All right, thank you very much. I'm Sami Badri with CS, and we have Sean Wallace, the CFO of Cogent Communications. Thank you, Sean.
Good morning.
Sean, one thing I wanted to discuss with you is one of the big things about Cogent is looking at the KPIs and then also tracking those KPIs on a quarterly basis and how those KPIs are either correlated or not correlated to your business. One of the biggest ones that actually is a leading indicator to your corporate business actually is the key cards.
Key cards.
Key cards and office building access. Where are we in from, like, that metric perspective, even after 3Q and going into 4Q?
Yeah. Well, we've discussed this, and there's really three things that we look at. It's key cards, and that has been steadily improving. It's a little bit different in different parts of the world. If you're in the Southwest, if you're in a place like Dallas, it's pretty close to normal. In some southern cities, it's actually above normal where it was sort of pre-pandemic. In a lot of other cities like New York, Boston, Philadelphia, San Francisco, L.A., it is still well below where we thought it was big.
That correlates significantly with our sales on the corporate side.
The other thing we look at very, very closely is subleasing and leasing activity. We had, in the third and fourth quarter of last year, a significant amount of retail space, you know, space that came on the market. Vacancy rates pre-pandemic were, like, 7%-8% in places like New York and Boston. They're now up in the mid-teens. We have customers who are going out of business, and we don't have a lot of activity bringing new tenants in.
We're optimistic that when the world comes back, January third.
Maybe it's January eleventh that subleasing activity and leasing activity will go up. When new tenants come in the building, that will hopefully be good for us.
We win. When we send out a proposal, we win 40% of the time. We know those buildings exceedingly well. We have salespeople who are now thankfully can go back into those buildings. They know who's in there. They know tenants are moving in, and they are typically all over those opportunities.
win rate of 40% of the time, when you lose that other 60% of the time, who are you losing to, and what are the usual features in those deals?
It's a good question. It's typically a smaller capacity, so it's 100 meg or less. So it's a little bit pricier and don't need mission-critical, high SLA, high capacity lines. It is sometimes where someone has 15 different locations, and maybe we're only three or four on-net, and we can't reach some of the others as effectively as we can. It is when some folks do an integrated package and put everything together, and some folks do security or other things, and they sort of throw that in. But we typically don't lose when, you know, sort of our really good spot, sweet spot, you know, a one gigabit circuit, we're not losing very, very much.
Got it. I did wanna address some of the salesperson turnover. Before I get into that, could we just kind of recap the dynamics at Netcentric? I know you're starting to lap some pretty difficult comps.
Yes.
What's the latest kinda on Netcentric?
We had four just amazing quarters in that business, and it is a function of the fact that Dave Schaeffer and the team have done a phenomenal job of positioning us for that streaming business. What does that mean? We're in 1,300 data centers. We're in more data centers than anybody else around the world, carrier-neutral data centers. We are in now 50 countries. We're also in Hawaii. That footprint enables streaming companies to basically effectively say, "What is the best network I wanna build?" Because we're in such great places, we're gonna be a first choice for them. Other pieces that sort of get us there, we have over 200 people, professionals, whose sole role in life is to sell this product. They're really smart about it. They know all those.
They find those types of customers, and they do a phenomenal job around that. We not only have ubiquity in terms of footprint, we're very aggressive on price. We will not lose on price. When you add all those things together, this is very much a commodity sale. It's done at the cross-connect at a data center.
We have more cross-connects. We have more salesmen selling it, and we have the best price.
Got it. One thing I've been trying to triangulate is you actually had a very significant salesperson turnover.
dynamic in 3Q of 2021. At the same time, your growth rate didn't actually take that big of a hit or a big of a deceleration. What is the bridging factors that explain this, right?
Like, you know, the growth rate did decelerate quarter-over-quarter subtly, but relative to the salesperson turnover, which was actually extreme, how do you kind of, like, connect all those dots together?
I really look at the world in a sort of pre-pandemic, post-pandemic. On March 15, 2020, our entire sales force, indeed our entire company, sort of went home. It's very clear, and Dave, our CEO, has been pretty honest about this, that it's just not as effective. It's a telephonic sales force. We're just not as effective in managing and mentoring and nurturing and bringing along salespeople in that environment. As a sales manager, you're gonna have 20 or 30 salespeople in an office. We have them in D.C. where I work, and they can go along, and they can stick their head in. They can hear the salesmen how they're doing.
