Good morning, and welcome to the Cogent Investor Conference Call. I would now like to turn the call over to Tad Weed with Cogent Communications Holdings, Inc. Please begin, sir.
Yes. Hi, good morning, everyone. I will just open the call by reading our safe harbor language before I hand the presentation over to Dave Schaeffer, our CEO. This investor call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to statements identified by words such as believes, expects, anticipates, estimates, intends, plans, targets, projects, and similar expressions. These forward-looking statements include, but are not limited to statements regarding benefits of the proposed acquisition, integration plans and expected synergies, and anticipated future financial and operating performance and results, including estimates for growth. The statements made on this call are based on current beliefs and expectations of Cogent's management and are subject to significant risks and uncertainty. Actual results may differ from those set forth in the forward-looking statements.
Numerous factors could cause or contribute to such differences, including risks related to the acquisition of T-Mobile's wireline business by Cogent and related transactions, such as the expected timing and likelihood of completion of the pending acquisition, including the timing, receipt and terms and conditions of any required governmental and regulatory approvals of the pending merger that could reduce anticipated benefits, the ability to successfully integrate the business, the occurrence of any event, change, or other circumstance that could give rise to the termination of the acquisition agreement, the risk that the parties may not be able to satisfy the conditions to the proposed transaction in a timely manner or at all, risk related to disruption of management time from ongoing business operations due to the proposed transaction, the risk that any announcements related to the proposed transaction could have adverse effects on the market price of Cogent's common stock, the risk that the proposed transaction and its announcement could have an adverse effect on the ability of Cogent and T-Mobile to retain customers, to retain and hire key personnel, or to maintain relationships with their suppliers and customers and on their operating results and business generally.
The risk that problems may arise in successfully integrating the businesses of the companies, which may result in the combined company not operating as effectively and efficiently as expected, the risk that the combined company may be unable to achieve cost-cutting synergies or that it may take longer than expected to achieve those synergies and other factors. Another risk discussed from time to time in Cogent's filings with the SEC, including, without limitation, our annual report on the 10-K for the year ended December 31, 2021, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2022 and June 30, 2022. Finally, Cogent undertakes no duty to update any forward-looking statement or any information provided on this call at any time. With that, I will hand the call over to Dave Schaeffer.
I would now like to turn the call over to Dave Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holdings. Mr. Schaeffer, please begin.
Hey, thank you, Norma, and good morning to everyone. I apologize for being both a few minutes late and some of our technical difficulties, but we are very pleased to announce the acquisition of T-Mobile's wireline business. This is the former Sprint legacy long distance business that was known as Sprint Global Markets Group. Cogent will be acquiring this business in its entirety. This will include its nationwide owned fiber network, as well as the physical real estate occupied by the data centers and POPs operated on the Sprint network. This is approximately 19,000 route miles of inner-city fiber along unique right of ways connected to 1,300 miles of metropolitan fiber. In addition to this, there are approximately 16,800 miles of leased dark fiber comprising the North American Sprint network.
In this acquisition, we will be acquiring the customer base that is comprised of approximately 1,400 enterprise customers that generate about $560 million in annual revenue. Those customers purchase four major product groups. They purchase private networking, today, primarily delivered via MPLS, and it is Cogent's intention to convert those customers to a higher capacity, more modern technology of virtual private line service, allowing those customers to receive high-quality VPN services at much greater throughput and lower price points. Also, the legacy business sells transit and dedicated internet access service to corporate customers. The business also provides for the ability to sell wavelength services. This is a new market for Cogent that will allow us to enter a $2 billion North American market that is growing at about 7% per year.
That is the provision of point-to-point high capacity wavelength services that are used by large corporates as well as other service providers. Cogent will also be able to sell dark fiber. Cogent has historically been a purchaser of dark fiber, and now with the inventory acquired, Cogent will be able to enter the intercity dark fiber sale market. Finally, there are a number of legacy products that will not be supported long-term. We are committed to supporting all of those customers for their current contract term, but at the end of that contract term, we will end those products. These products include voice termination and session initiation protocol or SIP voice services, as well as a large number of low capacity managed services.
Cogent will also be able to integrate 47 of the largest Sprint-owned facilities, comprising approximately 1.3 million sq ft of owned real estate into Cogent's data center footprint. We anticipate that at the end of the integration process, we will be operating over 100 data centers across our footprint and over 1 million sq ft of raised floor space. In this transaction, Cogent is acquiring these businesses for $1. Concurrent with the transaction, Cogent has entered into a 54-month supply agreement with T-Mobile to sell transit services, that is connectivity to the Internet. These services will be sold in on-net locations that carry 100% gross margin contribution. T-Mobile is committed to a stream of payments to Cogent for these services.
$350 million in the first 12 months of the transaction closing, divided into 12 equal monthly payments of approximately $29 million. At the end of that first initial year, Cogent will then continue to sell a lower amount of services to T-Mobile for the next 42 months. T-Mobile is committed to monthly payments of approximately $9 million per month or $100 million annually, bringing the total purchase commitment by T-Mobile to Cogent to $700 million. This will allow Cogent the operating cash flow necessary to continue efforts to restructure the business and reduce costs. We are pleased that there are nearly 1,300 employees in this business. They will be joining the approximately 1,050 Cogent colleagues, giving us the ability to operate this large network.
