Acquisition of Sprint’s Wireline Business Should Benefit Cogent

Equity Analyst

Matthew Dolgin

Cogent provides internet and private network connections for enterprises, and it carries internet traffic for internet service providers, content producers, and other websites. Both businesses face challenges as technological advancements allow those functions to be performed at lower cost, but we think Cogent's strategy leaves it positioned to succeed. 

Cogent's advantages arose from its leased, low cost, internet-specific network and the opportunistic buying it did to form its network. Rather than building a network itself by putting fiber into the ground, which we think often fails to justify the steep expense due to oversupply over many geographies, Cogent signed long-term leases to procure the rights. We think that advantage can persist now that Cogent has taken over the Sprint wireline network for T-Mobile. When combined with a network architecture that was optimized for the internet and a lack of legacy products to support, it is in a superior position to most competitors, which include major telecom companies.

Cogent's network connects to more than 1,800 high-rise buildings in North America. It serves enterprise customers in those buildings only, as its model would not profitable in less dense areas. Enterprises typically seek connections for both internet service and private networks. Private networks have evolved significantly in recent years, as firms can use internet-based, virtual solutions rather than more expensive legacy products. This shift is shrinking the market, but Cogent's lack of legacy offerings leaves it with more opportunity rather than the shrinking prospects of the industry.

Internet transit is a small addressable market—about $1.5 billion according to Cogent—and rapid price deflation mutes market growth despite the huge increases in data consumption. The small market has driven some competitors away and likely will keep others at bay, as they wouldn't be able to compete without an existing, low-cost network like Cogent has.

Business Strategy & Outlook

We believe Cogent has a narrow moat based on a cost advantage, which stems both from a smart and fortuitous compilation of its physical network, which consists of about 100,000 route miles of fiber (roughly 60% intercity; 40% metro), and from the technology and equipment that Cogent uses to light the network. Cogent decided from its inception to construct a network solely to accommodate internet communication that has increasingly become the preferred mode of communication versus the more expensive and less efficient services that legacy telephone and cable companies provide. With that vision, Cogent began putting together a network two decades ago for far less cost than we believe a firm could today, and its singular focus on internet communication results in lower operating costs as well. 

In our view, Cogent's biggest advantage is the relatively low capital outlay that was required to put together its underlying network, which Cogent says is the most interconnected network in the world, connecting to nearly 7,000 other networks (30 are settlement-free peers, while the remainder are customers) and carrying more than 20% of the world's internet traffic. Cogent also has over 1,800 skyscrapers on its network in North America, where it connects corporate customers. Rather than building the network itself, Cogent put together its network by leasing indefeasible rights of use, or IRUs, from network owners for unused, or dark, fiber. It enhanced its network shortly after the tech and telecom bubble burst at the beginning of the century, when, for a few hundred million dollars, it was able to lease capacity from or acquire financially distressed companies that had invested billions of dollars building networks. 

Cogent's IRUs have an average remaining life of around 20 years and come from over 200 different network suppliers. As a result, Cogent's capital spending now consists primarily of maintenance costs and equipment upgrades, and its capital intensity is materially lower than competitors. Capital spending as a percentage of sales has been 10% or less each of the last five years and is generally declining, as equipment pricing is often deflationary. This advantage has led to a relatively low invested capital base, especially since the accounting lives (for depreciation purposes) of many assets are shorter than the actual useful lives.

Beyond the physical footprint, Cogent's network architecture leads to an operating expense cost advantage. Cogent runs a homogenous network, built exclusively to offer internet connections and carry the traffic over its network. Cogent's competitors typically provide multiple services to enterprises, including voice, and use legacy technologies, such as MPLS-based VPNs (multiprotocol label switching based virtual private networks). Internet-based technologies and software solutions are replacing those services and causing those markets to dramatically shrink. Legacy networks also face more costs to accommodate the explosion in volume that is accompanying internet use (transit bit volume has been growing 25% annually for the last 25 years), and given the deflationary pricing environment for internet transit, competitors have been leaving, rather than entering the transit business. Cogent's more focused product portfolio results in a lower operating cost structure and a leaner back office, and without legacy products or technologies, Cogent can more easily adopt new and cheaper technology. 

Competitors' disadvantages do not stem solely from legacy networks; they are a product of their differing business models. According to Cogent, internet transit is only a $1.5 billion total market, and internet-based enterprise services are a $9 billion market, compared with tens of billions for voice and MPLS services. Legacy competitors must build their networks with an eye toward optimizing the bulk of their businesses, whereas Cogent can focus exclusively on carrying internet traffic. We think traditional carriers are unlikely to undertake significant spending to eliminate Cogent's cost advantage on businesses that for them are declining dramatically and where the total addressable markets are relatively small. Further, Cogent has indicated that its business model is only economical in the densest areas (about 10% of rentable office space), so we think legacy carriers are more likely to put their resources into the 90% of offices where they face less competition.

With that backdrop, it might seem likely that competitors that are unburdened by legacy networks could more readily replicate Cogent’s business, but we believe that leads back to the favorable terms Cogent originally secured for its network. With a $1.5 billion addressable internet transit market that is not likely to grow much, since price deflation has typically offset traffic growth, and an enterprise market that is geographically dispersed and shrinking due to technological advances, we think it would be too expensive for new competitors to cobble together economical networks today. They would not have the advantage Cogent had 20 years ago, when top providers in a more nascent internet business were phone and cable companies, and fiber assets could be procured on the cheap due to the collapse of the tech and telecom bubble.

Narrow

Economic Moat

Cogent Communications Holdings

Cogent Communications Holdings, Inc. engages in the provision of Internet access and Internet Protocol (IP) communications solutions. It offers Internet access and data transport through its fiber optic, IP data-only network, ethernet transport, and colocation services. The company was founded by David Schaeffer in August 1999 and is headquartered in Washington, DC.

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WASHINGTON , Sept. 25, 2023 /PRNewswire/ -- Cogent Communications Holdings, Inc.("Cogent") (NASDAQ: CCOI), one of the largest Internet service providers in the world, today announced that Dave Schaeffer, Cogent's Chief Executive Officer, will present at the following conferences: The RBC Capital Markets 2023 Global Communications Infrastructure Conference is being held at the Thompson Hotel in Chicago, IL.

Cogent Communications CEO to Present at Two Upcoming Conferences

WASHINGTON , Aug. 31, 2023 /PRNewswire/ -- Cogent Communications Holdings, Inc.("Cogent") (NASDAQ: CCOI), one of the largest Internet service providers in the world, today announced that Dave Schaeffer, Cogent's Chief Executive Officer, will present at the following conference: The BofA Securities 2023 Media Communications and Entertainment Conference is being held at the Bank of America Grace Pavilion in New York, NY. Dave Schaeffer will be presenting on Wednesday, September 13 at 2:00 p.m.

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Cogent Communications Holdings, Inc. (NASDAQ:CCOI ) Q2 2023 Earnings Conference Call August 10, 2023 8:30 AM ET Company Participants Dave Schaeffer - Chairman & CEO Thad Weed - CFO Conference Call Participants Phil Cusick - J.P. Morgan Frank Louthan - Raymond James Greg Williams - TD Cowen Walter Piecyk - LightShed Partners David Barden - Bank of America Brett Feldman - Goldman Sachs Tim Horan - Oppenheimer & Co. Nick Del Deo - MoffettNathanson Evan Young - KeyBanc Capital Markets Michael Rollins - Citigroup Operator Good morning, and welcome to the Cogent Communications Holdings Second Quarter 2023 Earnings Conference Call.

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