Cogent Communications Holdings, Inc. (CCOI) Earnings Call Transcript & Summary

My name is Phil Cusick. I follow the communications and media space here. Well, I want to welcome Dave Schaeffer, Founder and CEO of Cogent Communications. Dave, thanks for joining us.

Hey, Phil, thank you for hosting me, thank JP for a great venue. And most importantly, thank all the investors for taking some time to hear a little bit about our business.

Excellent. Well, let's start with the recently closed acquisition of Sprint's Global Media business. This is the first M&A deal you've done in nearly 16 years. And T-Mobile has been trying to sell it for what seems like almost that long. But why this one and why now?

Well, it has been a long time, and we've looked at over 825 potential targets and chose this asset. I think there are 3 reasons. First and foremost, we think there's an asset that can be repurposed and create significant value. Two, there is a customer base that has not been tended to and many of the products and services that they are purchasing are no longer economically viable. There's an ability to improve that business by grooming the products at modernizing the services we deliver and continue to support those large enterprise customers that have a 30-plus year relationship with Sprint. And then I think the third reason, to be blunt, is we were paid $700 million to take it. And rarely is there a situation where an asset 20 years previous was in the market and under contract to be sold for $129 billion. And then 20 years later, the seller is paying the acquirer $700 million. So I think they're derisking the acquisition for us.

How does the size of this company in terms of whether it's fiber or route miles compared to the existing Cogent?

Yes. So the current Cogent network is approximately 62,500 miles of intercity fiber. The Sprint network is 19,000 route miles. Cogent's metro network is 18,200 miles. Sprint's is 1,100 miles. So it is smaller in terms of geographic reach. In terms of traffic carried, Cogent's network is carrying about 1.1 exabytes a day. The Sprint network was carrying slightly under 10 petabytes. So roughly about 105x bigger the Cogent network. By revenue, Cogent was approximately $600 million in revenue. The Sprint network at time of deal signing was $560 million, at closing $470 million. So a significant acquisition in terms of revenue scale and network, but the real opportunity lies in the ability to take what is effectively a fallow footprint and begin to generate revenue off of it. This was the first nationwide fiberoptic network. It was built in the mid-80s. It terminates at a number of tandem switch sites that were purpose built that are going to be repositioned as data centers. And while we are being paid to fix the operating business, the real reason for doing the transaction was to control the assets and begin to sell new products.

It seems like a very underutilized asset, but it's not like Sprint didn't need money for the last 10 years. Why weren't they going after the wave market as well?

Well, we'll turn the clock back. This is actually an asset that Cogent had attempted to acquire twice previously. In 2013, when SoftBank was looking to acquire Sprint, we were engaged by their then current CFO Joe Euteneuer, met with SoftBank and actually agreed on the economics of a deal that were much more favorable to the seller. The business was in better shape. And eventually, that deal was not consummated. Fast forward to 2018, when T-Mobile acquired the asset, they engaged a banker, ran a process, the business had deteriorated. We had, again, bid on the asset and were rejected as were other bidders. The business had deteriorated further. But at that point, I think T-Mobile was not willing to accept either no cash compensation or pay a purchaser. After evaluating the business, they hired a consultant. They looked at the asset and had attempted to implement a wave strategy on -- upon the recommendation of that consultant. They spent about $10 million. They generated about $8 million in annual run rate and concluded that it was going to be too hard for 3 reasons: one, their network terminated in very unusual locations. So they would have to spend multiple billions of dollars to extend that network into the major carrier neutrals and get the reach necessary to satisfy the wavelength market. Secondly, they had no sales force that was equipped to sell wavelengths, so they would have to develop and hire that. And then finally, internally, they did not have a management team that was familiar with this market and want to execute the business. Putting those 3 concerns together and looking at the potential scale versus their wireless business, they concluded it was actually better to either shut the business down or attempt to sell it again. And prior to our acquisition, T-Mobile had hired yet a different consultant and went through an evaluation and concluded that a shutdown was most likely at a cost to the company of about $1.5 billion. We stepped in when they engaged a different banker. The transaction with Cogent includes a combination of $700 million of direct cash payments costs, $25 million of severance payments made to us for employees we terminate, $100 million of additional indemnification. And then finally, about $500 million in expenditures by T-Mobile between signing and closing. So the total cost to T-Mobile was slightly less than their $1.5 billion shutdown cost at about $1.35 billion. But I think what they got with Cogent was 3 advantages they wouldn't have gotten with a shutdown: one, they got certainty; two, there were no regulatory entanglements; and then finally, there was no brand damage as we agreed to support all customers going forward.

And since -- so the $8 million of wave's revenue that came with the business, that was all sold by T-Mobile a few years ago. You've ramped up that pipeline pretty quickly after the announcement of the deal. How should we think about that? And what's your -- been your ability to close those since the close of the deal?

