosening of credit ratio requirements.

Impact of rising interest rates: Some investors have questioned whether towerco credit quality is affected by the recent rise in interest rates and weaker equity performance. Although this could affect traditional REITs, where our higher leverage tolerance is mitigated by our emphasis on loan-to-value ratios, it should not affect our ratings on towercos. We expect the sector's underlying business strength and leverage ratios to remain stable, supported by long-term, inflation-resistant contracts, which can smooth economic and business cycles.

Why are we changing leverage thresholds for some towercos, but not all?

In deciding whether to loosen the thresholds, we analyzed the towercos' relative business strengths. In the case of the four towercos where we expanded our leverage tolerance, we concluded that the combined effect of their markets, business focus, and competitive positions gave them a material advantage compared with direct peers at their prior rating thresholds. The main factors affecting our analysis of towercos' relative advantages are:

• The maturity level and quality of the markets in which they operate, and in particular, concentration and competition in those markets;
• The dilutive effect of diversification into other markets or businesses, which can diminish the quality of a towerco's business;
• The competitive position of the tower portfolio, which is affected by the attractiveness of the towerco's locations and site types, its scale, and the proportion of sites that it owns;
• The relative strength of off-take contracts in terms of duration, renewal terms, and escalators.

The chart below is a relative strength ranking that shows our stand-alone credit profiles (SACPs) for towercos and their current leverage bands, in descending order of leverage tolerance.

All else being equal, we would raise the SACP for Cellnex and SBA Communications to 'bbb-' from 'bb+' if their leverage fell below 7x. We tolerate less leverage at American Tower Corp., where the 'bbb-'/'bb+' threshold is 0.5x tighter at 6.5x, and even less at Vantage, where the same threshold is another 1.0x tighter, at 5.5x.

Market maturity and quality: In most markets, tower infrastructure was built by MNOs while establishing mobile coverage across the region. Over time, many MNOs have sold off their tower assets because their relatively high valuation multiples offered an arbitrage opportunity, and tower ownership provided less of a competitive advantage compared with peer MNOs. This process has progressed further in the U.S., where a mature independent tower infrastructure market has developed. Most towers are owned by one of three independent towercos, rather than by an integrated MNO. We consider that such markets generally have more stable competitive dynamics, with less risk of disruption from the sale of a large overlapping portfolio, or the arrival of a new entrant into the market.

High-quality markets typically have strict zoning and other regulatory constraints, such as limitations on the amount of EMF emissions in an area, that create barriers to entry for competing towers. This heightens demand for the limited tower space available, allowing the towerco to charge higher rates, and enhances customer loyalty, which ultimately boosts its revenue and earnings.

Diversification: Because we assess the towerco business as so strong, diversification may not always have a positive effect. It can introduce risks to an otherwise credit-supportive business. In our relative strength analysis, the strongest option for a towerco based in a mature and stable market where country risk is low is to maintain a disciplined focus on the tower business. We make a distinction between such companies and those that have increased their exposure to less credit-supportive markets or business lines, often in pursuit of growth.

Although market diversity can be positive, it does depend on the markets. Less-mature markets can offer more opportunities for colocation and growth, but their less-stable competitive dynamics pose a risk. Often, the greater country risk associated with operating in less-mature, emerging markets offsets what would otherwise be relative strengths. For example, we give credit for having a high proportion of contracted revenue, but less if the legal framework for enforcing contracts in the jurisdiction is weak. Thus, we consider American Tower, which generates about 37% of sales in emerging markets, to be weaker than Cellnex and Crown Castle, which only operate in high investment-grade jurisdictions. In addition, operating in a market where the electricity network is less reliable can expose towercos to operational and cost volatility because they need to maintain onsite facilities for power generation, often using fossil fuels.

Diversifying the business by offering complementary products and services can also increase revenue and create more loyal customers, but against this, we weigh the risk that contract terms may be less robust and margins lower. Increased responsibilities and risks from operating active assets with greater performance standards than passive tower assets could also weaken our credit view. In search of growth opportunities, many towercos have expanded into services adjacent to the traditional tower rental business, such as data centers, backhaul fiber provision, and taking over elements of an MNO's network management responsibilities. However, straying too far from highly rated jurisdictions or the core tower business could lead us to reassess a towerco's relative strength. For companies like Cellnex, SBA Communications, and Crown Castle, such a change could affect our leverage tolerance, and bring them more in line with American Tower.

Portfolio and contractual quality: For prospective MNO customers, site location is a key selling point. This is particularly true for macro sites in densely-populated areas where higher hurdles to building new sites leaves fewer alternatives. We therefore consider the quality of the assets in a towerco's portfolio to be as important as the strength of its off-take contracts. Towercos that have larger portfolios typically offer a mixture of premium and more-commoditized sites. For these players, scale can enhance customer loyalty as the towerco can offer an efficient "one stop shop" portfolio that addresses an MNO's broad coverage needs. Site ownership can increase asset value and reduce renewal risk for the underlying land. SBA Communications owns over 70% of its sites, one of the highest levels among the rated group.