There may be certain job functions that are rationalized, and T-Mobile is committed to working with us to support those employees during this process. We will be able to begin to enter into a resale agreement with T-Mobile during the period between this announcement and the ultimate securing of necessary regulatory approvals. We hope that through that resale agreement, we can help accelerate the revenue growth of some of these, more nascent businesses, such as the sale of wavelengths. We will also try to provide a clear and technologically superior migration path for those customers who rely on the Sprint network for its VPN services. Because of the international breadth as well as operating in all 50 U.S. states, we are anticipating that the requisite regulatory approvals will occur in something between nine and 15 months.
We do not anticipate any regulatory obstacles to this transaction, in that this will broaden competition in the market. Allow Cogent, with its aggressive pricing strategy, to enter new markets and provide additional competition in markets where there has been limited competition for some of these infrastructure services. We are acquiring this business through a newly created subsidiary that is under Cogent Holdings, our publicly traded company. This subsidiary will operate outside of and in parallel to Cogent Communications Group, which is the entity that holds the debt that Cogent today has on its balance sheet. We believe that this transaction will also accelerate some of our international expansion. We will be able to gain licenses in some markets where Cogent today does not operate, such as India and Malaysia.
We also know that the utilization of the Cogent metro footprint dramatically increases the value and the marketability of this network. By connecting to the locations that have the greatest amount of demand, we should be able to allow for the acceleration in the sale of these new services, as well as broadening out the IP and VPLS product set. We are proud to integrate one of the initial eight backbones that comprise the internet SprintLink into the Cogent portfolio. Through some of our previous acquisitions, such as PSINet and NetRail, Cogent today actually will own and operate four of those original eight internet backbones. This transaction shall allow Cogent to become one of the largest, if not the largest internet provider globally.
Our revenue base post-closing will initially be approximately 180% of Cogent's current $600 million run rate, or about $1.1 billion. We anticipate that post-closing off of this larger revenue base, our revenues will grow in the 5%-7% annually range organically. We expect to reach revenues of over $1.5 billion by 2028. We believe this growth is going to come from existing products as well as these new products that would be added to our network. The commitment from T-Mobile to be the initial customer for these added transit services will add about $15 of gross margin per Cogent share over the 54-month period of this agreement. We expect our EBITDA margins for the combined company in five years to be in the low-to-mid 30s%.
We expect also to be able to continue to expand our EBITDA margins over time at approximately 100 basis points per year, until we reach a mature EBITDA margin profile of about 45%. To remind investors, Cogent today operates a business with some of the highest EBITDA margins in the industry. Last quarter, we were at 39.4%. We understand that the combined business, due to the historical underperformance of the Sprint GMG business, will initially have lower margins. We believe that through the right sizing of the cost structure as well as aggressive selling of these services, we will be able to achieve our historic margins that we have already achieved as well as continue to grow. We also know that this transaction is highly accretive. We will get higher revenue per employee through greater efficiencies.
We will be able to reduce our net leverage to about 3x EBITDA within the next five years on a combined basis. Again, we are not issuing any debt as part of this transaction. We are not assuming any debt. We are assuming a net working capital balance of zero at closing, and there will only be some de minimis trade payables at closing. We anticipate that this transaction will allow us to grow our aggregate cash flow at a more rapid rate and ultimately allow Cogent to continue to grow its dividend on a sequential basis. We also know that T-Mobile is entering into this transaction so it can focus on its market leading wireless services. Each company is doing what it does best. We will have the ability to become the premier global provider in transit services, VPN services, wavelength services, and dark fiber through this acquisition.
We recognize the many key employees inside of the wireline business at T-Mobile, many of those who have very long-term tenure with the company. They possess tremendous institutional knowledge, and we're welcoming those employees to the Cogent team. We look forward to continuing to serve customers with high quality services that Sprint had become known for. As the first company to deploy a nationwide fiber optic network, we are proud to follow in those footsteps and be able to be a steward of this great asset. We expect the transaction to be accretive per share on an EBITDA basis, both initially and over a multi-year period. We expect the transaction to be accretive on cash flow per share initially and on a multi-year period.
We are proud to add this company to the 13 other previous companies that we had acquired, who had deployed $40 billion of PP&E and had raised $14 billion of capital. This business that is now being integrated into the Cogent family is the largest and most significant. It's been nearly 16 years since Cogent has done an acquisition. You know, we have been careful in reviewing hundreds of opportunities and felt that this opportunity was the right transaction at the right time, with the right assets, at the right price point to make Cogent an even more successful company. With that, I'd like to open the floor for questions. Norma?
Thank you. Ladies and gentlemen, to ask a question at this time, you'll need to press star one one on your telephone. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question comes from Sami Badri from Credit Suisse. Your line is now open.
Hi. Thank you. First question I have is, how competitive was this transaction? Were there multiple parties at the table negotiating for this business? Did T-Mobile approach Cogent? Can you give us an idea on, you know, who initiated this just to give us, you know, a little bit of a background on, how and why this came up?
