The earning potential for Asia-Pacific telecom tower companies is strong. A boom in tower sales has spawned more towercos and paved the way for more sharing of towers among telcos, or colocation, and possibly consolidation within the tower industry. The surge in data traffic as well as the advance of 5G technology will support rising tower demand.

Much of the risk to the credit quality of these towercos will largely depend on their appetite for growth. Investors ask about the key credit differentiators, trends and risks in the towerco sector. They also want to understand how S&P Global Ratings views the unique characteristics of freshly carved out tower portfolios. We address their most common queries here.

Frequently Asked Questions

What are the key differentiators of earnings quality for tower companies?

The earnings quality of tower companies is the strongest among the wider telecom sector's major subsegments, in our view. The sector benefits from durable demand, high barriers to entry, and predictable revenue and cash generation. In addition, operating leverage is high (see "Telecom Tower Operators Show Their Mettle," published on RatingsDirect, Jan. 18, 2023).

But among the strongest, some are still sturdier than others. The key differentiators 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 differs according to 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 escalation clauses.

The maturity of tower markets across Asia-Pacific is uneven. Countries such as Japan and Thailand still have mobile network operators (MNOs) owning the majority of the tower assets; whereas in countries such as China and Indonesia, independent towercos own more towers than MNOs, by a large margin.

The higher the proportion of towers held by towercos, and the longer the towerco industry has been active, the more mature the country's towerco industry is likely to be. We consider Indonesia to be among the most mature towerco markets within Asia-Pacific. In the past three to five years, Indonesia's industry has gone through a phase of consolidation and now almost all of the country's towers are held by towercos.

We believe a more mature market typically translates into more standardized terms for tower leases and smoother lease maturity profiles, which improve earnings predictability. Following are some of the factors that we consider in determining the maturity and quality of selected Asia-Pacific towerco markets:

How does S&P Global Ratings assess tenancy ratios of independent towercos?

Generally, the higher the tenancy ratio, the better. A higher tenancy ratio--the number of tenants on a tower--means more efficient use of the tower assets. The addition of a tenant to a tower (colocation), and therefore an incremental stream of earnings, comes at little cost to the towerco. We therefore expect higher margins as co-tenancy increases.

For tower portfolios recently carved out from MNOs, it is not uncommon for the tenancy ratio to be low. This is because the towers could have been previously captive to an MNO for whom the competitive benefit of retaining proprietary tower access might have discouraged the marketing of tower access to rival telcos. In addition, peer MNOs might have been reluctant to become dependent on a competitor's tower infrastructure.

Chart 1

A towerco's tenancy ratio isn't the be-all and end-all. For a tower portfolio with attractive characteristics, a low tenancy ratio would increase growth potential compared with a tower portfolio that already has a high tenancy ratio. Attractive characteristics may include a high fiberization rate or a high proportion of towers that can accommodate multiple tenants (such as ground-based towers), and premium sites where there are no competitive towers in the vicinity. Take for example India towerco Summit Digitel Infrastructure Ltd. (BBB-/Stable/--), the company's EBITDA margin--net of pass-through costs--of about 80% is similar to that of peers despite its low tenancy ratio of about 1.1x.

The low tenancy ratio of a newly carved out towerco usually also translates into high tenant concentration. How does S&P Global Ratings consider this in its ratings on towercos?

High tenancy concentration carries the risk that an overreliance on a single tenant of poor credit standing could weigh on a towerco's earnings and cash flow quality.

Globally, we have yet to cap any of our ratings on towercos based on counterparty credit risk. This is because we view towers as a critical part of an MNO's operations. We thus expect MNOs to keep up with tower payments until the very end. That said, we will increase the emphasis we place on a counterparty MNO as the degree of concentration and the uniqueness of contract terms with a specific MNO increases.

For example, in the case of Summit Digitel,more than 90% of its tenancies are from mobile market leader Reliance Jio Infocomm Ltd. (Jio). We view this favorably. Summit was carved out of Jio and maintains deep-rooted ties with Jio, now its anchor tenant, as well as the wider Reliance Industries Ltd. (RIL; BBB+/Stable/--) group. In our view, this relationship enhances Summit's credit quality. Summit has a 30-year lease contract with Jio. This contract tenure is much longer than the typical 10-12 years. For Summit, such lease terms, together with strong ties with its key tenant, help to reduce renewal risk and improve earnings resilience, in our view.

In addition, we believe that cash flows from Jio are of high credit quality because we regard the telco as a key part of RIL. Jio is the largest mobile network operator in India and has built a telecom ecosystem with its own branded handsets and applications. Its leverage is moderate. We estimate its ratio of debt to EBITDA (on an S&P Global Ratings-adjusted basis) to be about 3.5x for fiscal 2023 (year ended March 31, 2023).

How will tower sharing evolve in Asia-Pacific?

Tower sharing is set to rise. This comes after a wave of tower sales by MNOs in the past three to five years, especially in Australia, New Zealand, and the Philippines. Many telcos are viewing such assets as less of a source of competitive advantage as network coverage improves. Such sales also came amid high 5G and fiber investments for the telcos, with sales proceeds creating balance sheet capacity for new investments.

Tower sharing will allow MNOs to improve coverage faster, and at a lower cost (see "Asia-Pacific's Stretched Telcos Turn To Tower Sales," Nov. 21, 2022). This would translate to rising tenancy ratios for independent towercos over time. We believe the potential to gain more tenants once independent of a telco was one of the reasons tower portfolios fetched valuations of up to 30x EV/EBITDA, according to public disclosures.

That said, the extent of tower-sharing growth in such cases will depend on whether MNOs retain a controlling or substantial stake in the tower businesses. The stakes could provide the MNO with significant control or influence over the rate of colocation, particularly where this could affect the MNO's competitive advantage. For example, Australia-based Telstra Group Ltd. has retained a 51% shareholding in the carved-out tower business Amplitel.

