Cogent Communications Holdings (CCOI) Earnings Call Transcript & Summary

Thank you, everyone, for joining us, and welcome to the Bank of America 2025 Leveraged Finance Conference. I'm Ana Goshko. I cover high-yield telecom and technology, and we're thrilled to have Cogent with us this morning and David Schaeffer, the company's CEO. Thank you, David, for being here as always. We appreciate you making the trek to Florida.

Thanks for hosting. Thanks for BofA for a great venue, and thank all the investors for taking time to hear a little bit about us.

Okay. Great. So I believe our audience here has a good background in Cogent. I thought that we kind of dive into some of the top questions.

Sure.

So the first one is really the wavelength business and the ability to scale the business and when we should expect to see a ramp. So just as a little bit of background. So you've cited strong wavelength circuit connection demand still hasn't really showed up in the revenue. And you've also said that you have a key customer that even though you've been installing circuits, they haven't been ready to accept the circuits. So just to put it in context, I think your 3Q wavelength revenue increased $1 million sequentially to $10 million. That's now $40 million annualized. The prior goal was to exit the year about $100 million annualized. So if you can just provide us some context about what's been kind of dragging that down in terms of the ramp and when you expect to achieve that first goal of the $100 million or the $25 million kind of a quarter annual -- of quarterly wavelength revenue?

Yes. So let me kind of step back. The first thing we had to do was convert the Sprint network into a wavelength network and then connect that to an initial target of 800 data centers. We laid out that goal in September of '22 when we announced the deal. We began working on that in earnest in May of '23. And by December of '24, we had wave-enabled 802 data centers. We've actually grown that footprint now to over 1,000 data centers where we can sell wavelengths. Those wavelengths can go from any data center to any data center. They can be provisioned in 30 days or less, and they can be delivered at 10, 100 or 400 gig speed. That gives us a unique footprint across the U.S., Canada and Mexico that is larger than any other provider. During that initial period, when we were enabling the network, we initially targeted a subset of those 800 data centers. In fact, 65 of the largest data centers in North America and started selling waves in that footprint. We actually did sell a 1,000 waves before we had the entire footprint complete. Remember, the Wave business is new to Cogent, and it did not exist inside of Sprint. It is a brand-new business. It's being deployed on a brand-new network. We had actually hoped to sell about three times as many waves in that core footprint as we did. Since the beginning of the year, in the first 9 months, we sold about another 800 waves, and we have gotten the quarterly revenue up to approximately $10 million. The revenue grew rapidly on a percentage basis, 93% year-over-year and 14% sequentially. The wavelengths that we have sold came out of the backlog that we initially built during that development phase. Much of that backlog disappeared. We have rebuilt a new backlog in that we expect to continue to deploy an increasing number of waves each quarter. We have a goal of hitting $500 million in revenue for 25% market share by midyear '28, so call it 2.5 years from now. In Q3 of '25, we were at a $40 million run rate. So it's a steep ramp to climb. We have been installing waves more quickly than customers could accept them. It's not just one customer, it's many customers. Our competitors typically sell wavelengths on a network that is a multipurpose network. We took a very different approach to the market. Our IP network, which is the largest in the world and carries 25% of the world's traffic, is completely independent of the wavelength network. It is entirely built on IRU fiber and stretches 92,000 intercity miles -- excuse me, 32,000 route miles of metropolitan in 58 countries around the world. Our wavelength network, which is exclusively in North America is predominantly built on owned fiber, on different pairs of fibers. And in terms of revenue growth, we had initially laid out a target to exit Q4 with a run rate of December [indiscernible] of $20 million to $25 million. It is unlikely we will hit that target in that time frame because some of the waves that we have installed have not yet been customer accepted. We do expect that distance or time between installation and acceptance to shrink. We have tried to change the customers' perception of the market. For most customers, they are accustomed to a market where 50% of their wave orders never get fulfilled by the supplier. And when they are fulfilled, it's generally a 3- to 4-month installation window. The customer bears costs initially for space and power in the data center as well as a cross connect, and they do not want to bear those costs before the service is ready. We have been able to demonstrate to about 200 customers and 500 data centers so far that we can meet that 30-day window. And I think as we continue to build credibility, we will continue to see a larger portion of the wave market shown to us and see our Wave revenues accelerate.

Okay. So I go back to the original question because of the shortfall and being able to achieve the original year-end target, which was the $25 million a quarter exiting the year. Are you setting a new target? Or at this point...

Target remains the same which is we will be at a run rate of $500 million by midyear '28 in wavelengths.

Okay. And any -- but interim guidepost?

No interim guide.

No interim guidepost. Okay. Okay. And then so on what is considered the legacy business, though I don't want legacy to be pejorative, but the heritage, I'd say, the heritage Cogent business?

The majority of Cogent.

Which is the IP, the IP business. So just in terms of the trends there and the growth outlook. So if I look at the corporate customers, the corporate customer connections in 3Q '25 was actually lower than it was before you acquired the Sprint network. And you still had a decline in this last quarter. So what is driving the decline? And when do you expect that to inflect?

