Cogent Communications Holdings Inc Q3 2024 Earnings Call Transcript

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

Question: Jim Schneider - Goldman Sachs - Analyst : Hello, good morning. Thanks for taking my question. I was wondering, Dave, if you could maybe just comment on the wavelengths business for a moment. Clearly, you had a nice uptick sequentially in revenue. Does that really reflect the fact that you're already getting better improvement on provisioning than you would expected maybe a quarter ago? And then maybe comment on what you said about the backlog, I think up 700 sequentially on the backlog, but also some of these may not be installed. So maybe talk about, as we look to the next few quarters, the rate of backlog growth we could expect and whether at any point you would expect to write down any of that backlog if you determine you can't provision it? David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Yeah. So three different questions, Jim. Thanks for them. First of all, we substantially increased the number of endpoints that we could deliver wavelength services. We are quite confident that while we ended the quarter at 657 sites by year-end, that number will be over 800 sites. In order to provision a wavelength rapidly, all of the intermediate sites need to be optimized for that wavelength implementation. Our goal is to get those wavelength install windows down to about two weeks from today about 90 days. We had certain customers in our backlog that had significant needs for the wavelengths, and we diverted some resources away from the network optimization program to provision these wavelengths. We were comfortable enough in the progress that we had made to hit the total 800 sites and all of the intermediate points by year-end that we did not risk that pushing out. We continue to talk to the customers that are in our backlog. And if we can accelerate certain of those orders, we will. We also know that some of those orders have been sitting for months. We have tried to be very transparent with customers in terms of our limitations on hitting what we view as acceptable provisioning windows. Most customers have been tolerant of that and have continued to reaffirm to us that they are interested in those wavelengths. But it is also realistic that if some of those orders have been sitting for six or seven months, when we actually go to provision and some customers may not accept those orders, and we'll have those discussions. Now with regard to the funnel building, we actually think the rate of funnel expansion should materially accelerate into next year. As we demonstrate success in delivering wavelengths, we then establish more credibility with those buyers. They see that we can, in fact, meet our provisioning windows. The quality of the service meets or exceeds industry standards and our pricing remains aggressive. So we feel very optimistic that in 2025, we will see a material ramp in the growth in our wavelength business to be able to hit our five-year post-acquisition target of doing $500 million in wavelength sales, which represents a market share of 25% in North America, similar to that of our market share for IP transit.

Question: Jim Schneider - Goldman Sachs - Analyst : Thank you very much. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Thanks Jim.

Question: Greg Williams - TD Cowen - Analyst : Dave, your on-net revenue was down quarter-over-quarter. You mentioned that, that contract that was terminated had that $3.5 million impact, but it still would have been down $2.8 million, excluding this. So just trying to understand the color here. And I think you mentioned the size and cadence of future uneconomic contracts going forward that will dribble into 2025. More color there would be great. And the same-store sales on corporate would be helpful. Second question is just on the data center sale process you just mentioned. Could they sell for less than the $10 million per megawatt marker? But it sounds like you're putting the CapEx into it for the next few quarters so they can then command and fetch a $10 million per megawatt price. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Let me try to hit all three of those, Greg. So first of all, in the on-net revenue, there were two primary contributors to that decline. The first was a sequential decline of $1.8 million in our commercial services agreement with T-Mobile. As we have been very clear that we are bound by our purchase agreement to deliver these services to T-Mobile. They are not particularly profitable, and T-Mobile can, at its decision, continue to use them or not. We do anticipate them going as methodically to zero, and they did come down $1.8 million in the quarter. The second big impact, it was actually twice as big as the reduction in the commercial services agreement, was the reduction of this contract. So we had a service that we were selling that had two counterparties to it that was resulting in a $3.5 million revenue stream, but actually more than that in costs. We could not get out of that agreement until both counterparties would agree to a buyout provision, which we exercised in the quarter. I think we may have some smaller opportunities like this going forward, but this was the one that we've been working on. And quite honestly, it took us almost 18 months to get the two parties to agree. It wasn't something that we didn't know about. And it also was impossible for us to predict when this would happen for investors just because we need a concurrence of both parties.

Question: Greg Williams - TD Cowen - Analyst : Thank you.

