Good morning. My name is Sebastiano Petti, and I follow the communications sector here at JP Morgan. It is my pleasure to introduce Dave Schaeffer, founder and CEO of Cogent Communications. Dave, thanks for joining us.
Hey, Sebastiano, thanks for hosting me. Thanks, JP Morgan, for a great venue, and I'd like to thank all the investors for starting your day early with us today.
Great. So Dave, we just passed the one-year anniversary of the Sprint deal, which was Cogent's first acquisition in nearly 16 years. As we sit here today, are you as excited about the opportunity in front of Cogent as you were at that time? And any potential green shoots or more challenging aspects of the integration thus far?
So we remain encouraged with our ability to monetize the assets of the Sprint network. We also began serving a new customer segment, that being large enterprises. I think in both of these dimensions, Cogent remains as encouraged, if not more encouraged, than it was when it initially announced the deal in September of 2022. We closed in May of 2023. And to just refresh investors' minds, there are really two aspects to this acquisition. The first is the acquisition of the physical assets of Sprint, the network, and the repurposing of those assets to deliver optical transport services and data center facilities. And then the second is the addition of a large enterprise customer segment to Cogent, where we'll continue to support our connectivity products of DIA and VPN services.
Okay, sticking with the Sprint deal, when you closed the acquisition, the legacy Sprint business was burning nearly $190 million of EBITDA on an annualized basis. What is the current cash burn rate today, and what is the trend line as we think about synergies and as you groom the legacy business?
So when we announced the transaction, the Sprint business was burning $300 million of EBITDA, negative $300 million. With a number of restructuring efforts that T-Mobile initiated with our input, we were able to get that burn rate down to negative $190 million at closing. Today, that burn rate is about $80 million annualized.
Okay, and you originally targeted $220 million of cost savings over three years, but you do anticipate exceeding this opportunity. When can you get to full run rate, and how much upside could there be to the synergy envelope over time?
Yeah, it'll take us three years from closing to fully achieve those cost synergies. The total synergies equal $220 million, divided into three major areas: approximately $25 million in savings from the elimination of the Sprint international network. That effort is complete, and those synergies have been achieved. The second is the migration of Cogent traffic off of a IRU, where our maintenance expense is about $15 million a year, onto the Sprint network. That will occur in mid-year 2025. And then finally, a total of $180 million in cost savings across the North American footprint, mainly as a result of migrating off-net traffic to on-net traffic, the ability to eliminate facilities that are redundant, and reductions in headcount.
We are slightly ahead of our run rate in terms of hitting these objectives, and we believe we'll be able to achieve in excess of the initial $220 million of savings that were laid out.
So now, just backing up a moment here, so the $190 million EBITDA burn, remind us what the goals were and the targets there and the one—I think you have a one-year target, what you were... So you're at $80 million burn rate today. What was the initially—remind us what the initial target was, the timelines.
The initial target was one year post-closing to be at an $80 million negative EBITDA number for the acquired business, and that is, in fact, where we are today.
When does that get to neutrality, or have you outlined when that gets to perhaps break even?
Break even will occur two years from closing or by May of 2025, and then we should be able to improve the margins of the acquired enterprise business to an approximately 20% positive margin. In order to help us accomplish these goals, we have been eliminating non-core products. These are products that were subscale at Sprint and were often sold at negative gross margin. So in addition to the network migration strategy that I outlined earlier of moving off-net traffic to on-net, the elimination of these non-core products and the grooming of circuits that are delivered over non-fiber facilities are key parts of us achieving and exceeding the cost savings goals that we laid out.
Gotcha. You've also talked about potential revenue synergies over time. Are you seeing any cross-sell opportunities today, or is this more longer term and longer-dated options?
So, there are both revenue synergies and dissynergies. I'll start with the dissynergies first, which are the elimination of these non-core products. There were a total of 28 product categories in Sprint at acquisition. We have eliminated 24 of those. Now, we are honoring customers' contracts, and the last of those non-core products won't roll off till the end of 2026. That will result in a reduction in revenues. We also have targeted sites that are being served with copper, coax, or fixed wireless or mobile wireless services, and looking to migrate those all to a fiber footprint that will result in some sites not being viable to serve based on their locations. We also are creating revenue synergies by being able to take the enterprise customer base and begin to sell them a more modern VPN service.
