For the companies that own cellphone towers, business has been brisk. American Tower Corp. (NYSE: AMT), SBA Communications Corp. (Nasdaq: SBAC) and Crown Castle International Corp. (NYSE: CCI) have generated 17%-to-22% compound annual sales growth over the past five years.  

The business model is fairly simple. Each cell tower can handle equipment and traffic for as many as four or five telecom carriers and transmit a signal anywhere from 22 to 45 miles. Leases of ten years and annual rent increases of around 3% mean the towers are great cash flow machines.

#-ad_banner-#As telecom carriers race to compete and raise money selling off their tower infrastructure, they’re finding eager buyers in the tower operators. Verizon Communications, Inc. (NYSE: VZ) announced a long-term lease and sale of 11,500 towers, one of the last remaining large carrier portfolios, to American Tower in February for $5.06 billion.

Since cash flows are all but certain, debt is easy to come by and tower operators are loading up to make capital investments for years to come.

American Tower has more than two-thirds of its capital structure (68%) in debt and a BBB credit rating by Morningstar, just one level above non-investment grade. Crown Castle holds 64% of its structure in debt on a BBB- credit rating. SBA Communications has negative equity of $661 million against $7.8 billion in debt and a BB+ rating.

The high debt loads aren’t a problem as long as sales and cash flow growth remains strong. But those strong fundamentals are on a shaky foundation.

Technological obsolescence is making the landline  extinct, to the benefit of the tower industry. Now tower operators may face their own technological extinction-level event. And those high debt loads may start to look like a giant meteor.

D2D — The Future Of Communications

When a call is made from a cell phone, it is relayed through one or more cell towers. However, new technology that is being developed by Qualcomm, Inc. (Nasdaq: QCOM) aims to bypass the towers.

The protocol, known as LTE Direct, is built on device-to-device (D2D) technology that allows enabled devices to communicate directly with each other at distances of up to 1,500 feet (500 meters). Through an idea called mesh networking, the technology can even be used to connect calls at greater distances by routing them through enabled devices along the distance.

The company tested the software with Deutsche Telekom AG (OTC: DTEGY) and Huawei last year and is expected to roll it out as a commercial product in late 2015 or early 2016. Public and emergency services are seen as early adopters, as the technology has the ability to keep communications open, even if something disrupts cell tower service. When hurricane Sandy slammed the East Coast in 2012, more than 25% of the tower service in 10 states was disrupted.

The D2D technology uses licensed LTE (Long-Term Edge) spectrum for discovery of devices within range, meaning any connected device could be used as a relay station.

The idea got a boost earlier in the year when the U.S. Federal Communications Commission (FCC) approved a plan to allow broadband providers to use and share spectrum previously held by the military (Citizens Broadband Radio Service). The scarcity of spectrum capacity has been seen as one of the few remaining roadblocks to viability for D2D service.

Apple, Inc. (Nasdaq: AAPL) and Facebook, Inc. (Nasdaq: FB) are already working with the new technology and are planning ways to promote advertising across the D2D network. The proximity feature would allow nearby businesses to target consumers more naturally and at a greater range than is allowed on Bluetooth protocol.

With the big players lining up to take advantage of the technology and the spectrum issue cleared, it looks like D2D technology could be a very real threat to tower operators over the next several years.  

Debt Levels And Cash Return Could Become Unsustainable

D2D technology would not mean the immediate disappearance of cell towers, but it could lead to a steady decline in data traffic on the cell towers. The technology only works over LTE-enabled devices, so it will take time to penetrate the market and reach its full potential as a relay service.

Long-term contract leases will protect sales in the near-term even as D2D is released, but new contracts could be impacted. The commercial launch of the service will likely be an immediate hit to investor sentiment, pushing down share prices for the tower operators.

AMT is spending heavily on building new towers for which it may have trouble contracting in the future. The company is planning on spending up to $900 million this year to build between 2,750 and 3,250 new towers globally, with up to 250 in the United States. Funds from operations (FFO) of $4.29 per share puts the price-to-FFO at 21.8 times, above the average 19.7 multiple for real estate investment trusts (REITs) and well above the long-term average of 16.1 times for the group.

SBA Communications may be the most at risk with its high debt load. The company reported a net loss of $24 million last year with interest expense ($292.6 million) representing 19% of total revenues. Shares trade for a relatively expensive 25 times 2014 FFO of $4.64 per share.

Risks To Consider: D2D technology is still in development and there is the chance that commercial availability will be pushed further into 2016. Investors should be ready to wait out this revolution in communications and be wary of high valuations in tower REITs.

Action To Take –> Buy Qualcomm on a potential revolution in communication technology, while avoiding or shorting tower operators.

Oftentimes the little ideas are the big game changers — something like the technology Qualcomm is working on. My colleague Andy Obermueller devotes his time to identifying game-changing trends and the companies that should benefit from this. This has led readers to investments that went on to gain triple-digits.

More recently, Andy has been talking about the threat that cyber criminals pose on individuals, multinational corporations and even governments. This is a serious problem, in its infancy and one that will take decades to fight. But don’t let this scare you. Andy has identified four companies that specialize in protecting sensitive information from criminals. These are young firms, just like US Ecology, provide robust upside potential for early investors. If you haven’t heard about this opportunity yet, then I urge you to check out his comprehensive report on how to profit from the world’s greatest threat, by clicking here.