Question: David Barden - BofA Securities - Analyst : Guys, it's Dave Barton. Dave and Ted, thanks for taking the question. I have two. The first is more of a housekeeping question, I guess, related to IPv4. And we've been seeing that IPv4 leasing volumes be growing at kind of like in the 5%, 6% range. You raised prices, and now it's kind of growing at the 1% range. Could you talk a little bit about, Dave, your sense as to the price elasticity in that market right now? We've been looking at some of the brokerage sites and prices have been falling. And just interested in your updated view there. And then second, Dave, at the risk of having you talk the rest of the call, I just wanted your latest thoughts. Lumen earlier this week basically made the case that the current physical Internet is too small, too slow, and not secure enough for the emerging AI opportunity. And that they're really in the sweet spot. And that they're going to kill it in the AI world and that the puck is moving away from where the Cogents of the world are operating. If you could give me your retort to that, I'd love to hear it. Thank you. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. NOVEMBER 07, 2024 / 1:30PM, CCOI.OQ - Q3 2024 Cogent Communications Holdings Inc Earnings Call David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Yeah, let me take the IP address space question first. So I think the demand remains robust. When we implemented a price increase, there was obviously some shock to customers that were in negotiations but had not signed contracts at the lower price. And there's just a bit of, I think, adjustment that they need to get their head around in order to then pay the new price. I think most of that is behind us. I think you will see volumes continue to increase. Also on the provisioning of those addresses, there is sometimes a bit of a lag as we do the diligence on the counterparties to make sure they don't run a file of any security issues or foreign corrupt practices type issues. We have a dedicated team of four people that monitor the existing base of addresses and then vet new customers to make sure that they don't present a security threat. I think you'll see the volumes begin to reaccelerate. And by the way, the 11.8% sequential revenue growth is still pretty good and off of a decent base. We do have substantial inventory. In terms of sales, I think the market is bifurcated. For small block sales, prices have fallen. For large block sales, the prices have held very firm. And remember, Cogent possesses the largest block that has ever been given on a single basis. Now there are others, the size of our block. So I don't want to present that we're unique. But no one has more than we have in a single contiguous block. So I think we have a lot of leverage in terms of whether we want to sell them. But right now, we're pretty pleased with both the growth in volume and the growth that we're going to be able to achieve in pricing per address. So I don't think there's yet a demand elasticity problem. I'm going to pivot, and I promise to keep my answer short because I do want to get everybody else's questions answered on two things; the state of the public Internet and then the needs of AI or bandwidth. The public Internet has been predicted to die for 25 years. Every time there is growth, there is always some alternate technology that's going to replace the Internet, whether it's cross connects in data centers, peering fabrics, direct connections, CDNs. And the Internet continues to grow. We grew traffic at an 8% sequential growth rate and a 19% year-over-year growth rate. That is hardly a technology that's in decline. AI is possible because of all of the data that has been collected over the Internet. Today, there is roughly 700 zettabytes of data that have been amassed from Internet collections, and that is actually now growing at the rate of about 165 zettabytes a year. So an acceleration in the collection and storage of data because it now has value for AI training. I think that trend is just beginning, and we're going to see continued acceleration. And these are third-party numbers. Cogent only has visibility to the transmission piece of it, not to the storage piece. And then to the point about the current infrastructure not being sufficient. There are thousands of strands of fiber sitting dark between every major metropolitan area and the developed world. We carry one-fourth of the Internet's traffic of one pair of fibers and are not fully exhausted the optical throughput of that pair of fibers, and we're still only utilizing about 29% of our lit capacity. It is true that certain training models do require defined latency and additional security. The fact that Cogent is selling wavelength services allows us to attack that market. There is a hierarchy of cost per bit mile. The cheapest, most efficient way to move bits is the Internet. The second most cost-effective way is a wavelength. The third most cost-effective way is to buy dark fiber. It's a premium service. And then finally, the absolute most expensive way to move a bit is build your own fiber. And there are companies engaged in those more expensive strategies. But I will disagree with the premise that the Internet has peaked and there's something else replacing it. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. NOVEMBER 07, 2024 / 1:30PM, CCOI.OQ - Q3 2024 Cogent Communications Holdings Inc Earnings Call

Question: Walter Piecyk - LightShed Partners - Analyst : Thanks. Dave first. Thanks for reducing the prepared remarks. That's a nice improvement for this core. Hopefully, we can continue that trend. I think you got some additional synergies there. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Thank you, Walt.