Yes, thanks for the question, Sami. Over a number of years, Cogent has had discussions with Sprint even prior to the combination with T-Mobile, about the future of this business. We concluded in conjunction with Sprint management that there was not a path forward at that time. Once T-Mobile had acquired this business and had begun the process of integrating the wireless assets into their portfolio, they initiated a process approximately 18 months ago with an investment bank. While we reviewed the transaction, we ultimately, and other parties ultimately did not transact. T-Mobile continued to integrate the asset. It continued to adjust the employee count and product portfolio. They reengaged in a formal process through a different investment bank, this summer.
We were contacted as a previous party who had worked with T-Mobile and with Sprint before it was part of T-Mobile to see if we were interested. We then began doing substantive due diligence. I believe there were approximately 20 parties who reviewed the transaction, and I think in working with the management team at T-Mobile, what Cogent quickly understood was that the primary objective of T-Mobile was to ensure a smooth and seamless transition for the customer base and for the employees. That was more important to them than the US dollar value of the transaction. While the process was competitive, we ultimately prevailed because of Cogent's track record, its record of customer service, and its record of growth in the industry. You know, we are proud to be chosen by T-Mobile to be the steward of this asset.
Remember, this business had its beginnings over 100 years ago in a couple of small rural telephone companies, United Telecom out of North Carolina and Brown out of Kansas, that merged. That then was the market entrant leader in competitive telecom and the first company to build a fiber optic network. They initially built the network on their own, then ultimately brought in a regional phone company, GTE, to be a partner, purchased GTE's position back and operated this business until the early 2000s in conjunction with their rural telephone footprint, and became the third largest long distance company in the country. Only in the early 2000s did they begin to develop their wireless business, which soon eclipsed this business and gave us the opportunity to integrate these assets and use them more efficiently. Thanks, Sami.
Got it. Dave, I had two other follow-ups. You did update the growth of revenue for the overall company on a combined basis, assuming the deal closes. Could you give us any kind of growth, you know, some kind of growth guidance or maybe just the historical growth levels of the T-Mobile business, over the last couple of years, just so we get an idea on how you're getting to the 5%-7%? One other follow-up is, after the two companies are combined, what should we be assuming for churn, you know, over the next five years? Just because it sounds like there's going to be a lot of changes.
Yeah, let me take both of those questions. The legacy business has been experiencing revenue declines in the order of about 10% per year prior to the acquisition. We actually anticipate that revenue decline to continue during the period between signing and closing. While the revenue at the end of 2021 was a run rate of $560 million, we think by closing it is more likely that the revenue run rate will be somewhere around $450 million. Most of that decline is generated by the decision to end a number of non-strategic and quite honestly, non-viable products that are not core to Sprint and are definitely not core to Cogent moving forward.
We are taking the physical asset base and repurposing that into the 21st century and using it in a way that will generate the highest returns with the highest margins and the best growth rate. While we anticipate T-Mobile will continue this restructuring during this period, we do not control the company until after closing. Once we take over, there will probably be some additional customer grooming that is necessary, but we will be very aggressive in selling these new products and expect the growth rate of the legacy business to go positive within the first year. We also know that we have the revenue coming from T-Mobile during this period.
Now, the amount that will actually be booked as revenue versus consideration for the transaction is yet to be determined by the accountants and the need for an independent appraisal of those market prices that we have provided to T-Mobile. We think that the business absent that contract will grow in the low single digits, so therefore the combined business will grow in the 5%-7% range. Now to your churn question, we anticipate that the churn will initially be higher as we jettison these legacy products. Ultimately, based on the go forward product set, we anticipate churn to be in line with where Cogent's historical churn rates have been, and that is in the order of about 1% per month.
Thank you.
Thank you.
Of course.
Our next question. One moment.
Our next question comes from the line of James Breen with William Blair. Your line is now open.
Thanks for taking the question. Just a couple, Dave. Just on the revenue side, you talked about the $450 million at close for the Sprint transaction. How much of that is coming from-
Can you possibly repeat that? I can't hear the question.
Can you hear me?
One moment. I can hear you, participant. Mr. Schaeffer cannot hear you. Can you go ahead and ask the question again, and I'll repeat it.
Sure. Just wondering, at close, you talked about $450 million of revenue for the Sprint asset. Wondering what the margin structure looks like there from an EBITDA perspective, and then how capital intensive the assets are that you'll be buying relative to where Cogent is today.
Can you do that one more time, sir? That was a lot. Repeat the question, Mr. Breen? Sorry.
I'll just dial back in.
Thank you. All right, our next question, one moment. Our next question comes from the line of Nick Del Deo with MoffettNathanson. Your line is open.
Hey. Morning. Dave, can you hear me?
Absolutely, Nick. Good morning.
Okay, great. Thanks for taking the question. A little disappointing to see that you couldn't negotiate the purchase price down to $0.50 from $1, but I'll let that slide. You shared some information about the physical asset, and I was hoping to get some additional details there. I guess, you know, what share of your owned routes would you characterize as unique? You know, what's the mix of direct buried cable versus routes with multiple conduits? You know, how many strands on average do you have to get a sense for the dark fiber potential? And, you know, any CapEx that you're thinking is necessary for remediation work?