Understanding how their conversations are going with the sales force and do real training, and there. We couldn't do any of that. I think, candidly, I think a lot of salespeople were doing a lot of things but also weren't working as hard as they were. In August, we had the Great Resignation, just like everybody else. We didn't have a lot more than anybody else. We definitely, as we were looking to come back in mid-October, went and found folks who weren't performing, underperformers and sort of parted ways, and a lot of them said, "This isn't for me," and we moved on. We are not finding a challenge hiring people.
We're optimistic that we're now in that in situ office situation that will do a better job in monitoring, nurturing, and mentoring these folks.
We hope productivity comes back, but it's been a very difficult environment because of that.
This is gonna be kind of one of my more fun questions that I ask people.
Go for it.
Assuming you have more kinda turbulence with the salesperson flywheel, could you still grow 4%, or would growth start to deteriorate if you did not backfill those seats for sales?
You know, Mitch McKenna is the guy who runs our training and Salesforce stuff. I call him up and I say, "Okay, Mitch," you know. I call him up every week, say, "How we doing?" He says, "It's not a problem to hire people. We can get people. We sometimes have competitive comp and everything else. We're optimistic that we can now train people in-house as opposed to do it virtually. We're happy that they're in-house." I think candidly, if you look at our numbers, this is on our presentation, which is on our website. You can see our productivity went down the last six quarters. We're optimistic that in an in situ environment, we are gonna be much more productive and hopefully we'll get back there.
You know, your question is, can we grow 4%?
Even with no backfilling of like productive salespeople.
The answer is yes, because I think it's gonna be a much easier environment. Remember, we have-
Close to 600 people in our sales and marketing organization who are already there. We continue to hire people and everything else, so that's at the margin. It's been a very difficult environment on the corporate side.
You can't go into the offices. You can't find people. You have clients leaving. We now hopefully are gonna see new tenants who are subleasing space, who are taking lease space. I think when corporates get done with getting people back to the office, they're gonna look at their configuration and say, "You know what? We haven't upgraded in 18 months. We have a lot of people who are now working more disparately. We need to upgrade the systems." We'll be hopefully gonna benefit from that.
Got it. Well, I think what's like very impressive is, with the amount of turnover you guys saw and 4% growth, I think cable companies would die to have that kind of mechanism in place. Maybe shifting gears a little bit more and going into 2022 and 2023, other than just office key cards and tracking and volumes of people going into the actual offices, what other metrics should we be tracking to detect a pickup back into your business?
Vacancy rates, so you should be looking at that. Colliers has pretty good data on that by city. You should probably focus on more northern cities and California cities. Those are the area where we have more. I mean, we are in many ways. I don't like to say this, but we are highly correlated to the return to office because we're in these cities.
Over 60% of our buildings are in cities where they've been sort of hurt the most.
Chicago, New York, L.A., San Francisco. If those cities return, we are optimistic for those two big pieces. You should look at subleasing and leasing activity. It's all of the brokers deliver that, and you can look at that on a quarterly basis. It is coming back. You could look at the net absorption of space. If the net absorption of space begins to get negative again, that, which is a good thing, we should be performing well. Then it's just anecdotally, are companies forcing their employees to come back to work.
Got it. I wanna shift over to margins because the margin story is equally as impressive as the durability of growth with excessive sales turnover.
Incredible, isn't it? Yep.
You know, I guess like what I asked Dave is the scenario analysis. You grow 4%, margins expand 50 basis points. If you grow 6%, they grow 150 basis points. What if they grow 10%, which is actually the long-term guide of the company? What is the margin expansion or contribution margin profile?
I mean, Dave talks about this and that's really. I like to say that's a sort of. That's what we hope to achieve.
It's not a projection in any way, shape, or form. Dave is very consistent saying we're gonna hit those numbers. We'll see. It's just math. When we sell a product that's on-net, 90%-92% of every dollar falls to the bottom line. As we grow that base of customers, we're gonna continue to grow that margin. I'm not gonna give projections on sort of how that will perform. What's really interesting to me is in a pretty anemic environment where corporate is basically we've been losing like $1 million-$2 million of revenue per quarter, we've obviously had real benefits of real dynamic growth on the Netcentric side is that we've been able to continue to get those margins up.
We were up 60 basis points year-over-year on the EBITDA margin. I guess I gotta tell you, I've been at Cogent a year and a half. We have a very smart, disciplined, management team that is constantly looking for systematic ways to improve our cost base.
