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

Anyway, once again, welcome to JPMorgan's Credit Conference down in Miami. As most of you know, I'm Tom Egan. I cover telecommunications and technology for the firm. And it's my pleasure today to introduce Dave Schaeffer. If you're in this room, you probably know who Dave is. He's been around a long time. I think I've known him for 25 years. We were both younger men. At least I was, Dave still looks the same. Anyway, Chief Executive Officer and Founder of Cogent.

So Dave, normally, I would start out with talking about the business, and then we'd get into some of the debt-related things like refinancing. But you had some news yesterday at another conference. And so I wanted to make sure that everybody was sort of level set on that stuff. So let's maybe talk about that. As most of you know, during his earnings call, Dave talked about the potential for refinancing the unsecured debt with secured debt. And most of us spent the next couple of days or weeks trying to figure out how you were going to do that. And yesterday, you kind of cleared the air on how that's going to happen. So why don't you take us through what it is you intend to do?

So first of all, Tom, thanks for hosting me. Thank JPMorgan for a great venue. And most importantly, I'd like to thank this full room of investors for taking time to hear about Cogent. So Cogent has been a high-yield issuer since December of 2010. And our high-yield issuances are done at the Cogent group level. Cogent Holdings is the public company that equity holders own stock in. Underneath Cogent Holdings, there are 2 parallel subsidiaries, one being group that houses all of the operations of Cogent, including the employees, the customers and all of the debt of the company as well as all of the payments that are being made to the company by T-Mobile as part of the consideration for acquiring the Sprint GMG assets from T-Mobile. To remind investors, we acquired a business that was burning almost $1 million a day. It had a negative 80% EBITDA margin, $300 million of negative EBITDA, $30 million of CapEx, and we were paid $700 million to take that business. When that business was combined with Cogent, we also directed the $700 million subsidy payments to the borrower group. Because those payments were front-end loaded, Cogent actually rapidly delevered. We had historically operated between 3.5x and 4x net leverage between 2010 and 2023. We had grown our equity dividend 52 sequential consecutive quarters. But with the onset of the pandemic, our leverage creeped up to 4.2x. And then with the acquisition of Sprint and the fact that 50% of those subsidy payments came in the first 12 months, the other remaining 50% were spread out over the next 42 months. Our leverage fell from 4.2x to 2.4x almost immediately. When we acquired Sprint, we did a second acquisition concurrently. We acquired the dormant Sprint network. That was comprised of 20,200 route miles of dark fiber and 482 buildings with 1.9 million square feet of space and 230 megawatts. These were former telephone switch sites. We got that entire asset base debt-free for $1, but there was a [indiscernible]. There was a negative $140 million burn associated with getting that free asset. An asset that doesn't produce income is really a liability at the end of the day. We had a clear vision of what we wanted to do. We wanted to repurpose that asset to be able to convert it into a wavelength network, and we wanted to convert a portion of the data centers or the buildings into data centers. We also to mitigate that burn, did place under that silo, Cogent Infrastructure, our asset-backed securitized IPV4 leasing business that has its own ring-fenced sleeve of $380 million of debt. So at the borrower group where the high-yield bondholders have a claim, there were 3 tranches of debt, $623 million of capital lease or finance lease obligations in the form of IRUs, $600 million of secured debt and $750 million of unsecured debt. Our indentures have 2 limitations on indebtedness, no more than 4x secured leverage, 6x total leverage, inclusive of unsecured and also requires a debt service coverage of 2x. It is an [indiscernible]. But it appeared that we did not have sufficient secured capacity to refinance all of the unsecured with secured. And the way in which we modified the structure enhances the quality of the collateral of bondholders. So we did 4 discrete things. The first is we took all of those capital leases and the associated liabilities and contributed them into a subsidiary under group. Two, we divided them into the capital leases associated with Western Europe and North America and then the Rest of the World. Those North American and Western European capital leases have a total liability of $569 million. We are selling that subsidiary from group to infrastructure. There is a net cash payment that is coming out of restricted payments. And as a result, $569 million of the most senior debt disappears from group's balance sheet. In order to be able to continue to use the fiber, Cogent Infrastructure in turn leases that fiber back to group for 10 years. By structuring that as a 10-year lease, under GAAP, it is treated as an operating lease, not as a finance lease. So the pro forma result is that the EBITDA at group declines by $69 million, the cash payments associated with these leases. On a pro forma basis, inclusive of reclassifying the unsecured as secured dollar-for-dollar paying off the unsecured and putting $750 million of secured in its place, we end up at 3.91x secured leverage under the 4x test and roughly 3x debt service. So we have plenty of room there. We have an additional $100 million of capacity available for us at the secured level that we have no intention of using. And we have about $800 of unsecured capacity that we have no intention of using. Because the fourth point is that at the holding company level, we have made a commitment to all stakeholders that we will dramatically reduce the return of capital to equity until such time as Cogent is at 4x net levered across all of its subsidiaries. Today, we are at 6.6x. We reduced our dividend by 98%. It went from $1.01 a share to $0.02 a share. It will stay fixed at that level, and we do not intend to have any material equity buybacks until we reach 4x levered. We may do some minor buybacks, but nothing material. With this 4-step program, we have created a dynamic where Cogent Group can easily raise $750 million of secured debt and that debt would sit pari passu with the existing 6.5% secured debt that matures in 2032. And temporarily, it will be extended 1 additional year. So we want to make sure that the new bonds have a maturity date at least 1 year beyond the current bonds. In order to further enhance the collateral pool of the borrower, we voluntarily said that we would commit the proceeds from our pending LOI for the sale of 10 data centers. We have no obligation to do that. Those assets sit at Cogent Infrastructure outside of the borrower group. But in order to further strengthen the credit, we felt that it made sense to inject that capital. Quite honestly, it was sleeves out of our vest because we already had committed to 4x net leverage. Now I have been asked today, does that commitment guarantee that we immediately purchase debt? Or can we just leave the cash on the borrower's balance sheet. And we're going to preserve that flexibility, but the cash will be trapped inside of Cogent Group. It is subject to removal via restricted payments tests. We do use some restricted payments in order to fund the operating burn at the infrastructure level, which is still existing, but we intend to continue to be able to grow EBITDA. Last year, we grew our underlying EBITDA for the full year, $70 million. Our EBITDA margins expanded year-over-year by 800 basis points. While we expect EBITDA growth and margin expansion going forward, I do not believe 800 basis points a year is sustainable, but we do believe that at least 200 basis points a year over a multiyear period is consistent with what Cogent has done historically and is prospectively possible. We also have attributed most of the low margin or negative margin acquired Sprint revenue. We've turned that operating business from burning $300 million to today slightly with probably low single-digit type EBITDA margins. We still have more work to do. We still have more cost to cut. But most importantly, the aggregate combined Cogent has returned to top line growth. For an 18-year period as a public company with no M&A, Cogent organically grew at a compounded rate of 10.2% a year. That growth rate turned negative 5.4% when we acquired the shrinking business from Sprint. Now that, that business has been purged of undesirable revenue, the combined company is continuing to grow. The organic Cogent business during that 9-quarter period grew 27%. The Sprint business, which represented 42% of revenues of the combined company at closing, shrunk by 64% during that same period. That rate of revenue attrition has moderated, and we're now in a position where the aggregate business is growing and margins are expanding. Hopefully, that was clear enough, Tom.