The vast majority of the VPN services delivered by Sprint were delivered over MPLS, or multiprotocol label switching, versus virtual private LAN service, or VPLS. We have committed to supporting those MPLS services for a decade post-closing, but we also see the ability to upsell customers as we move them to a more scalable, more modern, and easier-to-manage platform, such as VPLS. A second cross-selling opportunity is to utilize our data center footprint. Sprint had previously only had connectivity to 23 carrier-neutral data centers globally. Cogent has 1,800, or excuse me, 1,680 carrier-neutral data centers across its footprint. And by having that broader footprint, we have the ability to serve our multinational customers better.
We also have the ability to serve VPN services that ride over the internet using the breadth of our transit network, which is both substantially larger and more ubiquitous than Sprint's network. We also have the ability to begin selling optical transport services. This was the primary reason for Cogent entering into this transaction. The initial Sprint network was built to carry long-distance voice. That network has sat fallow for nearly a decade, with 93% of the traffic that Sprint was carrying being off-net. We are repurposing that network as a wavelength or transport network. We also evaluated the 482 pieces of fee-simple technical real estate that Cogent acquired. This footprint entailed 1.9 million sq ft of technical space and 230 megawatts of power.
We've identified 45 of those facilities with 170 MW of power as facilities that we will be converting to Cogent data centers. In that footprint, there are 25 of the large, or excuse me, 21 of the largest facilities that have nearly 100 MW of excess power and 1 million sq ft of space that will probably not fit the Cogent retail colo model, and we're beginning the process of trying to monetize that, either through a sale or lease program.
Okay. So a lot, a lot of opportunities still to come. So you brought up optical waves, and so I think, you know, Cogent's share opportunity in the $2 billion optical wavelength market is a key tenet of the long-term investment thesis. However, there has been maybe a slower-than-expected ramp thus far. And maybe you can take us through why that's been the case. I think on the most recent call, you talked about maybe a mismatch was somewhat new to us, but also, you know, maybe provisioning as well. So if you can take us through that.
So the Sprint network was comprised of 19,000 route miles of inter-city fiber, 1,200 route miles of metropolitan fiber. This was all owned fiber. In addition to that, there was nearly 4,600 route miles of leased fiber. We are eliminating that leased fiber, as it is not necessary for Cogent's network services. We have identified 800 carrier-neutral data centers where we intend to offer wavelength services with a any-to-any footprint that we will provision a wavelength on an average of two weeks. We are taking a network that was dormant and originally designed for voice traffic and repurposing it. Our initial thought was that we would be able to sell large data center to large data center connectivity.
And while we have sold some of that, the vast majority of our backlog and initial orders came from smaller data centers to larger data centers. We can provision wavelength services at the end of Q1 in 420 of those 800 facilities, but with an extended provisioning window. We have a number of foundational network upgrades and modifications that need to be completed to hit both the ubiquity of our coverage and the speed of installation that we have outlined. I think investors will see an increase in wavelength installs throughout the year, but it really will be at the end of the year when we will be able to hit full cadence and be able to deliver those services across all 800 locations with a shorter provisioning window.
The foundational steps that we have to undertake first included the connection of the Sprint network to the Cogent metropolitan network in approximately 100 markets. That work is complete at this time. The second thing it required was the installation of optical transponder shelves to accept wavelengths, a 4 RU shelf in each of those 800 carrier neutrals. We were in 420 at quarter end. Third, it requires the deployment of reconfigurable add-drop multiplexers at the intersection points of the long-haul and metropolitan network. We're about 50% of the way complete on that effort. And then finally, the most challenging of the efforts is the reconfiguration of approximately 14,000 route miles of metropolitan network that Cogent operates.
That network is comprised of about 800 physical rings that supported 2,650 buildings, with multi-tenant office buildings and data centers commingled on each of those rings. We are going through a process of reconfiguring those rings, segregating the multi-tenant office footprint of nearly 1 billion sq ft from the carrier-neutral data center footprint. This is the most labor-intensive portion of this reconfiguration, and we're about 40% of the way through that work effort. That work effort includes touching each and every one of these buildings, typically in a planned maintenance with multiple, service-impacting outages for customers, so they need to be coordinated. That effort is going according to plan, and we feel comfortable that we will have that reconfiguration work done by year-end, along with the completion of the two other steps of transponder deployment and ROADM deployment.
That would then give Cogent a architectural advantage over our competitors. So in looking at that $2 billion wavelength addressable market, Cogent will have four discrete advantages: more endpoints, unique routes, faster provisioning times due to this architectural distinction and configuration that is different than the way other wavelength providers deliver their service, and then maybe most importantly, we have no cost basis in this asset. It's an asset that we acquired for $1. Remember, the acquisition of Sprint from T-Mobile was really two somewhat decoupled acquisitions: the transfer of the network assets to Cogent for $1, and then the second, the assumption of that enterprise customer base with a cash subsidy from T-Mobile of $700 million, paid to Cogent over a 54-month period.