Yeah. I'm gonna actually take those in reverse order, Nick. Prior to deciding to divest of this asset, T-Mobile engaged Corning to come and do a detailed quality assessment of the fiber optic plant. The plant is almost entirely comprised of SMF-28, which is actually an older generation, but an optimal generation of fiber for a coherent technology. For any throughput per wavelength of 100 gigabits per second or greater, you need to be able to support coherent optics. This fiber can easily support 400 gig, 800 gigs, and ultimately several terabits per wavelength. The quality of the fiber is very high. The vast majority of the routes are direct buried armored fiber. There are some sections that are in conduit, but the vast majority is direct burial.
This fiber based on the rights of way, which are predominantly railroad, has been very secure and has had minimal number of cuts based on the way it was placed. Most of the rights of way are truly unique. While they cover city pairs that are in great demand, and we provided a copy of the map of both owned and leased routes on our website, most of these physical routes have no other provider on them. Most of the rest of the industry shares rights of way that are different than these rights of way, and many of them are congruent with one another. Therefore, we are truly providing an alternative redundant network in the majority of city pair instances. To the fiber count, it varies dramatically by route. The thinnest routes are about a dozen pairs.
The thickest routes are 144 pairs. I would say the mean number of fibers is probably 48 across the footprint. You know, as we have proven with wavelength division multiplexing, you can provide virtually unlimited capacity on one pair. We anticipate a model where we will be able to use one of those pairs for Cogent's IP and VPN business with additional waves and greater throughput per wavelength. Then, using an additional pair for the wavelength sale product set, and then all of the other inventory will be available for the sale as dark fiber or additional wavelength services.
Okay, that's super helpful, Dave. Thanks for sharing that. You know, I guess one other question. You talked about the potential for new products post-close. You know, you called out wavelengths and dark fiber specifically. I think, you know, one of your company's hallmarks historically has been, you know, having a very narrow product set so that, you know, this certainly marks a bit of a change in your thinking. You know, what prompted that? And, you know, was there anything preventing you from selling waves in your network today? And again, I guess kind of big picture, you talked about there being a $2 billion market for waves. You know, what sort of share do you think you can get? And do you attack that with low prices or some other, you know, product attribute?
Yeah. Let's start with the market opportunity. It is about $2 billion. It's sized by a couple of third-party consultants. We did not have the inventory of excess capacity in our fiber network today because we operated on a single pair. We utilized all of the wavelengths to support Cogent's IP product sets. We believe firmly that the internet is continuing to replace other products and services. We understand that many of the historical products that were carried on the Sprint network are no longer in demand and we're end-of-lifing them, or they've already been end-of-lifed. The ability to have surplus fiber gave us the ability to enter this wavelength market. The three primary customer bases for the wavelength market are the hyperscale operators who are looking for wavelengths for data center-to-data center data replication. This is a market that Cogent had never participated in.
These companies have been mostly forced to buy wavelengths from our new competitors in this space, and now we'll be able to provide them dark fiber that our competitors have been unwilling to sell. We also will sell wavelengths to that customer segment, and because of our cost basis, we will be able to price those far more aggressively than anyone else in the market. The second big opportunity for these products are actually our competitors, smaller tier two providers who look to build some, if not all, of their own footprint for Internet services. Today, again, these competitors are buying from a different competitor, and we will be in a position to lower their costs and provide them with diversity. Then the third segment, which is probably the smallest addressable market, are the limited number of corporate accounts that are committed to building their own proprietary network.
I think that's probably less than 100 very large corporations, but being able to sell these very largest companies a wavelength or fiber network is again, an expansion of Cogent's product set, but is adjacent to what we have today. We also know that by moving on to our own fiber, we will actually reduce going forward costs for Cogent and take an issue that frankly has not been an issue to date off of the table, but has given investors concern, which is what would happen at the end of our IRU agreement terms. While we've been successful in renewing them, and we will continue to use IRUs where appropriate, utilizing this 20,300 route miles of owned fiber will ensure lower operating costs for Cogent and a greater, you know, certainty to our future.
I think all in all, this is a truly accretive transaction. I'll close by taking offense at your, comment about our negotiating skills. I think the important thing to focus on is not what we pay, but rather the margin and revenue commitment that T-Mobile is making. T-Mobile had a de minimis customer relationship with Cogent prior to this transaction. T-Mobile's commitment to $700 million over 54 months of high margin on net services is a key component of making this transaction accretive to Cogent day one.
Yeah, absolutely. Thank you for all that detail, Dave. I appreciate it.
Okay, thanks, Nick. Next question. Margin on net services is a key component of making this transaction accretive to Cogent day one.
Yeah, absolutely. Thank you for all that detail, Dave. I appreciate it.
Okay, thanks, Nick. Next question.
Thank you. One moment for our next question. Our next question comes from the line of James Breen from William Blair. Your line is now open, sir.
Thanks. Dave, can you hear me this time?
It doesn't look like he can hear you.
Strange. Just wondering what the capital structure looks like on the Sprint assets in terms of capital intensity and EBITDA margins at close?
Mr. Breen wants to know the capital construction. Say again, Mr. Breen.
What the capital intensity of the assets looks like at close?
The capital intensity of the assets at close. Okay, it looks like we lost Mr. Schaeffer. One moment. Ladies and gentlemen, please stand by. Mr. Schaeffer, are you back? Mr. Schaeffer, are you back?
Hey, Norma, I'm sorry.
Okay.
I think I was dropped and did not hear.