Last summer, we implemented this thing called Compass. It's a CRM system. We had a software provider that we were spending $300,000-$400,000 a year on that. We're now, our out-of-pocket cost is probably $100,000, so there's
$300,000. In December of this year, we hope to finish a 1 MW solar array on our facility out in California in Pasadena. We'll probably save another $300,000 a month in SG&A, if depending on electricity rates and everything else and usage. We looked at every loop circuit that we had, and we found out that sometimes we'd have customers who would turn off and we wouldn't turn off those circuits. We were still paying for them. We created a process and we found, you know, another $200,000 in expenses.
This is just a really well-run company that systematically looks for ways of improving the bottom line. Combine that with 90% on-net contribution margin, we will get those margins up over time.
Got it. You know, I think historically, I recall, the entire network running on one specific large cap networking vendor's equipment.
Yes, sir.
Have you guys upgraded that? Have you refreshed the network, or are you guys still running on the former? I mean, not that there's anything wrong with it's just maybe more of a question of-
I have a pretty funny s-
network upgrades.
I have a pretty funny story. The network is this big living, breathing thing of 9,000 nodes, and the two big pieces of equipment we have are routers and DWDM. DWDM shoots the light on the fiber. The router basically takes in the packets when you type in something and looks up a table and then sends it on its way to the next. What we typically have done is when we get to capacity in central parts of the network, we take that equipment, we send it back to a facility in Northern Virginia. It gets cleaned up, and it gets sent back
Shrink-wrapped to an edgier part of the network. That big company today said, "Look, we're not gonna support that equipment anymore .
You've had it too long." Our CapEx have come up a little bit because we've pre-ordered stuff, and we've had to go and take stuff out that candidly it could be supported anymore.
The Cogent network is already superior than most networks, right? Because it's one layer, one operating system, fully distributed. It's not like you guys need the upgrade.
Here's the great question I asked Dave. Said, "Why did you choose IP Ethernet?" It was very simple. You could have done time-division multiplexing in around 2000. There were thousands of networks out there. There were millions of LANs.
Dave felt that IP and Ethernet was so far and so superior in terms of its cost base because of the installed base that, you know, every network would wanna be an IP Ethernet network, if they could.
It's just we are so much further down the cost curve in terms of manufacturing and R&D versus this stuff. Indeed, a lot of those protocols that you're mentioning from other companies which they can't get rid of, it's just too difficult and too costly. The cost of those networks is actually increasing on a per bit basis.
I have a off-script question for you.
Go.
These can be a little bit scary. One thing that people don't do is associate Cogent with this concept of the Metaverse. If that is a killer application, which it looks like it's turning into one, what would be the implications to a Cogent?
Of the Metaverse?
Yeah. Metaverse web traffic.
You know, I don't know enough about Metaverse.
Exactly. The bigger question is, you know, Dave always talks about the next big killer app.
Yep.
That's going to be a significant step function up in web traffic or just overall processing of bits. In the event that there is this big step up, you know, step up function of traffic, Cogent would be one of the key beneficiaries of something like this.
Correct.
Right?
Correct.
Right. Yeah, see, you never know with the off-script questions.
I mean, the things that we. If you look back 30 years on the Internet, it's sort of grown 35% a year. It's amazing. Things that sort of are candidly issues of content distribution, it's clear that some of the traffic that would have been on IP transit has moved there. Those modules are moving faster. But at the end of the day, the Internet just continues to innovate and grow. You know, I was looking at my daughter works at another investment bank, and I was just looking at. She's an analyst.
I was an analyst 25 years ago, and I was looking at what she does on a daily basis and the amount of data that is just there. I was just looking at their presentations. Our presentations were, for the most part, black and white. You might have one or two things. It is amazing the amount of data on every page and the amount of analytics and other things that are required to produce that page versus where it was 20, 25 years ago. That's across. George?
Hi, Sean. I guess maybe touching back on corporate 'cause I think, you know, most investors are pretty comfortable with the Fed rate. It's early days, but what have you heard from customers on like the new variant? Is that affecting office plans, or is it too early to say?
