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

For those of you I haven't met, I'm Mike Rollins. I cover communication services and infrastructure for Citi. And just before we begin, disclosures are available at the registration desk. It's a real pleasure to welcome back to the conference, Dave Schaeffer, CEO of Cogent. Dave, thank you so much for being with us. It's great to see you.

Mike, thanks for hosting me. Thank you, Roberta. Thanks Citi for a great venue. Thank investors for hanging around late in the day. And I'm here to try to answer some questions.

Great. I also want to introduce my colleague, Roberta Versiani, and we're going to co-host today's session. So maybe to kick us off, so Dave, when you look at the outlook over time, look at the growth trajectory. How much comes from the more recent product expansions? So, Waves, I mean put IPv4 into that bucket versus your traditional transit and VPN businesses, whether it's NetCentric or corporate?

Yes. So 84% of Cogent's revenues come from our legacy product set. That group of products is continuing to grow and has grown organically since the company began selling services in 2002. So for 24 years, we've experienced organic growth. Our DIA business is focused on large multi-tenant office buildings. That business had grown historically for an 18-year period at about 11.2% per year. When the pandemic hit, the growth rate in that corporate segment decelerated to a negative growth rate of 9%. It has subsequently rebounded to about a 3% growth rate. We today have about 35% market share in the 1.1 billion square feet that we have directly on-net where we are an ISP. The 2 primary products we sell are Internet access and VPN services, mostly based on a VPLS platform, some based on legacy MPLS platforms. We also have a transit business. We operate in 310 markets around the world, 58 countries and 1,950 data centers. I was actually asked the question earlier today, what is the power footprint of that universe of data centers? It's about 17.5 gigawatts of power in that footprint. Our primary product in that market is selling metered Internet access. It accounts for 98% of the traffic on Cogent's IP network. It is a business that today in revenue is growing about 8%. It is a business that traditionally is driven by a specific application at a point in time. So even though Internet traffic has grown at a compounded rate of 23% per year over the Internet's 30-year history, it's been very lumpy, and you can look at 6 discrete waves of growth. We're actually experiencing acceleration in that traffic growth now coming from agentic AI. In the past 2 quarters, we have seen traffic growth accelerate from 8% year-over-year to 15% year-over-year, allowing us to drive that high single-digit revenue growth. Now for the newer parts of Cogent's business. We have leased out IP address space since 2015. Between 2015 and 2022, we only leased addresses to companies that bought bandwidth from us. And it was a relatively small business. In '22, that business did about $20 million in revenue. Because of the headwinds we were facing from the pandemic, we lifted the restriction on selling bandwidth only or selling addresses only to customers that bought bandwidth from us. And we saw a rapid acceleration in that business. Our IPv4 leasing business today is about 7% of total revenues. It is roughly a $70 million business. We have leased out about 40% of the inventory of addresses that we have. And it's a business that last year on a year-over-year basis, grew 18%. We recently entered the wavelength business. Prior to acquiring Sprint, Sprint was not in the wavelength business. Cogent was not in the wavelength business. We saw this as an adjacent market where our technical acumen, coupled with our sales and customer relationships would allow us to address a new $2 billion total addressable market for North America. We spent nearly 2 years reconfiguring the legacy Sprint Global Markets network that was built to carry TDM voice into a wavelength network. In earnest, we began selling those services in January of '25. With that sale, we have seen our wavelength business grow. And today, it is about a $65 million run-rate business, about 6.5% of Cogent's total revenues. It grew on a year-over-year basis, 62%. And in the last quarter, it grew 9.2% sequentially. To round out our product portfolio, we have a colocation business. It has always been a small part of Cogent's revenues. It represents about 2% of our revenue base. We today have 170 data centers, representing 1.3 million square feet and roughly 150 megawatts of power. We have 14 of those data centers up for sale. Last quarter, we completed the sale of 10 of these surplus data centers. That sale resulted in $225 million of cash proceeds. The actual transaction costs were less than $1 million. We were able to effectively shelter that gain from taxes and used $175 million of those proceeds to reduce our leverage.

Great. One more on just like the top line trends before we get more into the products in detail. So what's your latest thoughts on when Cogent can return to sequential revenue growth and then year-over-year revenue growth?