So Cogent's core business had been selling Internet connectivity and IP-based VPNs to corporate customers and to wholesale customers. That business had grown organically at the rate of about 10% a year for 17 years. When the pandemic hit that growth rate in the Corporate segment turned negative. Our growth rate went from positive 11% among our corporate customers to negative 9%. Today, the growth rate of corporate services is about 3% for organic Cogent. When we acquired Sprint, we acquired 2 customer bases. They were either corporate customers or enterprise. They were buying 1 of 2 services, MPLS-based VPNs or DIA. The Sprint business represented 40% of the combined company's revenue. It was declining pre-acquisition at an average rate of 10.6% per year. We actually accelerated that rate of decline and the business that we acquired from T-Mobile for the past 9 quarters has declined at an annualized rate of 24.2%. The Cogent business, which is both transit to NetCentric customers and corporate actually has accelerated slightly and has resulted in total top line revenue declining at only 2.4%. To directly answer your corporate question, the corporate on-net portion of our business is growing. The corporate off-net portion of our business continues to decline, primarily due to the intentional reduction in the number of Sprint off-net customers. So prior to the acquisition, Cogent's corporate base by revenue was 60% on-net, 40% off. By units, it was 80% on and 20% off. After the acquisition, even with the attrition in the Sprint customer base, at the end of last quarter, 51% of our corporate business by revenue was off-net and only 49% on. So it has been a combination of migrating some customers from off to on, but a much larger impact on that has been the rate of attrition in those off-net customers. Virtually all of the revenue decline in the last quarter came from the off-net Corporate segment.

Okay. Staying on the topic of the corporate -- the classic corporate customer, do you have a geographic concentration with regard to your building footprint? And impacts that have potentially been a factor or things like weak return to office, actually Dodge and then increasingly concerns about AI impacting either slowed hiring or actually kind of a new round of corporate layoffs. Like to what degree are you -- do you feel that your business is exposed to these factors? And is there like a geographic concentration that would make you more exposed?

So our model for corporate users has always been to build our network into the largest and most tenant diverse buildings in the market. We are in approximately 1,870 buildings across North America, largest number of buildings in New York City, followed by Chicago, Toronto, L.A., pretty much following the population base. The average building that Cogent connects to is 550,000 square feet. Pre-pandemic, those buildings had an average of 51 discrete businesses. Today, the occupancy rate in those buildings has declined, and there are only 38 unique tenants within the building. The vacancy rate in our footprint increased from 4% to 18% at peak. Today, it is still at 17%. So that absolutely presents a headwind to our corporate business. And our corporate on-net business growth rate is about 1/3 of what it was pre-pandemic. It had been growing at about 11% per year. Now it's growing at about 3% per year.

Okay. And I think you touched on some of this in your earlier comments, but just to kind of crystallize it. So on the NetCentric side of the classic Cogent business, so the overall NetCentric customer connections did return to growth in 2Q and 3Q and the ARPU has gone up as well. But I think -- and then so your base right now, so 3Q, the NetCentric revenue was $100 million in the quarter. But -- and that was up about $3 million sequentially, $8 million year-over-year. But I do think in that mix is the IPV4 leasing as well as the wavelengths are actually the biggest driver really of that NetCentric growth. So what is the dynamic among sort of your classic customers in the NetCentric business right now?

So our historical business was selling bulk Internet connectivity and carrier-neutral data centers. As you pointed out, our wavelength business contributed $1 million of that $3 million of sequential revenue growth. The IPV4 leasing is 84% NetCentric, 15% corporate and 1% enterprise. So it also contributed about $400,000 of that incremental, but about $1.6 million sequentially was incremental IP transit sales. The primary driver of that revenue growth has been international as traffic growth in the developed world has slowed in the less developed markets, we've seen an acceleration in traffic growth. So when Cogent was founded in 1999, 85% of all Internet bits carried in the world originated and terminated in the U.S. Today, that number is under 30%. We operate in 58 countries around the world and have disproportionately gained traffic in some of the less developed markets where pricing per megabit is higher.

Okay. Switching to the overall outlook. So the legacy Sprint noncore business and costs since you acquired the Sprint wireline assets in early '23, you've been pruning both the undesirable noncore Sprint revenue as well as the costs. So where are you on that journey with regard to what's left still to do?

So we have taken about $220 million of direct costs out of that business between May of '23 and September of '25. We have about $20 million more to take out over the next 1.5 years or so. Secondly, we are still spending about $45 million annually on various integration projects as we continue to consolidate and optimize systems and personnel. We will expect those costs to also taper off and be completed by the end of '26.

