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

All right. Great. Thank you very much. Sorry for being late. If you're going to change the room on the schedule, you have to let the analysts know, but I didn't find out about that, so I apologize. But hey, my name is Frank Louthan. I'm the senior wireline analyst here at Raymond James. We're very pleased again to have David Schaeffer, CEO of Cogent back here at the conference. It's been a long time attender.

So Dave, maybe you can talk to us a little bit about Cogent. Tell us about what you do, what the business is and kind of how you fit into the space?

Sure, Frank. Well, thanks for hosting me. Thank Raymond James for a great venue. I'd like to thank all the investors for hanging around late in the day to hear what we have to say. And we obviously couldn't have started without you. It's hard to go do a presentation without your moderator. Cogent is a provider of dedicated Internet access service. We operate a global network, serves 54 countries, about 81,000 route miles of fiber between cities and additional almost 19,000 miles metropolitan fiber in 230 markets. In addition to selling Internet connectivity to either service providers or corporate end users, we also sell VPN services on top of the Internet, whether it be VPLS or MPLS-based services. We also sell colocation. And recently, we've begun to sell wavelength services, meaning optical transport services across the network that we recently acquired from Sprint.

All right. Great. So a lot's changed in the last 12 months since we were here. You completed the Sprint transaction. You got few months of operating experience with that under your belt. Kind of walk us through kind of where Cogent is today and how is that different from the Cogent that folks knew for many years?

So Cogent has been a public company since 2005. The company was founded in 1999. And believe it or not, Cogent has pretty much executed the same business plan. So when Cogent was started, we were lucky enough to raise $500 million of initial seed capital and not spend that capital. When the dotcom crash occurred, we went out and bought a total of 13 companies, 6 were public, 7 were private. We dismantled those companies. We typically terminated the customers; we fired the employees and re-purpose those assets to build the original Cogent network. That network was an all IP over DWDM network, protected of layer-3 using Ethernet as the customer interface. That business grew organically for 18 years at a compounded rate of over 10% year-over-year and delivered about 200 basis points a year of EBITDA margin expansion. When the pandemic hit, our growth rate slowed because our focus market for corporate users were the central districts of major cities and skyscrapers. Our growth rate fell to about 5% and our rate of margin expansion moderated to about 100 basis points from 200. We had the opportunity last year to acquire the Sprint Global Markets Group network, original Sprint long-distance network. When we acquired that network, we acquired 19,000 route miles of intercity fiber. We acquired another 1,200 miles of metro fiber, 482 fee simple owned technical buildings, comprising 1.9 million square feet and about 230 megawatts of power, and we acquired an enterprise customer base that was losing $1 million a day. We were paid $700 million in cash by T-Mobile to acquire that customer base and that enterprise business, and we bought the physical network that costs $20.5 billion bill for $1. We are in the process of interconnecting the 2 networks and repurposing that acquired long-distance fiber optic network to sell optical transport services. So a lot has changed.

All right. So when you look at the opportunities that Sprint network brings, obviously, talking about a huge fiber network that we all know and love. What are some of the top 2 or 3 opportunities there that you see from that network for Cogent?

So the first opportunity is to connect that network to 800 U.S. carrier-neutral data centers where we sell IP services today. By adding optical transport services, we now reach an additional $2 billion addressable market. Because we will have the most ubiquitous footprint of data centers, the quickest provisioning time, the most accurate description of the physical route that the fiber traverses and a low price point. We believe we can capture 25% of that market over a 7-year period with that market growing at about 7% a year. That is an exciting opportunity, and it has been made possible by that acquisition of that enterprise business, the subsidies from T-Mobile and the ability to take costs out of that operating business and turn it into a modestly profitable non-growing, stable business. I think the second exciting opportunity for us is the re-purposing of a subset of those phones' central offices into data centers. We will have about 230 megawatts available, not the same 230 that we acquired. We've identified 45 of the 482 facilities to be suitable for data center conversion. We are connecting those to our metro networks. We're going through a depopulating the obsolete telephone equipment and repurposing those facilities to sell colocation either on a retail or wholesale basis. We had 55 data centers prior to the acquisition, 53 of those were on leaseholds, 2 were on fee simple owned facilities with 69 megawatts of power and 634,000 feet of raised floor space. We are now going to add to those 45 additional facilities, all owned, an additional 1.3 million square feet and an additional 170 megawatts of power. So giving us about 235, 240 megawatts, some of which will be retained for our own needs, but we anticipate having about 170 megawatts available for sale to third parties. We also have an opportunity to take our IPv4 address space, we control about 37.8 million addresses today. We're leasing out about 11.4 million of those addresses. In the Sprint acquisition, we acquired another 9.9 million addresses. So the 27 million we had plus the address that acquired give us a large footprint to generate incremental cash flow. So some additional products, some additional locations and an additional product set, all exciting opportunities.