Towercos can also benefit from the presence of specific terms in their contracts with MNOs. Revenue is more predictable if contracts have longer durations--for example, Cellnex's average 15-20 years. Proactive renewal management can help avoid the short-term tail risk that a customer will not renew. In Europe, contracts typically include all-or-nothing renewal clauses that increase the potential cost to MNOs of walking away at the end of a contract. As renewal periods approach, this makes MNOs less likely to transfer their business, especially if the towerco has a large portfolio and it would be difficult to recreate the coverage level with a competitor. During the contract period, robust escalator provisions that have minimum indexation and no inflation caps also help to ensure that revenue grows and margins are preserved.

Why are we loosening leverage requirements now?

Periods of market stress can provide a good test of credit quality. Over the past three years, despite economic volatility, towercos have outperformed many sectors, including the sector average for the wider telecoms industry. Rising energy costs and higher inflation have also highlighted the value of the sector's energy cost pass-through and automatic escalators, and have reinforced the stability and visibility of earnings. Not only have long-term contracts protected towercos against demand volatility, but underlying demand for MNO services has also held up well. Tower services are a utility service for their users, which reassures us that recontracting risk is low.

The sector's recent resilience is not unexpected; it has a history of successfully navigating periods of market stress, including the great recession in 2007-2008. It has also weathered several periods of consolidation, more recently among MNOs and earlier in the U.S. wireless market (dating back to 2006). We have also observed resilience in the face of counterparty bankruptcy.

Consolidation could still be a risk, given that the MNO customer base is highly concentrated. If the consolidating MNOs have significant overlap in the towers they use, demand could fall sharply as they integrate--in theory, this could cut demand by up to 50%. That said, as we saw when T-Mobile US Inc. (TMUS) acquired Sprint in the U.S., contractual revenue was not immediately affected as renewal dates are often many years in the future. Although towercos may opt to renegotiate contracts, for customer relationship reasons, they do so on a discretionary basis, and from a position of contractual strength. In addition, operators may still choose to lease overlapping sites after consolidation, even after contracts have expired, because of the trend toward densification to address cellular capacity constraints. Maintaining "excess" leases allows operators to split cells and so add capacity in future.

The primary revenue driver for towercos is leased tower space, not the number of sites. Thus, even if a towerco decommissions redundant towers, the equipment is typically moved to another tower rather than being rationalized, given the growing capacity and equipment demands of higher data traffic and 5G buildouts. Rationalizing a large number of tower sites thus cuts costs, which helps to offset any loss of revenue. As a result, we forecast that revenue at Crown Castle will dip by only 3%-4% over the next three years, even though TMUS and Sprint represented about a third of its revenue before their merger. Furthermore, we expect its revenue will continue to grow by around 5% from 2026 on, and that margins will be higher, due to greater demand and increased colocation on its remaining towers.

Tower contracts have even been honored in a default scenario. When Brazilian MNO Oi filed for bankruptcy in 2016, it continues to honor its tower commitments so that it could maintain operations. This supports our view that towers are critical infrastructure and are highly likely to continue to generate revenue, as long as its MNO customers remain a going concern.

Can counterparty risk constrain our ratings on tower companies?

Our ratings on towercos are supported by their high proportion of contracted revenue, but only three or four MNOs operate in a typical market. Therefore, towercos have relatively few customers, each of which is likely to contribute a sizable share of total revenue. Where the credit quality of the MNOs that are leasing space from a towerco is weaker than that of the towerco, it could theoretically constrain our credit view. The table below compares our ratings on towercos with the weighted average rating on their MNO customers. In practice, we have yet to cap any of our ratings on towercos based on counterparty risk.

Tower assets are critical infrastructure if an MNO is to maintain its operations. As long as the MNO remains a going concern, even if it has filed for bankruptcy, we believe it would continue to honor its access agreements. We would only expect tower access contracts to be terminated if the MNO were to be liquidated. This would directly affect the towerco's credit quality.

There can be other situations where we consider counter party risk, such as when a customer has agreed particularly favorable contract terms. For example, an MNO may agree to pay above-market rates or commit to outsized price indexation when it spins off its tower business. In the short term, an out-of-market contract could enhance the transaction valuation, and therefore its proceeds, by boosting the towerco's future earnings. Where contract terms are so favorable that they enhance the towerco's credit profile, by boosting profitability or improving financial ratios, we would consider a rating cap if the support relies on a counterparty that has a weaker rating. We would consider the magnitude of the credit enhancement compared with market-based contracts and the differential between the towerco and counterparty ratings to determine the extent of the cap.

Related Research

• SBA Communications Corp. Upgraded To 'BB+' From 'BB' On Revised Leverage Trigger; Outlook Stable, Dec. 2, 2022
• Operadora de Sites Mexicanos 'BB+' Ratings Affirmed; Outlook Triggers Revised On High Predictability Of Stable Metrics, Nov. 25, 2022
• Crown Castle Inc. Upgraded To 'BBB', Outlook Stable On Favorable Business Prospects; Strong Leasing Activity, Nov. 21, 2022
• Cellnex Telecom S.A. Outlook Revised To Positive On Supportive Financial Policy; 'BB+' Ratings Affirmed, Nov. 11, 2022,
• Credit FAQ: Why Telecom Companies Across Europe Are Selling Their Towers, Oct. 11, 2019