Cogent Communications Holdings Inc at Deutsche Bank Leveraged Finance Conference Transcript

The following is excerpted from the question-and-answer section of the transcript.

Question: Jitendra Joshi - Deutsche Bank - Analyst : Great. So I thought we'd kick off because, Dave, you're obviously very visible with investors and you do a fantastic job communicating the story. But I think maybe more on the debt side, the two deals you've done and particularly with the IPV4 securitization notes that were put in, I was hoping you could maybe walk through the structural changes, the formation of communications infra and Cogent Communications Group and the transfer of assets and maybe just spend a few minutes on describing how that story unfolded. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Yeah, absolutely. Happy to. And a full disclosure, Deutsche Bank was one of our underwriters for that transaction. So Cogent has had a two-tiered capital structure: a holding company, which is a publicly listed company that issues a dividend; and an operating company, Cogent Communications Group. All of our debt had been held at Cogent Communications Group level. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. SEPTEMBER 24, 2024 / 9:55PM, CCOI.OQ - Cogent Communications Holdings Inc at Deutsche Bank Leveraged Finance Conference There are traps to restrict cash and allow for the upflow of cash from the operating company, the holding company, which is then freely usable for either dividends or for share buybacks. We have tried to be transparent with our debt investors since 2010, when we did our first debt offering, that the primary purpose of our debt offerings is to facilitate return of capital to shareholders. Cogent has grown its dividend for 48 sequential quarters consecutively. We have also purchased about 23% of our float back in the open market. Now that's over a 15-year period. Last summer, when we completed the acquisition of Sprint from T-Mobile, we knew that we acquired an uneconomic IRU that Sprint had entered into and had been consistently appreciating. The counterparty to that IRU was Verizon. We had the opportunity to buy out of that IRU at a 12% discount per year, and it had three years remaining. It had a current cash payment of approximately $49 million a year for the next three years. We initially had planned to come to the high-yield market, but at that time, market conditions were not conducive to launching a new offering. We then met with a number of banks around asset-backed securitizations. We were first pitched on the idea of doing an asset-backed securitization against our fiber network. We concluded that, that was not practical. Based on the geographic span of the network, it would just be too daunting of a task to try to perfect security interest in those right of ways. \ And then looking at portions of our business, we had a very small portion of our business, approximately 4% of revenues, that were coming from leasing IP addresses out. So maybe a bit of background for generalists on what that means in plain in English. When the Internet was created, there were three foundational protocols that allow the Internet to work. The first is TCP/IP, the protocol that allows two computers to talk to one another. The second protocol is BGP, or Border Gateway Protocol, that allows two networks to communicate with each other. And the third is a unique numbering scheme. It was ultimately settled that there would be 2 to the 32nd power or approximately 4.3 million addresses that would be issued for the Internet. And this would have been done in the early 1990s, actually late 1980s, when everyone thought that would be way more than it could ever be used. Well, as it turns out, those addresses became a scarce resource, and they now have monetary value. Addresses are routinely bought and sold on open exchanges. In 2011, the first addresses were sold at about $4 per address. Addresses peaked in 2023 at about $60, and today, routinely trade for the low $50s. Cogent has 37.9 million addresses, probably the third-largest holder of addresses in the world. We began leasing out those addresses in 2015 and had leased approximately 12.5 million of our 37.9 million addresses out. We wanted to place those addresses into a subsidiary that could raise asset-backed funding. In order to facilitate that, we injected additional addresses from outside of the credit group, approximately 9.9 million addresses, that we had acquired from Sprint. We gave the operating company a blanket IRU on fiber across the Sprint network, and then finally, a master lease on a number of data centers. We had a third-party appraisal done, and that appraisal showed that there was approximately $365 million of incremental collateral going into Cogent Group from Cogent Infrastructure, the entity that owns the Sprint assets. So Cogent Infrastructure then raised ABS funding of $206 million against the 8,000 customer relationships that we have and nearly 12,000 contracts, representing about $35 million at the time in EBITDA. And then that cash was then available to allow us, in conjunction with other cash, to buy out that unfavorable IRU that was bought out at a 12% discount, saving the company nearly $40 million in annual cash payments. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. SEPTEMBER 24, 2024 / 9:55PM, CCOI.OQ - Cogent Communications Holdings Inc at Deutsche Bank Leveraged Finance Conference

Question: Jitendra Joshi - Deutsche Bank - Analyst : Right. And that's a nuance that just, I think, for the benefit of the audience, one thing we've seen is that the rating agencies still continue to view leverage on a consolidated basis, but in theory, you have enhanced the interest coverage and the leverage profile at the bond issuer as a result of the transfer of the losses. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Well, it actually was a bit surprising to us that when we raised incremental debt in each offering, our ratings actually were increased, and it was because of the enhancement of the credit quality of the borrower.