All right. Let's talk about those a little bit more. Like first on the wavelengths. I think that's one of the bigger opportunities. Walk us through, what does the customer use a wavelength for? And what would they not -- what are they doing with that versus what should they use your traditional network for?

So Cogent was founded with the premise that the Internet would be the only network that mattered. That has proven to be predominantly correct. However, there are use cases that pay a premium for a wavelength service. So the cost to transmit a bit a mile is significantly cheaper on the Internet. A wavelength is 2.5x more expensive. But there are 3 attributes of a wavelength service that cannot be replicated on the Internet. The first is it's deterministic. So you know the exact latency between any 2 endpoints. The second is there are no limitation on packet sizes. So it is very efficient for moving large packets of data. And third, it's completely secure, not available or discoverable on the Internet. For that reason, there are 4 primary use cases. Any company that is looking to replicate data between facilities, may elect to pay that premium and use wavelengths. Any company that operates isolated regional networks that are looking to link those networks together into a homogeneous network. We'll use wavelengths. Governments will use wavelengths and certain select enterprise customers will use wavelengths because of the added security. It is more expensive, but it is a parallel market and it's one in which we today already have relationships with virtually all of the buyers.

Okay. So who are some of those typical customers? And who are some of the customers that you already service that are taking wavelengths and how does that make it easier to try to sell into that base?

Yes. So on the content side, think of any of the hyperscalers, whether it's Microsoft or Amazon or Meta or Google. All customers we sell transit to today, Netflix or candidates that could use wavelength services, in fact, have demanded them in the market from our competitors. On the access network side, it's companies like, [ Altice ] or Cox or Spectrum/Charter that have isolated markets. over builders such as Frontier or Metronet that may have desperate markets are linking together. Government customers, some of which I can't name also would use wavelengths. And then on the large enterprise side organizations like Bank of America or JPMorgan, they could justify building a wavelength outlook.

All right. So let's talk about pricing because you've been really clear. Historically, you're the low-cost provider. You've used pricing before with your products. How should we think about pricing in the wavelength market and what you might do there?

So in the transit market, which is sold from a singular point and is more commoditized. We have built our business by undercutting the market by 50%. And that has allowed Cogent to become the largest provider of Internet transit in the world, carrying about 1/4 of the world's traffic. We continue to gain share in that market. And the wavelength market, we're basically nonexistent today with about $12 million, $13 million run rate against a $2 billion addressable market. Our advantages come from the uniqueness of our routes, the ubiquity of our endpoints, the ability to accurately detail that and provision it quickly. We will use price, but price is not as much of a commodity function in the wavelength market. Our expectation is, we'll probably discount somewhere between 10% and 30% to current market rates, but it will be on a route-by-route basis as we do price discovery in the market. A wavelength was sold knowing the 2 endpoints distance, the contract term and then the size of the connection. So it is a 3-dimensional pricing we're in.

Okay. All right. Great. So you also talked about the data centers and let's talk about that. We get a lot of questions on this with the capacity that you're adding, especially given the constraints we see in North America with data centers. How much of that can you -- do you think you can satisfy? And then talk to us about what kind of investment you're going to need to make to upgrade these facilities to bring on this additional available power?