I think so, but I'm going to summarize it anyway because that was an awful lot to digest. So let me just see if I've got it right. Cogent's fiber that is under IRUs where you the fiber via IRU, you're going to take $569 million of those leases, which are now senior to the $750 million senior secured, and you're going to take them off the balance sheet and you're going to move them over to the unrestricted group. And then you're going to pay the unrestricted group $69 million in lease payments for those -- the use of that, and it will be a shorter-term lease. So it will end up not being a capital lease, not being on the balance sheet, it will end up being an operating lease. And then you're going to take whatever proceeds you get from the sale of the data centers, you're going to migrate that cash back into the restricted group. And when you're done with that, that's what gets you to the 3.91x net leverage? Or is that even before you do the money from the data centers?

It is before we do the money from the data centers. So the data center sale is a nice to have, but not a must-have. So we will most likely do the financing prior to closing the data center transaction, and it is not necessary. The only point I would clarify, Tom, is that the capital leases actually set senior not only to the $750 million of unsecured group, they sat senior to the $600 million of existing secured.

That's actually what I meant -- that's what I said.

So now the secured debt, which will grow to $1.35 billion will be effectively the most senior. There will be $54 million stub capital leases in some less developed countries.

Right. Okay. Got it. And is the $69 million in payments that you're going to make for the operating leases, is that the same amount of money that you were paying under the IRU when it was on your balance sheet? Or is that a...

No markup, no profit. Dollar for dollar. So there's no transference of value, and it's just meant as a mechanism to inject the capital into infrastructure so it can meet the capital lease obligations.

Okay. And normally, we'd continue. But what I want to do is because this is such an important topic to debt holders, I want to make sure that if there's anybody in the audience that has any questions on this topic. We'll move into something shortly. But if it's on this topic, could you please raise your hand and ask Dave?

And do you mind giving this gentleman maybe a mic so that people on the webcast can hear it and maybe I can hear it too then. Can you speak up?

