My name's Phil Cusick. I follow the comm services and infrastructure space here at JPMorgan. It's my pleasure to introduce Dave Schaeffer, Founder and CEO of Cogent Communications, and Sean Wallace, the CFO of Cogent. Dave and Sean, thanks for joining us.
Hey, Phil. Thanks for hosting us. Thank JPMorgan for a great venue. I know we'll be back in Boston next year, and I'd like to thank all the investors for taking some time to hear a little bit about our story.
I think you are the only executive so far who has expressed that hope, I am with you. Dave, the U.S. seems to be more open every week. Can you start with an update on what you see from customers recently?
Our corporate business is exclusively in North America, primarily the U.S. and Canada, three major cities, Toronto, Montréal, and Vancouver. I think in the West and South, we're seeing businesses almost return to normal. In the Northeast, we're still seeing most of our customers have limited access to the office. However, we're seeing that a lot of companies are planning for a complete return to work, and as part of that, they're looking to reconfigure their networks.
We've seen our corporate sales activity pick up substantially in the past six to eight weeks. We've seen the number of spoke to's between IT departments and our salespeople increase. We've seen the number of proposals issued increase, as well as the number of actual orders that have been booked. I think a lot of companies are really looking at taking stock and revamping their networks as they return to office. I think this pause will actually be a catalyst for accelerating corporate growth.
Let's take a couple pieces there. First, on the secondary office side, as you talk to companies about returning to the office, is that the, "Hey, we want to restart these secondary office contracts in one month, three months, six months?" Are they picking up to returning already? What's going on there?
Typically, IT departments plan three to nine months out from when they expect service to be operational, depending on how complex the changes are. With secondary offices, we're actually seeing locations bifurcate into two groups. If it is in a remote market, companies are expecting employees back in those offices and are looking for a combination of increased internet access as well as virtual network services between offices. In many cases, replacing legacy MPLS networks that were put on hold when the pandemic began.
We had seen a replacement cycle already underway. That kind of got put on hold while companies figured out what they wanted to do. If, however, a company has secondary offices in the same major market, in most cases, those companies are planning to shutter those secondary offices. In many cases, those secondary offices were put in place to accommodate commuting patterns. With the advent of a flexible work schedule and partial work from home, I think companies are expecting that employees will be in the office three or four days a week and work remotely one or two days. With that, they're able to accommodate those commuting employees in their main locations.
For those secondary offices that may end up being closed permanently, are you still getting revenue on many of those? Are we looking at another churn event in the sort of near term, or did most of those turn off their revenue stream already?
We typically sign three-year contracts with corporate customers. That means at the beginning of the pandemic, on average, those customers probably had about half of their contract term or about 18 months remaining. We also allow customers to upgrade in-te rm. They can increase their monthly revenue commit by buying more bandwidth at a fewer number of sites, and they can extend their contract term. We saw our churn peak in November of 2020, and then for each of the six months subsequent to that, we have seen a reduction in the rate of corporate churn. We do not anticipate any spike up in churn, and in fact, anticipate the continued improvement in our churn numbers probably throughout the year.
That's inclusive of May, that things have been improving.
Absolutely.
Okay. Let's go back to maybe the first comment you made about companies that are re-architecting their networks. It seems like we went through a pause there, but is there an acceleration in that re-architecting happening right now?
Cogent's goal with its corporate opportunities is to have a spoke to once a month. The reality is most companies, most of the time, are not ready to make a change to their network. However, it's important that we're in front of those customers when that change decision is made. When we get to that point, we actually close 40% of the proposals that we have presented to customers. In the pandemic, we saw a significant slowing down of requests for proposals. Companies just put the brakes on and literally stayed the course. I think with the planning for return to a full office footprint, companies are now making those change decisions. In addition to that, there had traditionally been two major catalysts to a customer needing more bandwidth.
That is when a customer migrated part of their computing to a cloud environment, or when they adopted a software platform that was hosted, Software as a Service as opposed to premise-based licensed software. With the pandemic, we've actually seen a third catalyst, and that catalyst is the need for a greater connection at the primary office and a symmetric connection to support those work-from-home employees. We, at the beginning of the pandemic, saw a surge in corporate upgrades. We continue to see almost all of our new sales be one gigabit sales as companies want to accommodate those remote workers. We're now seeing the second part of that, which is the upgrade cycle for SaaS and cloud re-accelerating.