Question: Walter Piecyk - LightShed Partners - Analyst : I understand that. And you said that in a prior comment. I think -- I don't want you to spend more time reiterating what you already said, and I appreciate that. I guess the question is, when you look at the data centers, it's like you spend the numbers so your CapEx is whatever it is, let's call it, $60 million-ish for three quarters, then you hope to get sales in the second half. Does it then drop off? Or do you say like, let's say, you get a sale in June of '25, September '25, and then there's $5 million more? Or do we have the $60 million then dropping back down to a more reasonable level? And then tied to that, the capital lease payments, I know you had a onetime payment last quarter, but that's $5 million, but I think there was like $80 million for the year. But is $5 million a new run rate in terms of capital lease? I'm just trying to get a sense of what else will contribute to cash burn. And does it basically end in June of next year? Or is there some continuation there? David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder So to directly answer your data center question, one, I believe we will have, transactions, whether they be leases or sales that are reportable before June. So you don't have to wait for June to a proof point. Now whether that's the entire portfolio, I doubt, but we will have proof points. Two, we will not have continuing CapEx related to the data centers beyond this initial conversion. So what we are spending is the money to convert 48 of the 482 acquired facilities. With regard to the capital lease payments, we did have a very meaningful prepayment last quarter. That was a onetime event. We do still have some incremental capital leases related to network reconfiguration. But we also will see some of the acquired fiber leases that we got when we acquired Sprint dropping off. And our total number of miles will actually go down and our expenses will go down.

Question: Walter Piecyk - LightShed Partners - Analyst : So when we put all the pieces together then in terms of ramping wavelengths, Barden talked about the IP things, those volumes obviously dropped off, but you're getting price increases. How this all contributes to revenue, now this elevated CapEx, you're going to obviously have to increase debt if you continue to sustain the dividend. So I guess the question because it's just there is cash burn. I don't know how the math, especially with the TSA payment drop-offs that exist. So debt has to go up because your cash is going to drop below, I don't know what you think is comfortable in terms of working capital. So is there any reconsideration in terms of the growth in the dividend, just given that maybe the interest rate outlook today? Obviously, these things change by the day, maybe not be as positive given some of the projected policies that are going to occur in future quarters. And by the way, also, your leverage is up a turn, you're probably headed higher just given how all these numbers work together before some of these sales and revenues kick in. Is it the right time to be adding additional debt to the balance sheet to fund the dividend? REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. NOVEMBER 07, 2024 / 1:30PM, CCOI.OQ - Q3 2024 Cogent Communications Holdings Inc Earnings Call David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder So we've had this discussion before, Walt, for 15 years, Cogent has more than 100% of cash flow as its EBITDA grew from 0 to $352 million last year. You are correct that the arithmetic of the T-Mobile IP transit payments dropped off, and it is an LTM test. So arithmetically, our leverage does go up. We have substantial access to additional capital. We have, for example, under the IPv4, ABS transaction, it's a trust. We have now increased the revenue into that trust by 50% run rate just since we initiated that would give us 50% of the borrowing capacity immediately. We are quite comfortable that we have multiple vectors of growth and ability to monetize and are very comfortable with our dividend policy as it has existed for the past 49 consecutive quarters and are comfortable in continuing a forward progression similar to what we've had historically.

Question: Michael Rollins - Citigroup Inc. - Analyst : Good morning. A couple of questions. First one is if you look at the constant currency revenue change year-over-year, I think this is now the first comparable quarter where you have everything in there for 12 months. And it's down 6.7%. And I apologize if you mentioned some of these numbers before, but can you share like on a year-over-year basis relative to that 6.7%, how much the heritage corporate is growing, how much the heritage NetCentric is growing? And then what the decline, the shrink is in all of these other things that you're managing through with the acquired revenue? And then secondly, just given how much noise you described was in the cost of goods or cost of service this quarter, what's the right run rate number that you get to in that cost of service to just appreciate cost on a more normalized basis? Thanks.