So, for 18 years prior to acquiring Sprint, but after going public in June of 2005, Cogent's total business grew at a compounded average rate of 10.2% a year with no acquisitions. We acquired the Sprint business, which represented 42% of the revenues of the combined company. Cogent represented 58%. Sprint's rate of revenue decline was 10.9% a year for the 3 previous years prior to deal closing. We actually took that 10.9% rate of decline and accelerated it to over 20%. So in the 12 quarters post transaction, the combined company has had an average growth rate of a negative 5% top line growth. The Sprint revenues have declined from 42% of combined company's revenues to 15% of revenues and the aggregate rate of revenue decline in that acquired base in 3 years has been 69%. During the same period, the organic Cogent business has grown from 58% of revenues to 85% of revenues and had a compounded growth rate over that 3-year period of 29%. We were encouraged last fall when we actually had 2 out of 3 months in a quarter of positive growth. But we then had some more churn coming from the acquired Sprint customer base. We have been able to inflect the margin on that acquired base from a negative 60% EBITDA margin to 0. So when we lose $1 of that acquired revenue, it no longer has any impact on our margin. But as we sell organic Cogent services, they carry much higher contribution margins. In the most recent quarter, 82% of our sales were on-net, 18% of sales were off-net. For the blended base, which still does include that acquired Sprint off-net base, we were 62% of on-net revenue, 38% off. As a result of this, the rate of revenue decline of the entire company is declining. It is difficult for me, Mike, to be able to give you a specific target date, but it does feel like that within the next year or 2, for sure, the Sprint business will be so de minimis and the organic Cogent businesses will be large enough that we will be able to return to total top line growth. Even with that 5% negative top line growth, we have been able to grow EBITDA, not just in margin, but in absolute terms in 11 of the past 12 quarters. And the rate of margin expansion over the past 3 years has averaged almost 800 basis points a year, far better than Cogent's historical average. We expect that rate of margin expansion to begin to moderate and revert back to the roughly 200 basis points a year that Cogent has historically delivered.

Great. And on asset monetization, what's the status of your process to monetize your remaining data center assets? And are there any other assets that you might be looking to monetize in the future?

Yes, Roberta. So first of all, we inherited 482 buildings that comprise 1.9 million square feet and 230 megawatts of inbound power. None of these were data centers. Cogent had 54 data centers; 52 of those 54 were in leaseholds, and they had a total of 634,000 feet of raised floor and 69 megawatts of power. We initially did not plan to convert the Sprint switch sites to data centers. But by January of '24, it became obvious to us that the asset power that we had in place had value to the market. We then initiated a program in June of '24 that ran 1 year, spent $100 million and converted 125 of those facilities into data centers. We identified 24 of the 125 as being large enough and geographically located in desirable locations, we should sell them. We placed those assets in the market. And on June 29 of this year, we closed the sale for the first 10 at $4.3 million a megawatt, resulting in the $225 million in proceeds; $125 million was a direct gain. The remaining 14 are still in the market for sale. We have 2 LOIs that we have received from credible counterparties. We have not yet chosen to move forward. I do think we will be selling most, if not all, of those 14. Above and beyond that, we have other data centers that may be for sale, many of them smaller and more geographically dispersed, but could be interesting for edge applications. A second asset that we could elect to monetize is our excess IP address space. As I mentioned, we have leased out 40% of our inventory. We have 38 million addresses. We have approximately $15 million of them under lease. We took that leased revenue and securitized it with 2 asset-backed securitizations at a cost of capital of about 6.8%. We may elect to either sell or securitize revenues from the remaining 23 million addresses. Finally, we have an intercity and metro dark fiber network. We are typically using 3 pairs or 6 fibers on those networks. We have strand counts from 24 to 144 fibers, and we may elect to sell some dark fiber. We have already done a handful of dark fiber sales. But to date, our primary focus has been on the data center monetization.

Dave, maybe just focusing on corporate for a moment. Historically, you and I have had a conversation about the marketing strategy, and you've outlined the importance of keeping it simple, keeping it low cost of acquisition and just driving penetration in your buildings with your Internet product and your VPNs. As that business sounds like that from our conversations, the penetration is maturing. Do you go into this next phase of trying to then sell more services into these customers? And are there services that you could sell to try to expand the TAM for the customers that you have versus the motion of just trying to deepen share in these corporate buildings?

So the answer is no. And I know that is against conventional wisdom. Part of what got Sprint in trouble was as its corporate and enterprise business declined, their solution was to sell more and more products to those customers further and further away from their core competency and eroding margins. T-Mobile realized that, that was a losing strategy and evaluated either shutting down the business or selling it. While they paid Cogent $700 million, their all-in cost to divest of that asset was about $1.3 billion. And I would attribute most, if not all of that as a result of product diversification. Now we do have the opportunity to upsell customers to larger connections. When you started covering Cogent, I guess Roberta was in elementary school at that time, and we were selling 100-meg connections that were viewed as far bigger than a customer could ever use with the average corporate customer using only about 1.2 megabits or less than 1.5% of the connection. In the late, kind of, '18 or '19 timeframe, we began a program to upgrade those customers. And virtually all of our customers now take a 1-gig connection, 10x what they originally had, and that gave us the ability to uplift ARPUs. So you have 2 different things going on simultaneously. Price per unit falling, but bundle size is growing, pulling ARPUs up, but at a more moderate rate. We have begun another round of capacity augmentations. We have enabled all 1,865 of our multi-tenant office buildings to also sell 10-gig connections. While today, only about 4% of our corporate base uses those 10-gig connections, they generally result in about 2.5x as much revenue per connection. Now the utilization rates fall even lower, but there is a subset of the market that just wants the best connection that money can buy. That is a far better strategy than us becoming a security provider, a hosting company, a managed service provider, a network as-a-service service provider, which I still struggle to fully understand what that means.