Okay.
the question.
You're back. I can hear you.
After this question.
Okay. Mr. Breen, can you try that again?
Sure. Dave, can you hear me?
Absolutely, Jim.
There we go. Okay. Just wondering, as you look at the Sprint assets, you talked about, you know, $450 million of revenue at close. What do those assets look like from a EBITDA margin and capital intensity perspective? Just sort of trying to figure out how much the dilution is initially on the business. And then going forward, you know, what's the opportunity there from the IRU perspective? Do you have current IRUs that are with these assets that will suddenly become owned assets? Thanks.
Yeah. We actually have no IRUs on the Sprint network. We do have IRUs from over 303 different suppliers around the world. As those assets, you know, we'll evaluate whether we need to keep them or not, or can we terminate those and then eliminate our maintenance payments on those assets. To the point of capital intensity, the physical network is actually in excellent shape and only needs ongoing maintenance CapEx related to lift and shift, i.e., relocation or any fiber cuts. There is no capital needed to remediate the physical 20,300-mile network. We also we'll be acquiring a large inventory of equipment that will be repurposed. These are routers, Cisco and Juniper, and optical transport equipment, Ciena. We will re-utilize that equipment in a more efficient architecture.
We will continue to add more modern, higher throughput wavelength equipment necessary. We anticipate that the incremental CapEx required of this business will probably be in the roughly $30 million a year range that will allow us to support the growing wavelength business. No real CapEx is required for either the dark fiber sales and for the IP and VPN product sets, the volumes are so de minimis compared to Cogent's current volumes that, we should be able to absorb that with equipment that we have in-hand. Now to the margin question, and that's a more nuanced answer in that we have to ultimately understand how much of the $700 million of revenue that we are receiving from T-Mobile can be counted as revenue.
This is not a decision that Cogent can make, but is dependent on an independent third party auditing the market pricing. If we are able to treat all of this as revenue, we will be able to have margins, you know, in the, you know, high to mid-20s. If a portion of this is ascribed to the assumption of the business, then it would not be counted as revenue, and the margins on this acquired business would be lower. As I said, during this transition period, T-Mobile is committed to continuing to improve the cost structure. Post-closing, but during the 54-month period of receiving payments from T-Mobile, we are quite confident that we can get the margins of the combined business into the low to mid-30s and maintain low CapEx. Sorry for the technical difficulties too, Jim.
No, that's fine. Just one follow-up on that. Is the current Sprint business now, and it all depends on how much the revenue shrinks over next year, is it EBITDA positive now?
It is not.
It is not. Okay. How does it impact your leverage? Will it hurt leverage a little bit at the close, and then you see that improvement over the first year?
It will not because we, as I said in my opening remarks, are acquiring this through a newly formed subsidiary, Cogent Infrastructure, that lies outside of the credit package of Cogent. All of our debt sits at the group level, and our leverage ratios will not change there. At the combined company level, we have no debt.
Great. Thanks.
Thanks, Jim.
Thank you. One moment for our next question, please. Our next question comes from Frank Louthan with Raymond James. Your line is now open.
Great. Thank you. I had a sort of a strategic question that I wanted to ask. Over time, Dave, you have-
I can't hear you, Frank.
You can't hear me? Is that better? Can you hear me? Operator, can you hear me?
I can hear you, Frank. Mr. Schaeffer cannot.
I cannot. Do you wanna try to repeat Frank's question for me, Norma?
Let me go ahead and take the next question, and then I'll come back to you, Frank. Sorry. One moment.
Okay. That's fine.
The next question comes from Michael Rollins with Citi. Your line is open.
Hi. Thanks, and good morning. Dave, curious about how you think of products in terms of additional products, maybe beyond some of the ones that you mentioned. Is there an opportunity for Cogent to leverage the building footprint and do small cells or do something with the, you know, buildings, the metro fiber you have, and now the potential for this long-haul access? I'll follow up with a second question afterwards.
Yeah. I think there are a couple of additional market opportunities that this provides Cogent. The first is to expand our co-location footprint. There is 1.3 million sq ft of owned Sprint technical space. We think the majority of that will be added to our co-location footprint and give us combined well over 1 million sq ft of colo raised floor space where we can sell rack and power. Because these facilities are widely distributed, there are 47 unique facilities. This gives us a significant opportunity in edge co-location close to customer bases. We also know that with the deployment of 5G, and T-Mobile is a market leader in that, having a dense metro footprint is helpful.
While that is not part of this transaction and there is no commitments either by Cogent or T-Mobile, we do look forward to working with them and other wireless providers to help them with these expanded assets. It's just not baked into our current thinking. We try to be realistic about products that are directly adjacent to our business. Your second question, Frank? I mean, Mike, I'm sorry.
Oh. That's okay.
I know we got Frank coming up next.
Second question is just on the dividend and how the board is thinking about the dividend in the context of the current business as well in the context of the pending acquisition.
Yeah. You know, as I stated on our last earnings call, our rate of growth and free cash flow has decelerated because of COVID. It's continued to grow, but it has decelerated. As a result of that, we are evaluating the rate of growth in the dividend. I think that will continue going forward. I think the combined business with the $700 million payment from T-Mobile is more likely to be able to continue to grow the dividend than perhaps even the standalone Cogent, unless the return to office trend accelerates. We feel confident that the combined company will be able to continue to grow its dividend for the foreseeable future. We again want to caution investors that we will continuously evaluate the pacing of that growth, but the commitment to that dividend growth is real.