Question: Michael Rollins - Citigroup Inc. - Analyst : I'm not asking about currency. I'm just using that as like the frame of if total revenue was down 6.7%. What did the heritage corporate grow at? What did the Heritage NetCentric grow at? And what did the acquired revenue shrink? David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Yes. So we basically had three buckets of intentional shrinkage. The first being the elimination of noncore services. And we're probably three-fourth of the way through those non-core services going away. We would have liked them all to go away day one. Two, we've had low-margin off-net services that we are grooming. Those are continuing to be groomed, but we're probably, again, 50% of the way through what we can grow. Third, we had this extraordinary situation, and it was larger than any of the others, but there are some bad deals that we inherited after Sprint had been in business for 40 years that we are trying to unwind. In this particular case, we did take $3.5 million quarterly sequential revenue hit from getting rid of that deal. And if we looked at the total acquired business of Sprint, it was in decline when we acquired it. Cogent was growing. The combined company is growing due to, as you phrased it, the heritage revenue streams. And let's parse those apart. There was no heritage enterprise revenue so there's nothing to talk about there. The current enterprise business, absent this one Tri-party termination actually grew sequentially, which is actually a little surprising to us. Some of that is because we've been able to implement some pricing discipline around the remaining services, and we've got better discipline as we've been selling new services. The core Cogent corporate business, absent these two reductions by design, that being low-margin off-net and noncore is growing at about a 4% annual growth rate. And that's off of now the included acquired Sprint corporate base for connectivity services. And then finally, on the NetCentric business, it is highly volatile. It's dependent on volume seasonality, but it is continuing to grow on a constant currency basis at around 10%. And while we saw a slowdown in traffic growth in Q2, in Q3, you saw a material reacceleration. And that is back to more historical patterns. But this goes back to Dave Barden's question, is the Internet peak and starting to decline? I can pretty comfortably say no.

Question: Michael Rollins - Citigroup Inc. - Analyst : And when you take a look at capital allocation in total and you look at the possibilities for asset monetization that you mentioned during this call and in past calls, do you have a target dollar number by a certain target date, which is giving you some comfort in the way that you're going to manage the capital allocation over a multiyear period of time? David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder So I think we have comfort in two dimensions, Mike. One, our ability to organically grow our EBITDA, absent the subsidy payment stream from T-Mobile and be able to grow that at a sufficient rate that we will be able to return more capital. We did buybacks in Q2 as well as dividends and do that even with a higher interest rate environment, as Walt pointed out. That may result in an equal or higher gross leverage, but a reduction in net leverage. And then we do see these three buckets of assets that will potentially be monetized. If I had to stack rank them today, I would say the data centers are the most probable, the IPv4 or the second most probable, and the dark fiber, the lowest probability just because we've had very little experience. We did one dark fiber sale in the quarter. It was actually to a customer as more of a favor than it was that we were trying to productize it. But we have had a fairly large number of inbounds around monetizing those, just as we had on the data centers. For me to have a specific date and a specific dollar amount, I think there's just too many permutations to put that in front of investors. But I feel comfortable that we will get added benefit in delevering beyond growth in EBITDA from the monetization of these other assets.

Question: Nick Del Deo - MoffettNathanson - Analyst : All right. Thanks, guys. Dave, you said that the number of switch sites that you're planning to convert into data centers has increased. I think you gave a number earlier in the call. Can you split out how that breaks out between retail sites you're planning to hang on to versus larger locations that you're looking to sell or engage in a long-term lease with, both in terms of number of locations and the number of protected megawatts? I'm most interested in the sites you think you can sell or lease on a wholesale basis, which I think had been 88 protected megawatts across 21 facilities previously. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. NOVEMBER 07, 2024 / 1:30PM, CCOI.OQ - Q3 2024 Cogent Communications Holdings Inc Earnings Call David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder And you are correct on both the megawatts and number of sites that we think are suitable for wholesale monetization that is 21 of the 48 total sites that we are converting to data centers. And it is 88 of the protected megawatts out of the 169 that we have today. And there are still a few more centers that have not yet even been converted to offer retail services. So the number of centers will go up probably by about five and the number of megawatts may go up by another 10 or so from where we're at today. But we only see 21 of them as good candidates. Now our view is that the market will tell us more than what we think. And if a particular counterparty comes by and says, we just need this facility in this location, we didn't think it was one that we would monetize through either wholesale or outright sale, everything is for sale at the end of the day.