Okay. So putting this all together, the wavelengths, the Heritage Cogent business and the remaining cost saves. So right now, about 1/3 of the reported adjusted EBITDA is -- comes from the IP transit payments that you get from T-Mobile, which is effectively a subsidy. So you got $100 million annualized. Right now, the EBITDA is about $300 million annualized. So you've got 2 more years on that. So I think you've got $224 million of contractual payments still to come by -- mostly by the end of '27. I think some of that might -- a little tail of that might come in '28. But -- so you basically got 2 years to make up $100 million of EBITDA that you'll be losing in 2 years. So when we think about the wavelengths, the growth in the Heritage Cogent and then the cost saves, what is the bridge? Like what mix is going to get you to make up that $100 million?

So let's just remind investors, we have grown EBITDA for 9 sequential quarters. We've grown quarterly underlying EBITDA without the subsidies from $3 million to $48 million in those 9 quarters. We will continue to get benefits from continued cost savings and integration efforts, but we are also returning to top line growth. We have busily pruned the noncore products. We also have accelerated the growth of on-net products. Those on-net products are Cogent's on-net corporate business as it's returned to that 3% growth rate. Cogent's transit business, which is growing at about 8%, the $1.6 million sequentially that you just referenced off of a base of a $100 million. the growth in our IPV4 leasing, which is on-net, which is growing at nearly 20% per year. And our wavelength business, which today is small, but grew at 93% year-over-year. We expect total top line growth to get to between 6% and 8%. With that 6% to 8% top line growth, we will be able to see our EBITDA margins, absent the T-Mobile subsidies expand by better than 200 basis points a year. Prior to the acquisition, Cogent saw its EBITDA margins organically grow from 0 when we went public in 2005 to 40.5%. We then took a massive step down due to the acquisition of a money-losing business. Our margins were reduced to below 3% EBITDA margins. We have recovered to 20% today without the subsidy payments. As those subsidy payments roll off in Q1 of '28, we do have $224 million, but that's actually discounted back. There's actually a little more than about $250 million in cash payments still due to us. We will continue to grow the underlying EBITDA through the growth in those on-net services with very little to slightly negative growth in off-net services. We anticipate eventually growing at about 200 basis points a year from the 20% margins today to back up to the 40% that Cogent had pre-acquisition off of a larger base in the next 8 to 10 years. But when those payments step off, we will have about a year in which reported EBITDA will be flat as the underlying growth will replace the $100 million that falls off on an LTM calculated basis.

Okay. So switching to just a credit conference here. So the company recently cut or paused its dividend, which is pretty substantial in order to focus on deleveraging. And you have $750 million of unsecured notes due in '27. So what is the game plan for dealing with those notes you have cash on the balance sheet. You're going to have cash flow that otherwise would have gone to the dividend. And then I know you obviously had some data centers. You recently said you had a nonbinding letter of intent for a sale of 2 of them for $144 million. What is the game plan in terms of addressing those notes? And might you do it sooner rather than later if you have the cash and the cash flow instead of kind of incurring the negative carry on just continuing to pay that interest expense?

Yes. So let me just remind investors, we had a dividend policy for 15 years that dividended out more than 100% of cash flow by growing EBITDA at about 18% a year. We were taking that growth in EBITDA and levering it and remaining levered between 3.5x and 4x EBITDA during that entire period. Because of the capital expenditures associated with the integration of the T-Mobile assets and the negative cash flow that we acquired, we have seen our leverage peak at 6.6x net leverage. As a result of that, we made the decision to dramatically reduce our dividend from $1 a share a quarter to $0.02 a quarter, and we committed to keeping that dividend reduced until such time as we reach 4x net leverage. So we are very serious about continuing to delever, making that a priority. We did pause our buyback program and then said we would retain the flexibility to execute up to $105 million of buybacks that have been authorized, but there is no immediate plans to necessarily do that. It's just a flexibility that we preserved. In terms of the current June 27, $750 million unsecured. We have multiple paths that we can take to repay that debt. One, we have about $400 million of incremental capacity at our secured borrowing entity and could do an additional secured offering. Two, we have about $150 million available in our current ABS that we could tack on to if we elected to take the B and C tranches that we initially did not take when we did those offerings. Third, we could refinance in the unsecured market. Fourth, we could look at an ABS structure for our fiber assets, which we have not done and has been invoked with many other fiber providers. And then finally, we have capacity. It would have an equity component at the holdco level with a convert now that we don't have a material dividend dragging down that conversion premium. I think we're going to look at all of those options. I think we need to demonstrate to debt holders that we are serious about getting to that 4x leverage target that we laid out. I think the asset sales, coupled with the reduction in the dividend and the growth in EBITDA will prove that. We do have a little over 1.5 years to go. In the past, we have gone as close to 3 months before maturity before we've refinanced. I think it's unlikely we'll go that long, but I also don't think there should be an expectation that we're immediately going to refinance the '27s sitting here in December of '25.

Okay. So you're going to keep us guessing.

No, no, keep our options on.

Okay. I think we're effectively out of time, but we could easily do another half hour. So thank you, Dave. All the best to you in 2027.

Thank you, Ana. Thank you all.

Very, very interesting. Thank you.

Take care.