[indiscernible]

Is that a traditional new issue and then the cash proceeds take out the unsecureds? Or is it you offer a secured security to unsecureds for them to tender into?

No, this is not an exchange offer. The current unsecureds mature in June of '27. They have a make-whole that lasts until June of '26. If we do a transaction between now and June of '26, we will fund into escrow and then break that escrow when the make-whole reverts to 0. But this is not an exchange offer. If we do the transaction after June, it will just be a takeout at par of the unsecureds. Yes, sir.

Just a question on the structure. Given the proceeds from any potential data sale, I understand there's a new LOI. Maybe you could just give some clarity on that. But committing the proceeds to the issuer group, because those are from the legacy Sprint network, the new waves business that you're building off that, does that sit in Cogent infrastructure?

So I'd say somewhat complicated question. Let me answer the 2 pieces of it. First of all, the data center sales are for physical assets that exist off of the Sprint infrastructure and are owned by Cogent Infrastructure and the proceeds that will come from a nonbinding LOI from a major global infrastructure fund for 10 facilities that is substantially more than $144 million. Those are the facts that are in the public domain. Those proceeds are being pledged to be not retained by infrastructure, but to be immediately contributed to Cogent Group to enhance the credit portfolio. The second part of the question, which is the building of the wavelength business. The Cogent infrastructure entity had already granted an IRU from infrastructure to group for 8 fibers across the entire footprint. That allowed Cogent Group to abandon a Lumen IRU and save $15 million a year in expenses. That was well documented in previous public disclosures. And it also allowed us to build a parallel new wavelength network off of completely fallow fiber. The equipment we use to do that is all owned by group. The equipment came from 3 sources: some new equipment purchased, some older Sprint legacy equipment that was just sitting dormant that we reactivated and then some older Cogent IP transport equipment that was then diverted to the wavelength network. So the wavelength business and all of the revenues associated with it go directly into group. The burn associated with the empty network and the empty buildings sit in infrastructure, and it is why that we use about $100 million a year of RP capacity from group to fund that negative burn at infrastructure.

And just a follow-up. In the new LOI, the 2 data centers that were part of the previous LOI that failed due to last-minute renegotiation of terms, are those 2 previous data centers in this current package for potential sale?

On e of the 2 is. And that was actually the critical gating item for this potential buyer. They were looking at the asset when we signed the original LOI for the first 2, but we're not ready to move to an agreement. And we chose the deal that was ready to go for 2 facilities. When those 2 were withdrawn, that party continued the work on the remaining 9 that they were interested in, but they were very clear to us they would not proceed unless they could get that 10th facility. When the original LOI party came back to us and demanded financing, it gave us the ability to withdraw from that LOI, which is what we did. And then we were free to enter into negotiations with the second acquirer for all 10 facilities, and we were able to conclude that in a matter of less than 2 weeks under terms that were acceptable to both parties. That buyer has done physical tours in 8 of the 10 facilities as of last week with a third-party consultant. They've had access to the data room, and they are completing their last 2 site visits this week. Their primary gating item is confirmatory due diligence on the power availability at the sites. These sites were fully powered to 109 megawatts in 2015. In 2015, Sprint decommissioned its TDM voice network. Since that, for the remaining almost 11 years, these sites have been really just drawing minimal power on a keep alive basis. Before we decided to convert those facilities, we went to each utility and did our own confirmatory due diligence to see that the power is available. There are no PPAs or purchase power agreements. All of this power is delivered at tariff rates. We have e-mails and confirmations from the engineering department that if we were willing to commit to the utilization, the power is available. The counterparty is validating the confirmations we got. I'm sure they've got additional due diligence. They're doing Phase 1 environmentals and they're doing title abstracts. We had done the title abstracts at acquisition. The Phase 1s, we relied on those that T-Mobile did when they acquired Sprint.

Anything else on this topic?

We have another one over here on the left.

I'm just curious how competitive the process was with this LOI. Do you have other counterparties behind them for other data centers, these data centers, et cetera?

So just to refresh everyone's memory on the time line, we acquired Sprint. We announced the initial tranche of data centers in May -- or actually June of '24, we began conversion in earnest on 125 facilities, including these 24 large facilities. At the end of June of '25, we ran a process and we chose the winner out of probably a half a dozen LOIs that were on the table. At that point, and we chose that winner because of both price and their ability to confirm availability of funds. The other party, including the one that ultimately concluded was doing work but had not progressed far enough to put in a firm offer. We have continued to build a pool of what I would consider backup LOIs and probably have today, again, somewhere between 5 and 10 of those types of agreements. But many of them, I think, are with parties that we don't have confidence will get to closure based on funding requirements. We've had literally dozens of counterparties trying to tie up the assets in exclusivity, owing to then go out and shop them to raise capital. And our view was before we would tie an asset up, we needed to know that the party tying it up could, in fact, perform if we delivered what we said we would deliver.