Thanks.
Thanks, Mike.
Thank you. Again, ladies and gentlemen, that's star one one to ask your question. One moment for the next question. The next question comes from Walter Piecyk with LightShed Partners. Your line is open.
Thanks. Dave, I kinda wanna go back to those last two questions from the combined Jim and Mike together. I'm not really interested in kinda where the debt sits within your corporate structure. If you're buying an EBITDA loss company, your ratios are going up, and I think the slide says you're gonna work to get them down to three in five years. That would be the target. What specifically is gonna be the new net debt to EBITDA after the combination?
Norma, who's asking the question? I think I was dropped again.
All right, Mr. Schaeffer. Mr. Piecyk, would you repeat your question?
For you to repeat or for Dave to-
Yeah. Walter, could you repeat? I apologize.
Yes. Dave couldn't hear you.
I think I was dropped.
Oh.
when, your question came up.
Sorry.
No problem. So you're buying an EBITDA loss company, obviously. I'm sure the question someone's saying you got $1 versus $0.50 is kind of funny because you're literally buying an EBITDA loss company that no one else wanted. I'm just trying to understand what your leverage ratio is gonna be, not where the debt sits when this transaction closes.
Okay. A couple of points, Walt. The first one is, this was a competitive process and there were other bidders. Second, this transaction is coupled with a purchase commitment of $700 million over the next-
No, I saw that, Dave. Let's give you the full credit of the $700 million. Let's assume the accountants let you book that as revenue and EBITDA. What is your ratio gonna be in that scenario?
It will be lower than it is today. If we book all of that as revenue, Cogent.
Uh-huh.
Combined leverage ratio will decline.
What could they force you to book it as?
It's one of two things.
The account.
It's either the recognition of revenue or.
Mm-hmm.
The assumption of non-economic customer contracts. Those are the two categories.
In other words, T-Mobile basically paid you that revenue to take this off their hands.
That is w-
Because they weren't pre-
That is one way to characterize it.
They weren't previously paying you before. Right. Where does it? Does it just not show up on the income statement? Is it just amortized on the income statement? How does that work?
Right. Under the old, and I'm not an accountant, but under the old rules, you would book that as negative goodwill and amortize it.
Mm-hmm.
Now it shows up below the line as just cash, but it doesn't show up.
Uh-huh.
On your income statement.
Understood. If that's the case, you can't obviously take the full $700. There'll probably be an NPV today of that value. What is the scenario there in terms of your leverage ratio on closing if it's counted that way?
Well, it depends on what the bifurcation is.
Uh-huh.
I cannot answer that today. I believe that based on the pricing and volume discounts that we have given T-Mobile, it should all be counted as revenue. Again, that's my opinion. It's going to depend on an independent third party.
Yeah, I understand.
to appraise it at closing. In the worst case scenario.
I understand. Your point is the board's gonna look at this and say, "Look, accountants are gonna do what they're gonna do, and wherever that ratio comes out, we're still fine with the dividend and increasing it." When you say growing at a potentially slower rate, is this still gonna go up sequentially every quarter, or are you just talking about the annual growth rate should, could slow, which means you might not make a sequential increase?
We are committed to making this sequential increase.
Got it.
What I have stated even prior to the announcement of this transaction, and it was actually in response to questions you asked in part on our last earnings call, that
Yeah.
We would reevaluate the rate of growth. We are committed to every quarter sequentially growing the dividend as we have for the past 40 quarters. Again, on a free cash flow per share basis, this is accretive and reduces leverage on a free cash. Whether it's counted for EBITDA or not is an accounting question that is dependent on that appraisal.
Got it. Let's talk about the margins then very, very briefly, which is, I think you have, like, 1,000 employees. You're taking on 1,300. I think you said T-Mobile cut some of these employees. I don't know how much they did. That would be helpful if you know. Like, you talk about 100 basis points of margin a year. You haven't done a large acquisition before. Does it make sense to bring someone in to make larger cuts to that organization to try and accelerate that margin expansion?
Two different points, Walter. We have purchased large companies. Now, it's been a number of years, but when we acquired PSINet, there were 9,000 employees. We retained 53 in that transaction. When we acquired Allied Riser, there were 971 employees. We retained two. When we acquired Verio from NTT, there were 1,801 employees. We kept 13. In terms of headcount reduction that has been ongoing, over the past year, Sprint has already shrunk its employee base by about 350 employees. T-Mobile is committed to continuing to treat its employees well and offer them severance packages during the period between signing and closing. In addition to the $700 million payment, we are getting additional payments from T-Mobile for further headcount reduction.
We do anticipate the headcount being lower at closing than it is today. We anticipate that number continuing to go down. We also anticipate continuing to grow the sales force of the combined company. To just remind you, less than 5% of the Sprint employees are involved in sales, whereas 65% of the Cogent employee base is involved in sales. We think that we need to add additional sales resources and right-size the operations teams.
Okay, got it. They're gonna pay you after deal closing, they're also on top of the revenue that they've guaranteed for the next couple of years. They're gonna pay you additional cash for severance expenses. Is that a capped number, or did I misunderstand what you said?