You know, I think what we typically see with these variants is that they become much more contagious, as this one is, and much less lethal. What the real estate people, and these are folks who are talking to companies all the time about what they're doing with everybody else, the question is no longer about COVID anymore, it's about their lifestyle. People have become used to working remotely. They don't like, you know, the. They're happy that they don't have to commute. You know, people who are in, you know, have long commutes are thrilled to do it two days or three days a week as opposed to that.
I don't know. I think it's too early to tell. Candidly, I think everybody is tired of COVID. It's unclear how lethal this really is. It looks like it's not. If it is, more people will get it, particularly young people who will probably have less of a chance of having mortality. I think this is just a bump in the road. I don't think it's the Delta variant.
Got it.
I'm not an expert, so you know. Yeah.
Maybe just one follow-up. Can you reiterate how the corporate sector can benefit from these smaller footprints in offices?
There's a law firm in Texas. A buddy of mine is a senior partner. They have three floors in a building. They're gonna go to two floors. I said, "What are you gonna do with the other floor?" He says, "Well, we're gonna sublease it. We have, you know, we have 10,000 sq ft in that footprint, and we're gonna lease it to somebody else." We average about 51 tenants per building. If you talk to JLL or CBRE, they think that the footprint, the core footprint in Class A buildings is gonna shrink maybe 10% or 15%. Do we go from 51 to 60 tenants per building? I don't know. If that happens, that's a good thing for us.
I, you know, we're not counting on that, and we haven't changed our models or, you know, we wouldn't change guidance on how we're gonna grow.
I want to split the regions and, you know, different growth rates. You know, Europe, I guess, has moved a little bit slower, in terms of reaction, reopening, things going back to normal. Part of that is the supply chain issues.
Yep.
Part of that, the U.S. just kind of moves faster sometimes. How is Europe progressing relative to the U.S.?
We don't sell any corporate. We sell it in North America, Canada, a couple cities in Canada and the U.S. Our customers in Europe are primarily two folks that are Netcentric, so streaming companies, ASPs, all these folks who are, you know, pushing out content. We have phone companies, cable companies, ISPs. The impact of people going back to office really has not changed and everything else. As you look at our revenues are counted where contracts are signed. We might have a global customer who might be having all of its network out in the rest of the world, like HBO Max uses AT&T, no surprise there in the United States, but uses other networks outside of the United States.
It's a little bit misleading. Obviously, there was no corporate business in Europe, so we don't have that impact-
Got it.
of back to office.
Got it. I wanted to go on to one of your newer businesses that you're trying to start up, which is the peering business.
Yep.
How is that progressing? What is the latest? Maybe, you know, if it's not as progressing as planned, what has come up as maybe some of the things that you have to focus in on?
It's needless to say, we're disappointed. We've had conversations about this. We thought that that business would be further along. It is a virtual business, so we've got to get folks on that network using it and making it part of their toolbox. It's likely that we're gonna have to get a large player to join that and be part of that. We're in discussions with some. Their pricing expectations are probably not where Dave would want them to be. So we've started that last fall, so almost, you know, about a year ago. I would say on a scale of one to ten in terms of performance and where we are versus expectations, it's a one or a two.
Okay.
We're not shutting it down. We're gonna continue to try to grind through, and we're optimistic that over time, it'll just cascade and get there.
The incremental cost of just powering that up, very almost zero.
Zero.
Right.
It was Dave's idea in July of last year. It was out in October. We had to create, you know, a new product code. We had to train some of the salespeople. There was some software, but zero cost.
Got it. For building that business up, is it gonna require a lot of salespeople, like salesperson investment?
You know, it's those 200 salespeople doing Netcentric are probably the folks who are gonna sell-
Those are the guys. Okay.
most of it. Candidly, I think it's gonna require, and there's debate internally about, you know, what we need to do. We're literally gonna have to probably give some big customer either a huge discount or free time to get them to go on.
Once they go on, you know, the flywheel will sort of turn.
One other question I forgot to ask you earlier—this was about the corporate customer base. A lot of corporate customers actually upgraded their internet speeds in the beginning of COVID, right? From 100 Mb to 1 Gb, some even higher. Have you seen any reversions to slower speeds, or have they, for the most part, once they upgrade, they're there and they stay?
You know, it's in many. I was-
Actually, it's a complicated question because even I remember when Dave did this, there were, I think it was contingencies or features in the contracts of upgrading, so the price was compelling, but the duration of the contract was longer and locked. Maybe we could just talk about, like, have there been any changes to those contracts or negotiations?