So once we announced the transaction, we entered into a commercial relationship prior to getting regulatory approval that allowed us to go to market and sell wavelengths as a reseller of T-Mobile. As a practical matter, none of those wavelengths were really installed, and we did not expect that, but it allowed us to test market demand. We have generated several hundred wave orders. The transaction just closed May 1. We are in the process of provisioning those initial orders. In the wave market, the traditional window for provisioning ranges between 90 to 180 days, in some cases more. Cogent has busily worked at connecting the Sprint network to carrier-neutral data centers and has the ability to sell wavelengths today in 200 of the 800 facilities that we have on our network. Over the next 18 months, we anticipate being able to sell wavelengths in all 800 U.S. carrier neutrals on our metro footprint. We also expect to be able to collapse that provisioning window from the market average of 90 to 180 days down to our traditional net window of a guarantee of 17 days and an actual observed install of 9. We will begin to rapidly provision those services in those first 200 locations, probably with an installation window up between 60 and 90 days initially, but we are busily working on completing the interconnection of the network and standardizing the network architecture to allow for a more rapid provisioning.

And what some of the incumbents in the wave market might say is this is old fiber. It's not necessarily what customers want today. What's the response been from customers as you go out and sell this?

It's actually been very positive. So there are some unique attributes to the network. It is absolutely correct that the network was the first nationwide fiberoptic network built in the mid-1980s. So it is a 40-year-old asset. It was built with SMF-28 fiber. That fiber was initially viewed to be end of life in the mid-90s and the market shifted to nonzero dispersion shifted fiber.

I don't know what that means.

It's 2 different ways in which the light moves through the fiber. So a light pulse when it goes through the fiber tends to pull apart, dramatically separate, becomes blurrier. And in a nondispersion shifted fiber, the fiber has chemicals in it that kind of push the light pulse back together. That was necessary when the transmission medium was noncoherent. So all of the initial fiber optic deployments were done using noncoherent, meaning pulses were sent individually down the fiber. In the mid-2000s as the equipment vendors struggle to get greater throughput per wavelength, all of the vendors, Ciena, Cisco, Nokia, Fujitsu, NEC, all of the vendors migrated to coherent technology, meaning the information is sent and comps down the fiber. The nonzero dispersion shifted fiber that was put in, in the mid-90s through mid-2000s actually is worse because that compression of the signal actually distorts the coherent transmission. So the older fiber is actually better. The second reason there's an advantage is, this network was built by a single provider, meaning there are very accurate records of where the network exists. Our competitors are roll-ups that have had fiber built by dozens of independent companies and, therefore, do not have accurate records of their outside plan. We can autogenerate a file with every proposal that intend is accurate, instantaneously with 1 meter of accuracy. That's very valuable to a buyer, particularly since the wavelength market is about deterministic routes, whereas the Internet is indeterministic. It's path independent. The third advantage is that the fiber was deployed differently. It was an armored cable, typically deployed along railroad right of way, buried 6 feet deep. Most newer fiber is in plastic conduit, only 2 feet deep. As a result, even though the fiber is 20 years older, it's had less cuts per kilometer, typically by almost an order of magnitude than the fiber that was deployed 20 years later. As a result, there are less cost in the fiber, less prices. Finally, the fiber in 90% of the routes is unique. No one else shares that route. So in building a deterministic network with wavelengths having unique routing is extremely important. So we have the best of 3 possible combinations, high-quality fiber for the highest transmission, unique routing and a maximum number of endpoints. Couple that with the fact that we have a negative cost basis in the asset, we are in a superior position to our competitors in selling in this market.

And customers accept this argument?

Not only do they accept it, we -- quite honest, we're a bit shocked by their desire to buy. So if you go back and look at the wavelength market, it initially was dominated by AT&T and Verizon. The primary customers were LD resellers who put switches in markets and bought wavelengths to connect those switches. That market existed from the mid-80s to about 2000. In the early 2000s, the market changed and the entire customer base became regional ISPs for wavelengths. AT&T and Verizon exited that market. Lumen and Zayo came to dominate that market. That independent ISP market disappeared. Today, the buyers of wavelengths fall into 3 major categories. Content generators who are linking together major content aggregation sites, a Facebook or Google, a Netflix, a Microsoft, even a content delivery network like an Akamai. And then the second base of customers are regional access networks that are linking together islands of service. So someone like a Mediacom or a Cox or a spectrum that have disparate markets that are linked together in a holistic market. And then finally, there is still a corporate wavelength market. It's the smallest segments, and it's dominated by very large companies like JPMorgan. All 3 of those segments have expressed interest in having a new supplier, unique routes and are frustrated with the provisioning time and lack of endpoints that the competitors have. So I think we are filling a gap in the market. And remember, Cogent already has existing transit relationships with 3/4 of the potential buyers of these services. We also have the largest sales force in the industry focusing on this segment. We are depending on how you measure it, the #1 or #2 transit provider in the world, and it's off of these transit relationships that we're now going back to the same customer base and selling them an adjacent product with the credibility we've established and gaining market share in transit.

So we're talking about not selling that at a discount. Could you sell it at a premium to the current market?