Okay. That actually cleared up a whole bunch of questions I had on data centers. Maybe just one more, David, was -- if my memory serves me correctly, you had originally something like 23 data centers that you considered to be superfluous...

24.

24 data centers that were superfluous. What are you thinking about the remaining 14, let's say?

We think that there will be buyers for some. Our hope is to sell all them. Each one is slightly different. They're in different geographies, different power. They're all of about the same vintage and design. They were all built as telephone central offices to house switchgear. The total of 482 facilities, most of those, about 355 of them, we concluded are just not suitable for conversion. They're just too remote or too small or both. Of the remaining, we have actually converted now 125. Most of those, 101 of them are small, and we think we can fill them up with our traditional colo model of selling 1 or 2 racks at a time. These larger facilities, 24 of them are of a different scale. The fundamental difference was the smaller facilities hold Class 5 switches, the larger facilities held Class 4 switches. There's probably nobody in this room or even old enough to remember what the difference in those 2 switch types are because they don't make any of them anymore. They're all in the scrap heap. But the bigger sites were designed mostly for long distance and the smaller sites were more for regional or local traffic.

I might end up on that scrap heat because I remember those switches. One of the questions I get quite frequently is regarding your waves business. You had originally given us a target of I think it was $500 million?

$500 million by run rate by midyear '28.

By midyear '28. And at this point, that looks like a stretch. Now maybe, you're...

We only did $40 million last year.

I understand that. But it still looks like a bit of a stretch. Could you just talk a little bit about your confidence in that number? Or -- and maybe just a little bit about besides the things that you've talked about before where folks make the order and then you put it together and then they don't want it turned on for 6 months because they weren't expecting it to be on in the first place. Could you just talk a little bit about maybe what you might have missed on getting to that number quicker than maybe not getting to that number as quick as maybe you thought you would have?

So first of all, I think we can still achieve the multiyear target that we laid out. That target was laid out in September of '22. It was meant to be 5 years post closing, so 5 years mid-'23. And I think we needed to lay out some justification. Sprint was not in the wavelength business. Cogent was not in the wavelength business. What we know is there is a total addressable market for North American intercity waves of about $2 billion. We also built out the most ubiquitous footprint. We initially targeted 800 data centers. That's actually grown to 1,096 as of the end of fourth quarter. That is a much broader footprint. We have 5 discrete competitive advantages over the current wavelength providers. We have a broader footprint, faster delivery, unique routes, higher reliability and lower prices. Those characteristics should allow us to capture 25% of the market. Our Wave business initially was manually provisioned between 65 data centers, a subset of the 800. In 18 months, we actually installed about 1,000 waves in that footprint. But we also knew that model would not scale and would not get us to our endpoints. We were busily working on all of the steps necessary to take a TDM voice network and turn it into a wave network. We completed that work in the end of 2024 -- December 31, 2024. Over the next year, the Wave business grew year-over-year 100%. It grew sequentially in the fourth quarter, 19%. If we could keep that growth rate up over a larger base, we can, in fact, hit our numbers. We need to continue to earn credibility in that market. The fact that we've delivered waves to 518 sites and to about 200 unique customers is helping us build that credibility. The market is dominated by companies that fail to deliver. And when they do deliver, it takes anywhere from 3 to 4 months to do so. We are attempting to change that customer expectation. We are making real progress. Tom is correct. We've installed waves in advance of customers being ready to take them. That gap is starting to close. We also probably made a mistake being too granular around both funnel size and exact progression in a specific product. Cogent does not give quarterly guidance for any of its metrics. It was necessary in the short term while we were building that business. We will maintain that granularity of disclosure historically. But on a going-forward basis, the metrics that investors should hold us to are top line growth of all products of somewhere between 6% and 8% over a multiyear period measured annually, an average of 200 basis points, not including the 800 that we did historically, but just going forward. And then third, maintaining a debt maturity that will ensure that we have adequate runway and liquidity to be successful. We want to not deemphasize waves. Waves are, in fact, the easiest way for us to grow because we only have 2% market share. In the transit business, we have 25% of global market share. In our multi-tenant office building business, where many of your firms are customers, we have 35% market share. It's always easier to grow from a small share to a large share, and that's why waves are critical. But any on-net product carries identical contribution margins of over 90%.

Fantastic. Dave, we've run out of time, but appreciate you coming here.

And I didn't get through hardly any of those questions, Tom.

You didn't on that. Didn't I ask too. Thank you.

Thanks, Tom. Thank you.