Uh, it-
Okay. Is that a capped number?
There is a cap in that number. It is $25 million.
Okay. Yep.
That's above and beyond the $700.
Sorry, last question. Is the subjective view of the board here that, look, the thing that our investors care about most, the ones that actually own the stock, are dividend growth. This is not gonna blow up our dividend growth as we just identified. Even though this is gonna like, you're gonna substantially change the company and look more like, I don't know, just a junky enterprise company based on the assets you're buying, which are gonna be a big percent of the revenue, that it doesn't matter because it's just, I'm gonna continue to deliver on that dividend. Is it also basically just an acknowledgement that your corporate business is just never gonna return to the growth we saw pre-pandemic?
Well, first of all, I take offense at the term junky corporate business.
I mean, Dave, they're paying you to take the business. How else would you define it?
No, it needs different stewardship. It is a valuable asset that needs to be repurposed for a more modern product set.
Okay.
No, no, no. To your point about our corporate business, our corporate growth rate was dramatically impacted more steeply and for longer by the pandemic than we had anticipated. It is improving, and we expect it to continue to improve. This business is accretive to the combined company, giving us owned assets, giving us a customer base that is larger than the average customer size within Cogent's existing customer base, and allowing us to sell to those customers products that are future looking rather than legacy. The legacy products are being terminated. Thank you. Who's got the next question?
Thanks. Thanks, Dave.
Thank you. One moment for our next question. Brandon Nispel with KB, KBCM, your line is open.
Great. Thank you for taking the question. Dave, I guess, is it fair to assume that you would not have done this deal without the T-Mobile agreement? If so, what happens once this initial agreement expires after, what is it, 52 months? Then is it on the Sprint assets, is there a hard synergy number we should be thinking about in terms of sort of pro forming out the EBITDA of that business? Thanks.
First of all, the purchase commitment from T-Mobile and the gross margin it provides us was a critical component of the total consideration for this transaction. There is a belief that it will take some time both for T-Mobile to continue to improve the business between signing and closing, and our ability to continue that improvement and accelerate it post-closing. The structuring and timing of those payments were designed to allow us to continue to grow our cash flow during that time period. In terms of synergies, there are synergies both in cost reductions on the Sprint side as well as actual cost savings for Cogent. Those synergies are what are blended together to give us the confidence that by the end of the initial T-Mobile period, we will have a revenue base of $1.5 billion and EBITDA margins in the low-to-mid 30s.
That is substantially more EBITDA and cash flow than Cogent would have had on a standalone basis. We will continue to work with T-Mobile and potentially may have other opportunities to sell them services, but we are not counting on that in our go-forward business plan. Next question, Norma.
Our next question comes from Tim Horan with Oppenheimer. Your line is open.
Thanks, guys. A few clarifications, Dave. Just the $350 million revenue in the first year, you'll only really be allowed to book $170 million of that regardless, right? Whatever happens from the accounts, just because it's part of the five-year deal. You know that money, will that make you extremely free cash flow positive that you can reduce some of the debt?
On the booking of the revenue, there is specific volumes and port counts associated with that revenue. These are products that we sell in the ordinary course of business, and if it is counted as revenue, we would book it all as it is received. We don't have an amortization issue because there is a step down in volumes associated with the step down in monthly payments. To the answer of the cash flow question, yes, this will be accretive to cash flow, but we know that we will need some of this cash to complete the restructuring, the one-time expenses associated with modernizing the product set. It is unlikely that we will utilize this cash short-term windfall to reduce debt.
Great. The $450 million ongoing revenue, what percentage of that do you think is the legacy or is your MPLS or what you consider legacy?
Of the revenues going forward, we believe at closing it will all be from either VPN services, DIA and transit, or wavelength and colocation services. Those four major product categories will comprise the vast majority of that revenue. We're anticipating that the end of life product process that has already begun inside of T-Mobile will continue, and we're anticipating closing anywhere from nine-15 months. We don't anticipate any regulatory obstacles, but there are just a lot of jurisdictions that have to weigh in.
No, of course. How many wavelengths are lit right now in the network on the average of 48? What percentage would be lit?
Oh, de minimis. They've lit just a handful of wavelengths. Remember, today's technology, utilizing the C and L band will support up to 160 wavelengths per fiber. They've lit just a handful on just a pair of fibers. There is substantial opportunity to utilize this asset much more effectively.
How many buildings are connected on the metro side, and is there, you know, good synergies for you to enter other new buildings from that or for you to lower some of your own IRUs on the metro side?
The answer there is no. That's a big part of the value add that's being created in the combination of the company. They are in only about 25 carrier neutral data centers and their own proprietary facilities and no end user locations. A big part of the synergy is to utilize the Sprint backbone in conjunction with Cogent's metropolitan assets.
I have about 20 other questions, but I'll take them offline, Dave. I apologize.
That's fine, Sam.
I'll just ask one last one. You were kind of growing EBITDA historically in the 12%+ range. I mean, if you can continue that out from 2022 to 2028, you would have hit the EBITDA that you're guiding to right now. You know, I guess, are you being conservative, you know, with this EBITDA that you're talking about in 2028, but, is there just more free cash flow maybe that we're not seeing because the CapEx will be a lot lower? Yeah, any other color would be great.
