Analysis of Cogent Communications Group Results, by David Dixon of FBR & Co.
1. This post was written by FBR’s David Dixon; edited for clarity and content by Alan J Weissberger.
2. Cogent Communications was a pioneer in offering 100M b/sec Ethernet services, especially for Internet access, in the from 1999-2001. They are one of the few “new age” carriers that survived the dotcom bust/telecom crash. Cogent was founded in 1999, is headquartered in Washington, D.C. and is traded on the NASDAQ Stock Market under the ticker symbol CCOI.
3. Today, Cogent Communications is a multinational, Tier 1 facilities-based ISP. Cogent specializes in providing businesses with high speed Internet access, point-to-point transport and colocation services. Cogent’s reliable Tier 1, MPLS-enabled optical IP network connects to 2,200 office buildings and data centers. Cogent owns and operates 51 data centers in North America and Europe used primarilly for collocations services.
Analysis of Earnings Report:
Cogent reported another mixed quarter. Revenues for 4Q15 grew 8.7% YOY to $105.2M, in line with consensus. Corporate revenues maintained a doubledigit growth rate at 17.1% YOY. Over the last five years, corporate revenues as a percentage of total has steadily grown to 58.1% (versus 48.9% in 2011), compared to 41.9% for the higher-margin, but pressured, net-centric business.
Despite continued declines in the average price per megabit ($1.52 versus $1.81 in 4Q14 and $1.57 in 3Q15), CCOI has so far managed to offset this through increased customer count, driven by higher rep productivity. Rep sales productivity of 6.3 was the highest on record for the company, driven by a combination of:
(1) strong product demand,
(2) better training, and
(3) matching seasoned reps to correct accounts.
Excluding capex-related notes payable, capex of $4.9M was materially lower than the consensus estimate of $10.6M and our estimate of $11.2M, buoying free cash flow. We continue to see downside risk to the net-centric business due to our nonconsensus view that the FCC supports paid settlement peering and carrier network architecture shifts to decentralized lower latency compute platforms.
■ 4Q15 results recap. Revenues for 4Q15 of $105.2M were in line with consensus and above our estimate of $101.6M. Adjusted EBITDA of $34.7M compared to consensus of $35.7M and our estimate of $34.8M. Diluted EPS was $0.06, versus our Street-comparable estimate of $0.08, due to higher income tax expense.
■ Downside risk to net-centric revenues. We think the FY16 revenue guidance range of 10% to 20% YOY, combined with likely lower capex and principal payments of capitalized leases, will be challenging. We expect the netcentric business to remain under pressure due to uncertainty associated with settlement-free peering, offsetting growth in the corporate business. MWC 2016 signaled strong carrier momentum in carrier network architecture shifts to decentralized lower latency compute platforms.
■ Return of shareholder capital. The board of directors increased the dividend to $0.36 per share, up from $0.35 per share. For full-year 2015, CCOI paid $66.3M in dividends and $39.4M in share repurchases. At year-end 2015, $47.8M of share repurchase authorization remains, which is set to expire at the end of 2016. Management noted that it expects gross leverage to fall below 4.25:1 in 2016, which will allow access to $115M currently in the builder basket.
Will revenue growth slow longer term? Timeframe: 6 to 18 months
While higher capex and capitalized leases can help drive revenue growth, Cogent s on-net growth prospects are more uncertain going forward as Web 2.0 providers migrate to direct-carrier relationships over time (GOOG, FB, NFLX, etc.), particularly as content distribution becomes bundled with other services. In our view, the company has done well to avoid relationships with highbandwidth CDNs, which pressure competitors to a greater extent. We see multiple sellers of high-bandwidth pricing below $1/Mbps (below Cogent) and note that the market rate for peering is $0.50 $1/Mbps; contrary to Cogent s view, we believe the FCC supports this where traffic imbalances exist. Looking further ahead, a slowing of network footprint growth, coupled with continued perMbps pricing declines, implies a challenging revenue and FCF margin trajectory unless Cogent succeeds in further penetrating its existing footprint or raises capex guidance. We expect Cogent to show modest momentum from the lower-margin corporate and off-net segments.
Can Cogent drive margins higher in the longer term? Timeframe: 12 to 24 months
The key question, in our view, is the relevancy of Cogent s network to the Internet backbone amid a major shift in network architectures. The impact of changes to the settlement-free peering model on Cogent s cost structure is negative. Furthermore, we see more pressure on Cogent from incumbent operators and policy makers in Europe. From an M&A perspective, it is important to note that many on-net customers are multi-homed to Cogent and other providers, such that, if combined, the net (high-margin) revenue loss on leased network facilities could be significant. FCF results to date have been underwhelming, and we believe caution is warranted.
Will capex management and incremental margin improvement lead to accelerated Free Cash Flow (FCF) generation? Timeframe: 12 to 24 months
We believe the revenue guidance range, coupled with lower capex and capitalized leases, will prove challenging. Management has not generated adequate free cash flow growth for equityholders, in our opinion. The high-FCF-margin net-centric business is under pressure from an uncertain outlook for settlement-free peering in Europe and the U.S. The low-FCF-margin corporate segment is doing reasonably well. Under the new settlement-free peering agreement with Verizon, Cogent will not generate revenue from the increasing number of content customers behind Edgecast s differentiated CDN platform, which is scaling up nicely, and this may increase pressure on traffic ratios at Cogent s other interconnection points.
We believe that current industry dynamics are challenging and that content relationships are changing amid a major shift in network architectures that will pressure the settlement-free peering model. Cogent appears increasingly challenged to reach an inflection point in free cash flow generation.
March 8th & 9th Presentations:
Dave Schaeffer, Cogent’s Chief Executive Officer, will present at the two upcoming conferences:
The Deutsche Bank 2016 Media, Internet & Telecom Conference is being held at The Breakers Hotel in Palm Beach, FL.Dave Schaeffer will be presenting on Tuesday, March 8th at 2:45 p.m. EST.
The Raymond James 37th Annual Institutional Investors Conference is being held at the JW Marriott Grande Lakes inOrlando, FL. Dave Schaeffer will be presenting on Wednesday, March 9th at 8:05 a.m. EST.
Investors and other interested parties may access a live audio webcast of the conference presentations by going to the “Events” section of Cogent’s website at www.cogentco.com/events. A replay of the Deutsche Bank webcast will be available for 90 days following the presentation and a replay of the Raymond James webcast will be available for 7 days following the presentation.
Cogent Communications Reports Fourth Quarter 2015 and Full Year 2015 Results