For Cogent, it's critical that there be some change involved because virtually every one of our customers already has internet connectivity, and if they needed a private network, they probably had an MPLS network in place. It's really one of these catalysts that create the opportunity for us to upsell those customers to our solution by giving them more bandwidth, a quick install, and high reliability, and doing all of that upselling while probably reducing their total overall spend on network.
Okay. I want to come back to that in a second. I neglected to say that if you have questions, you can use the ask a question button in the system, and I'll see that. One question I did get over the line was, can you quantify for us at all your exposure today of those secondary offices in region that are sort of commuter hubs, and what that's done over the last year? Has that come down dramatically from churn?
Going into the pandemic, our exposure from multiple offices within the same market was approximately 20%. That is down significantly. Today, it's probably still somewhere between 10%-15% of locations, but it has already exhibited a significant amount of location grooming.
Is the way to think about that maybe half of the secondary offices have gone away, or is that just the secondary offices was that 20% outside of the primary offices?
I think it's half of secondary offices in the same market.
Yeah.
In remote markets, those offices have experienced almost no churn.
Right.
A great example would be you'll find JPMorgan with offices in New York. You still have offices in San Francisco, Los Angeles, Houston, a major money center, Chicago, and those offices will remain in place. They're not going to be impacted by the grooming. If you had an office in Stamford or an office maybe in downtown as well as Midtown, maybe that downtown office goes away.
Okay. Let's think about the primary offices again and that re-architecting of the network. Do you think we've pulled forward a lot of the traffic demand growth, maybe it's that 1 gb upgrade into the last 12 or 18 months, and that you expect to slow down from here?
Before the pandemic hit, we were still experiencing an uptick in one gigabit sales relative to 100 meg. If we turn the clock back when Cogent was founded, our initial investors laughed when we proposed 100 MB connections, saying, "No business would need that much bandwidth." We chose that 100 meg connection because the customer premise equipment that was the interface between the local area network and the wide area network could only support 100 MB interface. Over the past five years, virtually all CPE has now been upgraded to support one gigabit. The upcharge is generally only about $200 per month. It's a de minimis cost. I think we benefit two ways. Existing base, still upgrading, although more than half have already switched to 1 GB . Virtually all new sales are one gigabit sales.
The more bandwidth the customer desires, the more Cogent differentiates itself from its competitors. Because our bandwidth is non-oversubscribed, non-blocked, it's completely symmetric, and there are no possibilities of metered service usage caps, we are viewed as a much better path as companies re-architect their internet. The second re-architecture is that office-to-office connectivity. Roughly 25% of our corporate business are private VPNs, either based on VPLS or SD-WAN. The pandemic stopped companies replacing their MPLS networks with one of these two technologies. Now that companies are reopening those remote offices, they're using this as an opportunity to tear out that MPLS and put one of these lower-cost, more flexible network architectures in place. I think there's actually a bit of a tailwind rather than a headwind to our corporate growth re-accelerating.
Okay. The other issue, this is more seasonal, is that going into the summer months, you typically see data traffic fall off as people spend more time outside. Last year you really didn't because of COVID. How should we be thinking about this year and what that means for just comps over the next couple of quarters?
First of all, our corporate business, which is what we've been talking about, is a non-metered service. It only accounts for about 7% of our total traffic. Our NetCentric business, which is metered and dependent on traffic volumes, does typically experience slower traffic growth in warm weather months. You're correct, though, people spend more time outside. This year is a bit different. Roughly half of that NetCentric business is in North America, but half of it's in the rest of the world.
Outside of a few pockets, Israel, Singapore, maybe U.K., the rest of the world is still behind the U.S. and struggling with the effects of the pandemic. I was on a call this morning with some of the team in continental Europe, and they pointed out that they are still under curfew. They have lifted lockdowns, but they're still requested to spend almost all of their time at home. As people are at home more, even with weather getting better, I think we're going to see a more muted deceleration in traffic growth.
Okay. Yeah, thank you. I should've been more clear about the transition to NetCentric. Let's stick with that and just talk about the outsized growth that you saw in the fourth quarter and then again in the first quarter. How much of that resurgence is due to COVID versus secular trends in streaming and other things?
There are multiple factors that impact both traffic growth and revenue growth. Our revenue growth accelerated much more substantially than our traffic growth. We had a good quarter in traffic growth, but not a great quarter. We did have a great quarter in the first quarter and an excellent quarter in the fourth quarter in revenue growth. I think there are really four things going on concurrent. One, a broadening of the customer base on the content generation side. That means we're less beholden to one or two large customers. We're getting a higher effective price per megabit. The second thing is that more of the traffic is international. Today, over half of our traffic is outside of the U.S. Third, we're getting paid in a larger number of instances on both sides.