Question: Jitendra Joshi - Deutsche Bank - Analyst : But perhaps not commensurate with the actual cash flow that resulted at group. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder I think that's probably right, but we were not overly aggressive in trying to lobby for some additional enhancement to our ratings. We were pretty comfortable that the ratings that we have reflect appropriately the nature of the business. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. SEPTEMBER 24, 2024 / 9:55PM, CCOI.OQ - Cogent Communications Holdings Inc at Deutsche Bank Leveraged Finance Conference

Question: Jitendra Joshi - Deutsche Bank - Analyst : Okay. Great. And that's actually a good segue, just talking about the losses that you inherited from Sprint, right, regardless of just ignoring the boxes and the fact that the losses were -- some or maybe all the losses were transferred into infrastructure and -- David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Some were.

Question: Jitendra Joshi - Deutsche Bank - Analyst : Fair enough. And of course, obviously, the $700 million is meant to offset the -- you inheriting the negative cash flow stream. So sticking with that and just ignoring the IP Transit payments for the moment, at the time when you closed the deal last year -- in fact, when we spoke a year ago, you had said that you would get that $190 million negative EBITDA down to $80 million within a year and zero within two years. Where are you on that timeline? So what do you think the run rate losses are today? And when can you get that? David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder We are actually slightly ahead of plan. We identified $220 million of cost saving synergies that we would achieve over a 36-month period. In the first 15 months of closing, we have achieved 62% of those savings, and we have got the annualized burn rate below $80 million as of last quarter. And we anticipate by the time we report Q2 of '25, the burn rate of the acquired business will be down to zero.

Question: Jitendra Joshi - Deutsche Bank - Analyst : Let's just say there's no upside to wavelengths, right? Clearly, we know why you bought this strategically. There's a very strong equity story behind buying an asset that has a $20 billion total invested capital base. You bought it for $1. You have T-Mobile that's agreed, from a financial perspective, to make these IP Transit payments to gradually work your way out of the losses that you've inherited. And if, as a bondholder, you look at the last full-year EBITDA that you reported, so it was $236 million in 2022, if I'm not mistaken. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Correct.

Question: Jitendra Joshi - Deutsche Bank - Analyst : I want to keep the transit payment calculation out of it. Just your downside -- David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Well, transit payment is a contractual obligation from an investment-grade issuer.

Question: Jitendra Joshi - Deutsche Bank - Analyst : Low 20s, (multiple speakers) $80 million to $90 million on a $400 million basis. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Right. So we're right on track for the EBITDA from this transaction. And while I know you said you wanted to exclude the transfer payments, the way we thought about it in derisking this transaction was that we would consume about $400 million of the $700 million in subsidies to fund the losses and fund the efforts to fix that business to the best extent it could be fixed. It is still not nearly as robust a business as Cogent's legacy business, which has organic growth and superior margins. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. SEPTEMBER 24, 2024 / 9:55PM, CCOI.OQ - Cogent Communications Holdings Inc at Deutsche Bank Leveraged Finance Conference But if you just looked at it on a stand-alone basis, ascribing zero value to the physical network that we acquired and saying we did not produce any wavelength revenue, the combined company would still end up with $300 million of net incremental cash that it did not have, and it would end up with between $80 million and $90 million of incremental EBITDA it did not have prior to the transaction. Now what makes this complicated is we have combined our billing systems, our customer care systems, our network management systems, so it is difficult break out which customer came from where, and it's even more complicated by the fact that we have migrated much of the off-net revenue to on-net. It is one of the key ways that we have achieved the improvements in margin. But in trying to minimize risk, we clearly looked at two discrete transactions, the first of which is picking up the operating business, its associated losses, in a subsidy payment, and then the ability to turn those profitable. The second is taking the fallow assets, and the assets that were acquired were quantifiable: 19,000 route miles of intercity fiber owned, another 1,200 route miles of metropolitan fiber owned, a 3,800 mile bad IRU that we had to buy out of, and 482 fee simple owned buildings that comprise 230 megawatts of power and 1.9 million square feet. Now many of these buildings are either too remote or too small to have much conversion potential, but we have identified about 100 megawatts of existing power and 1 million square feet that are suitable for data center conversion, and we've begun marketing those facilities. The final asset that physically transferred were an additional 9.9 million IPV4 addresses, so our base went from 28 million to 37.9 million.