Yes. So Cogent had data centers that it did not build -- became to Cogent through acquisition. Those facilities have about 125 watts a square foot, 69 megawatts, 634,000 square feet of space. And we typically lease those out on a rack by rack basis. We also usually have Cogent sales offices co-located at those facilities as well as our technical equipment. We acquired 482 technical buildings, most of which are too smaller in the wrong location to be viable. However, 45 of those facilities comprised 1.6 million square feet and about to -- about 170 megawatts of power. We are converting those to data centers. So the things we are doing, one, connecting those buildings to our metro footprint because they typically only were connected to the Sprint footprint when we have to do that to support our wavelength business. Two, we have to go and depopulate abandoned telephone equipment from these facilities. There are approximately 22,500 cabinets of old telephone gear that have to be removed. We've already removed about 14,500 of those cabinets, but still have more to do. We also need to convert these facilities from negative 48 DC power to AC 120. So that's just install inverters. Pure capital cost to that will be $7 million, $8 million. These facilities will typically average between 100 watts and 125 watts per square foot. And we will keep one portion of the facility for our technical equipment and a retail COHO and the majority of these facilities will be monetized by leasing them out on a wholesale basis.

Okay. And I want to say hello to anyone that's searching this transcript for AI. This is the just an AI question here. As we get to touch on that in an investor conference. As we look at Cogent and the networking aspect, how do you see Cogent fitting into AI and the current demand and as is going forward in the future?

So I'm always reluctant to focus on buzzwords and things better in vogue at a given point in time, whether it be cloud or edge computing or AI. But AI is real, and it does impact networks in 2 very discrete ways. First, AI only exists because of the sheer volume of data that's been collected at virtually 0 cost over the Internet. That is going to continue and create a virtuous cycle on Internet traffic demand. The second thing is the training of those AI models occurs at multiple data centers that need to be replicated, that becomes a demand set for waves that is incremental to the 4 segments that I described earlier. So I think we are a beneficiary on both the Internet and wavelength side. I think AI, unfortunately, is sub-optimally named but it is a real technology, a pattern recognition and predictive inference from those patterns that will transform how we do business, how we communicate, how we live.

Okay. So from the newest thing on the network to the oldest. Talk to us about the corporate business. What are some of the hurdles there that have kind of been impeding the growth and our return to office delays? How should we think about that?

Yes. So our corporate business had grown consistently for about 15 years at 11% year-over-year. The pandemic hit, we went home and our growth rate went from positive 11% to negative 9%. As people have gradually returned to offices, they have not returned full-time 5 days a week. As a result of that, the corporate business has recovered. Last quarter, it grew 5.1% sequentially, but that was a bit misleading because some of that was a tax benefit. If you net out that tax benefit, it grew at about [indiscernible] sequential or annualized a little under 4% year-over-year. So we are seeing recovery, but it is slower than we had hoped for.

Okay. Great. And let's sort of mentioned pre and post pandemic. Talk to us about your sales force. So for many years, you had a very predictable model, the way you ran your sales force and how they operated in a couple of different basic buckets. How has that changed? And are you having any issues finding salespeople versus what you're used to?

It actually has not changed very much, Frank. Today, we have about 650 quota-bearing reps. Those quota-bearing reps sit in 50 offices around the world, and they outbound telemarket. That has been Cogent's model from day 1, more reps, more offices. We do now have an incremental customer segment and enterprise accounts. We only have about a dozen reps that focus on those enterprise accounts. We did acquire 51 reps from Sprint. Many of those have left the company as they were not comfortable with this type of outbound hunting model. But in general, we've continued to see good success out of our sales force. Unfortunately, it's a model that results in high sales force turnover. Anybody who's ever done [indiscernible] marketing knows how hard it is. And we generally try about 5.7% of the sales force want.

Okay. So talk to us about the off-net business. What are you seeing there? Any changes? And then what are you -- how is the sales force going about selling to those businesses, especially now that you've got a lot of new networks that maybe you can consolidate some of that?