Over the past two years, our dual-sided payments traffic has gone from 50% of traffic to 70%. For those investors who haven't followed Cogent closely, traffic either enters or exits our network, and then we have to deliver it to the public internet. We are the second-largest carrier of internet traffic in the world.
When that traffic exits Cogent, there's one of two ways that can occur. It can either go to a peer, in which case we are not getting paid or we also are not paying, or it can go to a paying Cogent customer. We have seen, as we have grown our access network business globally, a much greater proportion of customers where we are getting paid on both sides. That has been very helpful to us. The final thing is actually a bit harmful, and that is we have seen traffic patterns spread out during the pandemic.
Normally, peak traffic usage are between generally 7:00 P.M. and 10:00 P.M. in normal times. During the pandemic, we saw that window expand substantially, now it runs from 3:00 P.M. to 7:00 P.M. pretty much around the world. We get paid on peak usage, we actually will carry more traffic with a wider window not necessarily generate more revenue.
When we put these four factors together, our effective yield per megabit has gone up substantially. Our sale price has declined pretty much in line with historical averages. In fact, it was slightly steeper decline in Q1 than historically. Our historic average is 23% for a year, Q1 was about 29%. For the installed base, we actually saw the price per megabit flat over the year, and that's as a result of that broadening of the customer base, where most of the contracts were coming from smaller players that do pay a higher price per megabit.
Okay. I think you mentioned that the first quarter was the sales team's best quarter in history. Was that more NetCentric driven or corporate driven?
It was the most number of units sold. We actually did it with a slightly lower number of reps than the previous quarter. Our sales rep productivity increased. We're still up on a year-over-year basis. Most of that growth was NetCentric, and most of that growth was outside of the U.S. We also saw these leading indicators that I spoke of earlier accelerating for corporate growth. It feels like we're going to have pretty good rep productivity and unit sales in Q2, probably a little better than Q1.
Okay. again, that's mostly NetCentric driven on that.
It is, but we're starting to see that balance shift a little bit. I think over the next several quarters, we'll see NetCentric revenue growth revert back to more normalized rates. The 24.5% year-over-year growth that we exhibited in Q1 was the second-best NetCentric growth we had ever had. Even if you adjust for FX, it was 18% year-over-year, which is double the long-term average. I think it's reasonable that not necessarily the next quarter, but over the next several quarters, that NetCentric revenue growth kind of reverts back to the roughly 9% average. Offsetting that will be a return to more traditional corporate growth. In 62 quarters as a public company, our corporate growth has been positive at an average rate of 2.5% for roughly 56 of those 62 quarters.
We had two negative quarters in the great financial recession, and we've had four negative quarters in the pandemic. I think the rate of negativity improved sequentially from fourth quarter to first. It'll continue to improve. Also think we're probably a couple of quarters away from corporate being back to that steady 2%, 2.5% sequential growth. Based on sales pipelines and sales activities, it seems very realistic.
Only a couple quarters away from 2 or 2.5% sequential growth would be a lot quicker than I think most people are looking for. Do you think you're at the point where that corporate revenue number has bottomed and you can be at least flat from 1Q to 2Q at this point?
I'm not going to predict exact numbers for the quarter. I think the rate of decline will be better than it was in Q1. Whether it gets to flat or it's slightly negative or slightly positive, I don't know. It's going to be pretty close to that kind of flat number. I just don't have the granularity of the quarter's only half over to answer that question with precision.
Yeah. Not the last two quarters it averaged about -2% sequentially. We're not going to be anywhere near that again.
No, much better.
Okay. We talked about the streaming market and the driver of that on your business. You've been a astute observer of this industry for a long time. How do you see that market shaking out, given some of the changes that we've seen just recently?
Yeah. I think there are a number of new offerings, some of which have gotten scale quickly. Others maybe struggled a little, so they've combined to gain scale. I think there's three things going on in streaming. First, and I think most importantly, an internationalization. What began in the U.S. is now spreading around the world. I think secondly, we're still seeing an increase in the number of minutes per day an average user streams. We've gone from, at the beginning of the pandemic, somewhere around 18% of video consumption was streaming, to today, around 40%. Ultimately, that's going to get up to closer to 80%. I think streaming has a long way to go in the markets where it's already established and a lot of new markets.