Question: Jitendra Joshi - Deutsche Bank - Analyst : And $300 million of cash, but that's in aggregate, right, the $300 million. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder That's correct.

Question: Jitendra Joshi - Deutsche Bank - Analyst : Fair enough. Fair enough. That said, the mid-$300 million EBITDA gets high-yield investors excited and interested. Maybe not equity investors, but it's framing the downside, if you will, to some extent. Now obviously, the story is much more complicated, so I think this is a good segue to go into how the integration is going. Let's start with the physical side. You talk about what you need to prepare the -- what you need to do to prepare the network for wavelengths, and -- can you give us an update, just purely not -- excluding the numbers for a moment, what the physical elements are that you have needed to go through over the last year to get the wavelength opportunity and hand it off to the sales team if you will. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Yeah. So the Sprint network was built to carry long-distance voice. It terminated typically at a Sprint tandem switch site 15 miles from downtown, including a facility here in Phoenix, about 15 miles from downtown. That facility was only interconnected to the regional Bell company with a lit circuit to terminate voice calls. What we have done is physically extended the Sprint network to touch our metropolitan network in approximately 110 markets. That physical extension was completed in February of '24. The second thing that has to happen physically is that these buildings were full of old telephone switches. We have to remove that old telephone gear. There were 22,500 cabinets of telephone equipment in these buildings that was obsolete and not in service. We have removed a little over 16,000 as of the end of the quarter. The third thing that we had to do is reconfigure our metropolitan networks in order to accept wavelengths. So while we had an extensive 18,600-mile global metro network, about 13,000 of those miles were in North America, they connected to 800 carrier-neutral data centers in North America and roughly 1,870 skyscrapers, and we needed to segregate the skyscrapers from the multi-tenant office buildings, and reconfiguring those networks and then direct wavelengths solely to the data centers. We are about three-quarters of the way through that physical reconfiguration. The fourth thing that we had to do was we have to deploy a transponder shelf, literally a 2RU, so 3-inch tall unit, that you put in each rack of a data center to allow customers to plug wavelengths in when they buy from you, and we're about three-quarters of the way through that deployment across those 800 facilities. And then finally, we need to deploy about 110 reconfigurable add-drop multiplexers that would direct the wavelengths to the correct data center. We are also about 75% of the way through that project. By the end of 2024, so in three months and a week, we will be done with this reconfiguration. The outcome of that reconfiguration will allow us to provision a wavelength from any North American data center to any North American data center in two weeks with only two field deployments. It will allow us to support 10 gig, 100 gig, and 400 gig wavelengths. The permutation of possible combinations is truly astronomical. It's 800 minus 1, so 799 divided -- factorial divided by 2. I mean that's trillions of possible combinations. You can never pre-provision all that, but you could build an infrastructure that then allows the field team to just deploy inexpensive pluggable optics to then turn up each wavelength as customers require them. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. SEPTEMBER 24, 2024 / 9:55PM, CCOI.OQ - Cogent Communications Holdings Inc at Deutsche Bank Leveraged Finance Conference

Question: Jitendra Joshi - Deutsche Bank - Analyst : And so how do you see that playing out over the next couple of years in '24 into '25 and '26? David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder So we will continue to build the backlog. We will custom deploy only a handful of wavelengths, because until this reconfiguration work is done, it is a very manual process. Once that work is done, we should be in a position with our current resources to deploy about 500 wavelengths per month out of the backlog and continue to sell. If we are more successful in that, we can add additional field resources and provisioning teams and scale that further. But the goal is within five years of closing, so that would be run rate of May of '28, we would be doing $500 million of wavelength business. And because that wavelength revenue is on-net, it carries a 100% gross margin contribution and $0.95 of incremental EBITDA.