So you'll have the architectural advantage. How should we think about Cogent's, I guess, go-to-market at that point, and how are you thinking about pricing?
So the wavelength market has four distinct customer bases. Three of those four are serviced by our NetCentric sales force. This is a sales force of 284 quota-bearing individuals that have assisted Cogent in becoming the largest provider of transit services in the world. The four segments are: content-generating businesses who are looking to replicate content between data centers. The second segment is access networks, whether global or domestic, that are looking to link islands of traffic. Both of these segments are today serviced by Cogent's NetCentric sales team. The third segment is new and emerging, and that is AI training using data centers that are distributed for their training models and may not be co-resident with the databases that are being used for that training. That also is a market segment that is focused on by our NetCentric sales force.
The final and smallest segment would be government and large enterprise, which is covered by our enterprise sales team. As we think about the competitive dynamic, we have these multidimensional advantages that I think will allow Cogent to continue to gain market share. Oftentimes, in our NetCentric transit business, customers associated Cogent with low price, but it was also our more expeditious provisioning that allowed us to become the largest transit provider in the world.
Now, shifting gears, the IPv4, I think, is interesting and new opportunity that some investors had not necessarily appreciated. On the call, you noted that that Cogent's current portfolio of leased internet addresses currently generates $3.4 million of revenue per month and has been growing at 2%-3% monthly over the last year and a half. IPv4 is an opportunity that, you know, I, I guess should be pretty interesting over time, but it raises the question, perhaps: why was IPv4 not a bigger focus for Cogent in the past?
Yes. So let's maybe go back in history a little bit to the initial architecture of the internet. Three basic protocols define what is the internet today. The first is TCP/IP, the way in which two devices communicate with one another. The second key protocol is BGP, the way in which two networks interconnect. To support both of these protocols, it is necessary to have a unique numbering scheme. When the internet was initially designed, first as the DARPAnet, then as the ARPANET, it was decided that there would be 2 to the 32nd power unique hexadecimal addresses. These are IPv4 addresses. There are 4.3 billion addresses possible. The U.S. government initially controlled all of those addresses. While they retained approximately 800 million addresses for their own needs, they made 3.5 billion addresses available to support the public internet.
Cogent owns about 1% of that pool, or approximately 37.8 million addresses. Addresses were readily available for free from 1991, with the initial commercialization of the internet, till 2011. At that point, addresses began to become rationed. In 2015, Cogent was unique among service providers, and it began leasing out its address space at an average price of about $0.30 per address per month, but only to those customers that purchased bandwidth from us. In mid-year 2022, Cogent relaxed that restriction, saw a material increase in our leasing rates, and today we are continuing to grow that business at between 2% and 3% sequentially per month. We also have taken some additional steps to recognize value out of these addresses. One is we securitized a portion of our leased address space and raised $206 million through an asset-backed securitization.
The second is we increased the prices for new address leasing starting about 6 weeks ago and continue to see unimpacted demand in terms of new leases. You know, we have leased only about 30% of our total inventory. This is an area that Cogent will focus on more going forward.
How big could this opportunity be as you think about the pricing umbr ella relative to AWS, Azure, as well as the unutilized inventory?
... So the opportunity has two dimensions to it. There's a possibility we could sell some of our unleased addresses. The market price for those addresses is between $50 and $60 per address. The second would be to lease out the remainder of the address pool, the approximately 24 million unleased addresses, and to continue to increase pricing on those address leases. We got an additional boost in our leasing business when Amazon and Microsoft began leasing addresses in 2023 at a price that was 12x Cogent's pricing. That pricing umbrella gave us the leeway to raise prices. We are initially increasing prices by 50% on new sales. We will then revisit the installed base, and may then implement additional increases on both new and existing customers.
While it is unlikely we will ever be able to achieve the average of $3.60 an address and fully lease out our entire inventory, I think there's significant room to grow this business, both in terms of increasing the leased inventory, you know, tripling it, and then maybe continuing to increase prices.
That's great. Shifting to the NetCentric business, this was positively impacted by the pandemic as demand for connectivity rose sharply. However, you know, growth in that segment has started to moderate. Do you still expect this business to grow at 10% per annum long term, and how should we think about pricing and volume dynamics there?