Question: Nick Del Deo - MoffettNathanson - Analyst : Okay. And then last one, just thinking about the waves opportunity, you've talked quite a bit about a number of data centers you're going to have enabled and network work that you're undertaking to get things where you need them to be. Thinking about the other building blocks that go into being able to sell waves at the cadence that you want to achieve. Do you feel like the sales force is appropriately trained and ready to go when you decide to press the button? You have the test installations you've done been providing results consistent with the provisioning time frames you've laid out and so on? Just want to make sure that every building block of that business is settling into where it needs to be. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Yeah. And I think in looking at those building blocks, everything starts with the sales force. We have conducted multiple trainings and certification for the 279 NetCentric salespeople. Now not every one of them has sold a wave yet, but we've got a little over 1,000 waves sold, but it's not by one or two reps. It is fairly broad across the organization. We have developed online training manuals. We have our regional learning managers that do supplemental work, and we work with transponder vendors to hold teach-ins and tutorials. So the CRM system is today completely integrated with the Wave design tool. So the rep without engaging a sales engineer gets a map with 1 meter accuracy, latency down to 100 of a millisecond contractual accuracy. And we feel that we can generate contracts and deliver all the documentation quickly. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. NOVEMBER 07, 2024 / 1:30PM, CCOI.OQ - Q3 2024 Cogent Communications Holdings Inc Earnings Call The second piece is our service delivery organization. We have developed tools there. We have been able to provision waves in test cases, only a few because not all of the sites that were necessary for all of the waves could, but we have had some waves provisioned in a couple of weeks, which is our ultimate target. So we feel pretty comfortable that the service delivery process, toolkit and staffing should allow us to do that. The building block of the network is dependent on the endpoints and the intermediate points. We would not have diverted people to sell some dark fiber and to even install the waves we did in the quarter if we thought we jeopardize the goal of being fully wave-enabled across the entire 800 North American locations by quarter's end. So I feel that the network will be there, the service delivery team will be there and the sales team will be there to deliver it. But ultimately, what we have to do is build confidence with customers. And that's probably the most important of the building blocks. And the way you do that, actually deliver what you say you're going to deliver without a problem and then the customer comes back. It's exactly how we built our credibility in IP, and it's how we're going to do it in the wavelength market.

Question: Timothy Horan - Oppenheimer & Co. Inc. - Analyst : Thanks guys. I have three questions. Dave, there's a feeding frenzy for data center capacity at the moment, and it looks like a good chance we're running out of capacity in the next year or so. So what dictates the timing of you announcing a sale or a lease of the capacity? And do you have any customers that want to buy the whole portfolio at this point? And then secondly, I know you don't give much guidance, but can you give us a range of EBITDA margins for next year, given all the moving parts and maybe just update again, thinking in five years? And then lastly, can you just remind us, what was the timing that you increased the ITV for pricing and how much? And can you do so next year? Thank you. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder So I'll take each of those questions. There are several counterparties who are interested in the entire portfolio. We are not certain that is the highest and best type of transaction to enter into. It may be. We're not initially contemplating this. You are correct. The market is continuing to tighten as there is more demand for power than can be met in a timely manner. Over time, there will be no power shortage, but that's a multiyear cycle. We have power available today. We've got to get these facilities ready. I think we hope sometime in the next couple of quarters, we'll be far enough along that we'll have deals that we can announce. But part of it's on us to get the work done. Part of it is on the market to pay us what we think is a fair price. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. NOVEMBER 07, 2024 / 1:30PM, CCOI.OQ - Q3 2024 Cogent Communications Holdings Inc Earnings Call In terms of EBITDA, we don't give quarterly guidance. So I want to be clear there. But we also understand that the rate of improvement in underlying EBITDA that we demonstrated over the last couple of quarters is a cadence that investors should expect. So our improvement in EBITDA as adjusted will lap the differential in payments from T-Mobile and therefore, will be on a more clean basis. So the $25 million that we received in that IP transit payment this quarter will continue for the next nine quarters. And then the underlying EBITDA should probably continue to improve at 200 to 300 basis points a quarter as we continue to achieve these cost savings. And then on the IPv4 pricing, it was a two-step effort. The first step was raising prices early summer on the new sales. And then second, taking 25% of the installed base and raising prices. We did that in September. We will also probably by year-end, go through and raise prices on another significant portion of the installed base. There is very little of that base that has contractual protections against our ability to do that. So I think there will be more growth in IP leasing revenue. The 11.8% sequential growth that we demonstrated this quarter, I think, is pretty significant and should continue. And going back to Walt's question, just gives us another tool if we choose to use ABS as a way to monetize it.

Question: Timothy Horan - Oppenheimer & Co. Inc. - Analyst : Thank you. David Schaeffer - Cogent Communications Holdings Inc - Chairman of the Board, President, Chief Executive Officer, Founder Thanks.