CCI Update: Another win for shareholders

Another big win for Elliott and shareholders today.

Crown Castle International (CCI) announced:

1. A comprehensive review of the fiber program.
2. Adding two new independent directors to the board.

Independent means independent from CCI, not from Elliott. One of the board members is a senior portfolio manager for Elliott.

This is positive for shareholders because the fiber strategy wasn't working. I would describe the strategy as:

1. Spend billions building fiber at a poor return.
2. Tout the return on the small cells, which are only a small part of the investment.

If they were achieving the small cell returns on all capital expenditures, it would've been fine. But there was just way too much going into fiber.

I believe if CCI sells the fiber segment, it will be at a price below the cost paid to build the network (construction + acquisitions). It would be dilutive to “AFFO”, but it would improve the quality and growth rate of AFFO for all future years.

The reason it would be dilutive to near-term results is that fiber assets should trade at a cap rate higher than the rate on debt. Of course, there isn't just one rate on debt. I'm thinking in terms of current short-term rates on debt for a company with a great credit rating. Of course, that rate can change materially.

Note: If investors just wanted the highest AFFO yield, they would have been speculating in office REITs for quite a while. They would've been in mall REITs before that. Not great.

We are not trying to own assets with the highest cap rates. We are looking for a combination of net operating income (fuels AFFO) and growth. The tower portfolio within CCI is outstanding. If they sold off 100% of the fiber assets at a reasonable price and reduced debt, they would have less AFFO but they would deserve a higher AFFO multiple.

There is dividend risk, but it would depend on decisions by the board and the value available for the fiber portfolio. Keeping in mind that they are not forced to sell it. If they don't have a good bidder, they can just continue to own it. That's fine. The fiber strategy and fiber portfolio are different. The strategy (billions in capital expenditures) was bad, but they could slash capital expenditures without selling the assets.

There is nothing inherently wrong with that outcome. They could still have some capital expenditures when it provided a clear and immediate return on invested capital. They weren't getting enough of that (returns) for the money they committed. That's why the old CEO is out.

Note: This will likely trigger another small upgrade to target prices because it indicates an improvement in the company's strategy. Risk rating won't change for now. Probably won't change until we have more clarity on the path the board is choosing.

The worst ways to approach this would be to pull a Jay Brown or a WPC.

• A Jay Brown means continuing to invest billions into fiber at poor returns.
• A WPC means abruptly announcing a poorly designed spin off that leads to significant additional costs while cutting dividends.

Anything other than those options is probably going to range from good to great.

The best solution would probably be to set a policy of raising dividends by $.01 per year (to establish growth history) and selling off assets opportunistically. If they can do a huge sale, great. If not, that's okay. This strategy could lead to the payout ratio going over 100%, which would be fine if they take a long-term view. The towers generate natural growth with very low capital expenditures.

In this best-case scenario, they should ramp up transparency. Specifically, include more calculations on returns and capital expenditures until the fiber assets are sold. Commit to following all best-in-class policies on corporate governance. Green Street Advisors could give them an easy list for which areas still need fixing.

ESG is a strange combo. The G is governance. That's referring to the board acting as intelligent fiduciaries for shareholders. Which shareholder actually opposes that? Today's announcement indicates the board doing a better job of representing shareholders.

Disclosure: Long all 3 big tower REITs: CCI, AMT, SBAC