Yeah. So in our NetCentric business, we are selling bulk internet connectivity in those 1,680 data centers around the world. That business, for the past 20 years, has grown at an average of 9% a year. Heading into the pandemic, we were actually growing our NetCentric business substantially below long-term trend line at only 3% year-over-year. With the onset of the pandemic, that business materially accelerated and reached a peak growth rate, in the first year of the pandemic of 26% year-over-year. That surge in growth has moderated but stabilized at around 10% year-over-year, so just slightly above the long-term average.
That business will probably grow faster than that because of the inclusion of wavelength sales in our NetCentric revenue classification, and the fact that 85% of our IPv4 leasing is NetCentric, with only 14% of it being corporate and 1% being enterprise.
So conversely, Cogent's corporate business was negatively impacted by the pandemic and has not quite returned to prior growth rates. As you think about the macro backdrop and the pivot to hybrid work models, can the corporate segment get back to sustainable growth levels over time?
I-
What are you hearing currently from your customers?
I think you're being too kind in your question. It, our, corporate business has disappointed. It has grown historically pre-pandemic at 11% year-over-year. When the pandemic hit, the growth rate in that business decelerated to -9% year-over-year. It has re-accelerated to between 3%-4% annual growth. You know, many companies have directed employees back to the office. I believe your boss has been particularly vocal on that topic. But, my guess is if I went to 383 Madison, the attendance would not be at pre-pandemic levels. If we look across the entire footprint of multi-tenant office space, if we take, security card entry rates at pre-pandemic levels being 100, we're today at about 62% of that, so 38% of the employee days are not in the office.
That problem is probably even a little more acute since the office employee base has probably grown 4% in that four-year period, so we're really looking at about a 40% reduction. That reduction in number of days in the office has caused many companies to rethink their IT infrastructure. Now, what we have seen is many companies are now settling on a more permanent infrastructure, and they are now implementing architectural changes that they may have pushed out until they understood their exact real estate requirements. That, I think, has been helpful in increasing our corporate business. The return to office has been uneven across the country. We continue to see weakness in the Pacific Northwest and Northern California. We see particular strength in Florida and Texas. Cities such as Boston and New York are probably more in the middle of that pack.
But I think there is a gradual return to office that is underway. There's also companies re-implementing new architectures that they had procrastinated on deploying. For those two reasons, I think we'll continue to see a gradual improvement in our corporate business, but I've given up on when I'm comfortable in saying we'll return to the double-digit growth that we saw pre-pandemic. What I do know is that the addressable market is still there to support that growth rate.
And so being mindful of time here, just wanted to make sure that we touched on, you know, capital returns and, you know, the de-levering story at Cogent, because we have gotten some questions and concerns around the, the company's leverage profile and the ability to fund the dividend. While historically Cogent has funded the dividend through debt, we covered a lot today, so there's a lot going on in the business between the Sprint integration, standing up some longer-term opportunities, you know, the corporate segment you just kind of talked about as well, and the path to recovery there. How do all those factors or all the different, moving pieces within the business factor into your view about the appropriate level for, of leverage for the business and the company's payout ratio over the next several years?
So we actually have materially de-levered in the past year, with our net leverage going from 4.7 times EBITDA down to 3.17 times, and we're going to continue to de-lever for the next several quarters. Cogent was very fortunate that it built its business without debt. We have used our balance sheet and its under-levered status to return increasing amounts of capital to shareholders. We have implemented a dividend in 2010 and grown that dividend for 47 sequential quarters. We intend to be able to continue to do that going forward. We also have retired approximately 22% of our outstanding shares. Now, this was done with a combination of internally generated free cash flow, plus the addition of leverage.
I think as our payment subsidies from T-Mobile drop off, our leverage will increase in the short term as we are continuing to take costs out of the acquired enterprise business and ramping the high-margin business associated with our wavelength sales. We have said that 5 years post-closing, so that is May of 2028, the company will be on a revenue run rate of $500 million of EBITDA, with $1.5 billion of aggregate revenue. Our EBITDA today is about $350 million annually. While I know that, Q1's rate of $115 million was substantially higher, that will step down in the latter part of the year due to the step down in those subsidy payments from T-Mobile.
But I think with the combination of the securitization, the cash flow generation of the business, the assets that we have available for sale, and our borrowing capabilities, we feel quite comfortable that we'll be continuing to increase the capital that we're returning to shareholders.
Right on time, Dave, I think it's a great place to end it. Thanks for joining us. Thanks, everybody.
Hey, thanks, Sebastiano.