I think the third thing that's happening is we're starting to see some differentiation among content and a recognition that scale is critical. I think the pandemic actually exposed some of the weaknesses in the production funnel. Some of the services are starting to run out of content that they couldn't film during the pandemic. I think we're going to see a much larger inventory of new content.
Just like television changed in the 1970s with the made-for-television movie, Netflix really started the trend, but we're seeing an acceleration in made-for-streaming content. I think what's going to happen is there are breakout series and content produced for streaming that's going to further accelerate the transition away from linear. I don't think there'll be any significant new linear series that are the main breakouts, since most of the production dollars are going into streaming these days.
Okay. Another question we get about your business quite a bit. Fiber multiples have expanded quite a bit in the last year. Fiber to the home has become infrastructure pretty commonly where it wasn't before. What do you think about the fiber space today? Has your view changed at all with increased need for data and speeds? How do you think about all these companies that are building new fiber routes?
Our business for 21 years has been based exclusively on fiber. We understand, though, that overbuilding a footprint is very capital intensive, and there have not yet been any examples globally of anyone getting a return on capital greater than their cost of capital. The problem is actually exacerbated by the fact that the internet, which is the key driver of bandwidth demand, was designed as an overlay network. It could sit on top of a cable network, a phone network, or a mobile phone network. A fiber purpose-built network is clearly superior, but your capital is proportional to homes or businesses passed. Your revenue is proportional to homes or businesses served. Because many consumers have choices and, quite honestly, are lazy, the better product doesn't always win. Fios is a great example.
It was clearly a superior product to a cable product, it never achieved enough market penetration to be profitable for Verizon. They basically halted that program. Today, their fiber builds are for other purposes, mainly to support backhaul. We are clearly in a golden age of fiber construction. There is a huge social benefit from fiber being deployed. It's not clear there's great benefit to investors.
We have chosen to be a buyer of fiber, not a builder of fiber. We buy fiber from 280 different suppliers around the world. Cogent cheats in its overbuilding two ways. One, we buy fiber rather than build it to get as close to the customer as possible, then only build that very short extension into the building and up the riser. Secondly, we're ultra-selective about where we buy fiber and what buildings we serve.
We serve data centers, over 1,300 globally, and we serve very large multi-tenant office buildings. The average building we serve is 550,000 ft with 51 tenants. That's very different than the average office building in America. Which is 11,000 ft and has 2.1 tenants . We have concluded we can't make a return selling our products there. While I'm very heartened by all of the investment in fiber, I'm not ready to deploy capital to build fiber. I'm much happier buying fiber through long-term IRUs, 20, 30 years in duration, and getting all of the technological benefit without the sunk capital cost. That's really allowed us a unique return on capital strategy.
Okay. Last question following up on the return of capital strategy. You talked about raising your leverage over the years as you got to, I think it's three and a half times is the high end. We've seen infrastructure businesses, rating agencies raising their comfort up to 5x , 6x leverage on those. Do you consider yourself an infrastructure-like business that would be appropriate over time at a much higher leverage level? Do you have a different way of looking at things?
First of all, we're a utility. Our service is as necessary as electricity or water to our customers. Our customers are very sticky. We have no significant customer concentration, so we have a great deal of diversification in our revenue streams. We have a stated leverage goal of 2.5-3.5 x EBITDA. In fact, our leverage slightly declined in the most recent quarter. We're about 3.3 x net leverage with about $400 million of cash on our balance sheet. Actually, with the help of JPMorgan, we refinanced our secured debt, lowering our interest rate from 5.375%-3.5% and extended those maturities. The rating agencies recognized the positive attributes of our business and increased our ratings. We're today a 4-B credit, S&P and Moody's. We will continue to be prudent in our return of capital.
We have 35 consecutive quarters of sequentially growing our dividend. We are investing in our business as rapidly as we can. We're in 48 countries, 210 markets, over 3,000 endpoints connected to the network. We are returning capital episodically with buybacks to supplement the dividend. We didn't do a lot of buybacks, but in total, since returning capital, we've actually bought back over 20% of our float. We're going to be opportunistic and we'll continue to monitor our leverage. Clearly, our cost of debt capital is the lowest it's been in the company's history, which allows us to magnify returns to equity.
Makes sense. Dave, we're about out of time. Thanks very much for joining us. Thanks, Sean, as well. Have a great day, guys.
Hey, thanks a lot, Phil. Take care and stay safe.
Thanks, Dave. Thanks, all.