The March sales bonanza, March, April, May of last year was a blip in a very long trend of. You know, in 2015, I've gone back and looked at all our products. I looked at the entire general ledger, and there are about eight products which are the most important products in the company. They're about 80% of the revenue. You can see. I mean, first of all, people thought Dave Schaeffer was out of his mind for selling 100 Mb around the turn of the century. It is now that's the buggy whip. I would almost look at it as an MPLS product.
That has been around for a very long time and is declining. It was declining in 2015. It was declining in 2018, 2019. In 2020, that decline accelerated due to COVID, folks going out of business, as well as sales to get there. That product base is declining around 20%-25% in terms of count every year. It's now getting into that asymptotic range. It used to be our largest product. It's now our fourth biggest product, and it will continue to decline. GigE, which was at the time, like our third or fourth biggest product, is now our biggest product. What's really interesting to us is that it's more difficult for a lot of our competitors to provide 1 Gb symmetric service.
They like to sort of say, "You're gonna get 100 Mb, but you won't get 100 Mb all the time." This is another leap and another more pressure on their network. We're optimistic that we can go to customers and say, "Look, you don't wanna have any time where you don't have blockages. We will give you 1 Gb for basically just a little premium over 100 Mb that you get from somebody else." It's a compelling sales opportunity. I think when we see more tenants, when we see folks restructuring their network, we're gonna really benefit from that. FE will go down, and GigE will continue to go up. I think I've said this to you. We're sort of in 2020, we were like a duck on the water.
Corporate was sort of going flat, but there was a lot going on, and a lot of that transitioned from FE to GigE has already been done.
Got it. One thing I like to ask people that are meeting with investors is: what do you think is the most overlooked thing about the company at this point? You know, when investors ask you questions, they might ask you specifics, things that may seem borderline non-relevant.
You do really good numbers. Maybe George does more the numbers than you. Sorry, George.
We'll give George a credit.
Give George a credit. You know, the big issue I ask is an arbitrage issue. We have senior secured notes.
The other side of your house helped us raise $500 million at 3-3.5%. It's now trading at 3.25%. Our stock, which is junior in the capital structure, let's call it 4%-4.75%. Why is that happening? It basically.
4.75% dividend yield.
Dividend yield.
Yes. Okay.
So-
Unique arbitrage
What is the market saying? The market is saying that it doesn't believe that Cogent can continue to grow that dividend.
It will slow down. Once it goes ex growth, there are other telephone stocks, I'm not gonna pick on any of them, but they're yielding 8%-10% that have similar dynamics. Because of the things we were talking about earlier, which is the margin, the 90% margin, it doesn't take much for this company to continue to grow EBITDA margins, and pay those dividends. I think if you look at the numbers of what you really need to achieve, it's not a material growth rate-
Yeah
...for this company to continue to grow. I sort of look at those two numbers.
The market has really made a decision that, you know, let's call it we're a 5% yield going to 8%, when in reality, it doesn't take much for us to get to that.
Yeah.
That, uh-
You brought like a very good, not covered idea. What's even more interesting is maybe if we went back two or three quarters, the trajectory of revenue growth was higher, so free cash flow was higher, which means that the leverage was actually stabilized or locked, right? Did this arbitrage exist back then or is it because you guys renewed the debt and therefore now the arbitrage exists?
It sort of did, but now I think yeah, we had debt that was coming close. It was its yield to call paper-
Mm-hmm
It really didn't have that. This is a five-year instrument, it's now 4.5 years-
Mm
...that's yielding a little over 3%, and we're yielding at 4.75%. I'd also say, and this is public data, if you go back and look at Dave's purchases of stock from 2015 on, you know, two standard deviations are 25 basis points around that 4.75%. So you have this interesting dynamic where if you run the numbers, and you guys have, and you say Cogent grows 4%-6% a year, which is not a big leap, it'll easily be able to pay that dividend. You also have a CEO who has historically bought the stock sort of at that level. You have an interesting arbitrage between-
What the bonds trade at and what the stock trades at.
Interesting. Well, Sean, I think that was actually my most interesting insight that an executive mentioned about like something people overlooking. Yeah, thank you very much for pointing that out, and thank you for spending time with us.
Great. Thrilled to be here. Thank you very much for the conference. Very exciting to be here.
Absolutely
Good luck. Congratulations on your wedding. That's fantastic.
Oh, yeah. Thank you. Thank you.
It's awesome.