Yeah. I think we're trying to be conservative here, and we're being realistic that the corporate growth rate has not returned to pre-pandemic levels. Because of that, we are being more cautious. Listen, I've been overly pessimistic on the prospects of our NetCentric business prior to this transaction, and I've been overly optimistic on the rate of return to office and the improvement in the corporate business. In coming up with these goals and targets, we have tried to be very conservative on our expectations of return to office.
Thank you very much. Good luck.
Thanks.
Thank you. One moment for our next question. The next question comes from Ana Goshko with Bank of America. Your line is now open.
Hi. Thanks very much. Dave, why are you structuring the transaction from a debt perspective that these assets will be put in a non-recourse subsidiary? Because it does sound like they're gonna be, you know, very integrated ultimately into the larger business. And it just adds a lot of complexity, I think both for you and for investors to understand, you know, what the credit risk is, you know, what the financials are, how we should think about leverage, et cetera.
Yeah. Ana, thanks for the question. Hopefully, I'm gonna see you later today. You know, the idea was that we would keep the infrastructure portion of the business separate to be able to sell dark fiber and to enter into the wavelength business. Eventually the services that are delivered, either whether they be VPLS or transit and DIA, will migrate onto the Cogent network. Our scale in those products by bit volume is several orders of magnitude greater than Sprint's scale. It made sense to kind of segregate these two into two separate silos and eventually looking at that infrastructure as a standalone business that may be able to have its own capital structure and raise debt.
Ultimately, we think that Cogent's group, its operating business, will be a customer of that infrastructure business, allowing investors to understand the dynamics of both the IRU business which they've become accustomed to, and then also to be able to show the performance of the infrastructure as a standalone business.
Okay. Well, you know, as I mentioned, it sounds pretty complex. Will you be reporting for financial information for the credit group only?
No. We will report at the holding company level, and therefore we will have a breakout of the credit, the financial reporting for the credit group and the financial reporting for the infrastructure group will be segregated.
Okay. Well, that was my question. Okay, great. Okay. I will see you later today. Okay. Thank you, Dave.
Okay. Thanks.
Thank you. One moment for our next question. Our next question comes from Frank Louthan with Raymond James. Your line is open.
Great, Dave. We fixed the audio issues. Can you hear me? Guess not.
Dave, are you there?
Somebody's telling me this isn't on the Sprint network.
I'm not sure. Dave, are you there? I think he may have disconnected. One moment, please. Ladies and gentlemen, please stand by. Again, ladies and gentlemen, please stand by. We're experiencing technical difficulties. One moment, please.
Hey, Norma. Can you hear me?
Yes, Mr. Schaeffer. You're back.
Hey, Dave, can you hear me?
Hello?
Mr. Schaeffer, can you hear me?
Hello.
Mr. Schaeffer, can you hear me?
I hear you now. It seems like every time you initiate a new question, you've been dropping me.
Hey, Dave, can you hear me? It's Frank.
Yeah. Hey, Frank. I'm sorry, I didn't hear you. I hear you fine now.
That's all right. That's okay.
We'll take this question. This will probably wrap it up. Frank, go ahead.
Yeah. Hopefully this call isn't on the Sprint network, but I guess my question, how long will it take you to wind down that legacy Sprint business? That's kinda my first question. The second one is, what percentage of your IRUs that you have today do you think you can ultimately put on the Sprint network? How much of that will be completed by the time of the close? Thanks.
Okay. In terms of the wind down, T-Mobile is continuing to end the life of the non-core products, and they have contractual obligations to customers, so they will extend, most likely, past closing, and it will take as much as three years to end all of those legacy products. The second piece of that is the migration of the transit and DIA from AS 1239 SprintLink onto the Cogent AS 174 network. That can only happen post-closing but should happen very quickly, probably in a period of less than 90 days, and will achieve tremendous efficiencies by being able to pull those redundant routers and other equipment out of service, saving space, power, and equipment. For the MPLS to VPLS conversion, that is going to be an ongoing process that will begin immediately. T-Mobile is committed to that.
We will provide some technical guidance to help show them how to do that efficiently. I doubt all of that will have occurred prior to closing, and it may take another year or so till we can completely migrate all of those MPLS customers to a more modern VPN architecture.
Okay, great. All right, Dave. Thank you very much.
Thanks.
Thank you.
Well, I want to.
Ladies and gentlemen, please stand by. Mr. Schaeffer, if you're able to hear me, you disconnected. Mr. Schaeffer?
Yes, I was going to just.
Okay, you can go ahead and conclude.
All right. I want to thank everyone. Please accept my sincere apologies for the technical challenges today. I look forward to talking to everyone individually and answering any questions. We are excited that this opens up a new chapter in Cogent's history, but also continues on the success we have built on from our previous acquisitions. You know, whether it be PSINet or Allied Riser, you know, Carrier1 or FirstMark, and now adding Sprint, one of the initial Internet backbones, into the Cogent family gives us tremendous opportunity and allows us to be truly the world's leading Internet service provider. Thank you all very much. Take care. Bye-bye.
Ladies and gentlemen, thank you for your participation. You may now disconnect everyone. Have a wonderful day.