Regulators have also encouraged tower sharing. A common objective is faster and more cost-effective improvement in the market's network quality. Consider, for instance, markets where there are big differences in population density between urban and rural areas. MNOs have less incentive to set up towers in rural areas because of lower anticipated returns. Regulations promoting or mandating tower sharing will thus help to improve network accessibility to rural areas. In addition to network improvement, such regulations can level the playing field among MNOs, thereby promoting competition and ultimately favoring consumers.

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Why does S&P Global Ratings think tower demand will rise?

Growing data demand is a key driver. Increasing data traffic requires a denser and wider tower network. It also serves to compensate for the weaker penetrative ability of high-band 5G signals. At the same time, regulatory pressure should lead to more towers being built in rural areas.

In the past five years, total mobile data traffic in Asia-Pacific has ballooned, with 2.5x to more than 8x growth in different parts of the region. In particular, the average mobile data usage has risen fastest in Southeast Asia and Oceania in the past three years. Average data traffic per smartphone in Southeast Asia and Oceania rose almost 300% to 24 gigabytes (GB) a month in 2023, from 2020. Comparatively, that statistic grew 130% on a global basis over the same period.

Chart 2

The advent and advancement of 5G will increase data usage. While the use of 5G services, alone, does not consume more data, it enables more data-heavy applications, such as superior video streaming. This better user experience, and the potential for new use cases, could in turn encourage more consumption.

Tower demand growth could be much higher in some Asia-Pacific markets, in our view. Tower density is exceptionally high in Japan and China, with more than 1,500 towers per million population. Japan's tower density is 4.3x that of Indonesia and 3.4x that of India--markets where we have publicly rated towercos. While tower density may differ according to a country's terrain and urban-rural population density, the wide variation in tower density in Asia-Pacific suggests ample room to raise tower count in some markets.

Chart 3

Does consolidation within the telco space affect towercos?

Yes. Where the consolidating MNOs both have leases on a tower site, they may choose to keep just one tower lease. In theory, this could cut the tower leases from the consolidating MNOs by up to 50%. In practice, however, the impact on towercos is lower.

Firstly, towercos are protected by tower lease contracts, which are typically long-dated. This means MNOs cannot simply abandon tower leases before they expire. However, towercos act as long-term infrastructure partners to MNOs, therefore mutually beneficial outcomes are often negotiated. Where tower leases overlap, towercos may allow the merged MNO to move one of the leases to a new tower site, out of goodwill.

Secondly, MNOs may choose to keep some overlapping tower leases in anticipation of the need for denser networks. The demand is driven by growing data traffic and the advancement of 5G. Signals on the millimeter wave spectrum used by 5G standalone networks can only travel short distances and will need more towers to provide coverage.

Indonesia in recent years has shown the effect of consolidation. In early 2022 Hutchison 3 Indonesia PT and Indosat Tbk. PT merged to form Indosat Ooredoo Hutchison (IOH). There was a mere 0.9% increase in revenue from IOH for towerco Profesional Telekomunikasi Indonesia PT (Protelindo) in the fourth quarter of 2022, as compared with the same period of 2021. This is much lower than 20.8% average increase in revenue from two other major MNO tenants--XL Axiata Tbk PT and Telekomunikasi Selular PT over the same period.

The same effect occurred in another Indonesia-based towerco Tower Bersama Infrastructure Tbk. PT. In this case, revenue from IOH fell 13.4% over the same period, compared with 5.8% revenue growth on average from the same two other major MNO tenants. This suggests rationalization of tower leases by the merged MNO. We expect the impact of the merger to ease but linger as IOH re-evaluates remaining overlapping tower leases at their expiries. This could result in weaker colocation growth for the towercos.

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What is the key risk for Asia-Pacific towercos?

To expand is to expend. We view acquisitions by towercos as one of the key credit risks. Towercos may chase growth by seeking to acquire other smaller towercos or tower portfolios. This is a bigger risk in less mature towerco markets as they go through a phase of consolidation.

Towercos and their investors believe that the earnings resilience and predictability of towercos can allow them to cope with higher leverage than telcos. For both the public and privately rated towercos under our global coverage, the median debt-to-EBITDA ratio for 2023 was close to 5.5x. This is much higher than the 3x-4x for the wider rated telecom and cable universe.

S&P Global Ratings is of the same view. In most cases, we allow towercos to operate with slightly higher leverage than telco peers to take into account the higher earnings resilience and predictability of towercos. The extent of leverage threshold difference depends on the relative strength of the towerco.

Notwithstanding that, if towercos fund acquisitions by debt, this could lead to step changes to their debt load. For example, in 2022 we downgraded Protelindo to 'BBB-' from 'BBB' when it acquired Solusi Tunas Pratama Tbk. PT. The acquisition led Protelindo's leverage to rise above the 2x-3x range at which it had previously operated. Besides the increased interest burden from higher debt, especially when rates are rising, higher leverage poses additional risks. These include currency mismatch, exposure to interest rate movements, and liquidity squeezes, among others.

On balance, an enlarged tower portfolio can enhance a towerco's value proposition. A larger towerco can act as a one-stop-shop for MNOs to lease a comprehensive tower footprint.

Towercos will have to balance their growth aspirations with the expectations of their debt and equity investors. An enlarged portfolio could come with a cost beyond the sticker price, and towercos chart their own fates.

Editor: Lex Hall

Related Research

• Telecom Tower Operators Show Their Mettle, Jan. 18, 2023
• Asia-Pacific's Stretched Telcos Turn To Tower Sales, Nov. 21, 2022