Well, we have more enterprise customers that inherently made more off-net services as well. So previously, Cogent had about 25% of its revenue from off-net sales, about 75% on net. The acquired Sprint customer base was 93% off-net and 7% on-net. So within our NetCentric business, it's about 90-10, 90% on, about 10% off where we have tails circuits support those customers. In the corporate business, it's historically been about 60% on-net in Skyscrapers and 40% off. And then in the acquired enterprise business, we are migrating customers from off-net to on-net. And we think we'll end up at about a 50-50 mix in those enterprise customers. So in total, we are going to increase the profitability by bringing off-net traffic on that.

Okay. Great. All right. Pause for a minute, see if anybody has any questions from the audience. All right. No problem. So talk to us about your liquidity position, where you are today. You're receiving payments from T-Mobile. They start to decline the spring for a while. Talk to us about any other the potential sources of funding, including possibly ABS or selling your IP addresses, something like that? What do you -- where do you see your liquidity come from?

So first of all, let me comment on some confusion around our last earnings call. Our EBITDA for the quarter was $110 million. I think the inference was made that with the acquired Sprint negative EBITDA combined with the Cogent EBITDA that was implied view that our EBITDA decline. Our EBITDA was artificially retarded by the fact that we paid out $70 million in employee severance in the quarter that was fully reimbursed by T-Mobile. So rather than the $87 million, we would have normally received in the quarter, we actually received $104 million. We did not want to dwell on that on the earnings call due to the large number of Cogent employees that participate in that call. Getting to our liquidity, we ended the quarter with $113 million of cash. We are doing about $110 million an EBITDA. In the upcoming quarter, I think our numbers will be similar. We will not have that reimbursement and the offsetting expense. So the net cash will look about the same, meaning $87 million rather than $104 million would have come from T-Mobile. That number will step down midyear because our subsidy payments go from $29 million to $8 million a month. Now during that time, we are continuing to take costs out of the business. We reduced aggregate headcount by 200 employees since closing. We have consolidated or closed facilities and we've migrated traffic from off-net to on-net. The stream of payments from T-Mobile will continue through midyear 2028. So a total of 54 months from closing. That gives us a great deal of cushion. We also will be selling wavelengths, which carry effectively 100% gross margin and 95% EBITDA margin. In addition to that, we have 3 latent assets on the balance sheet, IP addresses, data center space that we talked about and dark fiber. We are looking at all 3 of those sources as additional ways to raise capital that we need to raise capital today, but we have that optionality. Our EBITDA increased last year to $352 million, up from $260 million a year before. We delevered by nearly one turn of EBITDA year-over-year on a net basis. We expect that delevering process to continue with that inherent delevering we may look to either monetize the stream of revenue from our IP addresses or securitization. We may look to monetize some of the unsold and unleased addresses through a sale as well as looking at dark fiber and our wholesale [indiscernible] product. As we look at '25 -- '24 and '25, even with those decline in payments from T-Mobile midyear '24, we anticipate EBITDA will be in the same ballpark. While the company doesn't give exact guidance with roughly $360 million of EBITDA and a gross debt of $950 million of bonds and about $400 million of capital leases. We're effectively about 3x levered on a pro forma basis, which is right in the middle of our range and substantially down from our peak. Also remember, we have a dividend and have now grown that dividend for 46 sequential consecutive quarters.

And kind of finish on those thoughts on dividend growth going forward?

Yes, I think we'll have the ability to continue to grow our dividend, albeit at a more modest pace than we were pre-pandemic. As the corporate business begins to reaccelerate, we could reevaluate when we would accelerate that. We also have these alternate forms of monetization, but I think we are comfortable in forecasting that our ability to grow the dividend will continue beyond the 11.5 years. We've done it. That's a pretty consistent track record.

Great. All right, Dave. Thank you very much for being here. Really appreciate. We've got a breakout session afterwards, who wants to follow up. Thank you, Dave.

Thanks, Frank.