All right. Hello everybody. My name's Brandon Nispel. I cover comm services for KeyBanc. We have Dave Schaeffer here, CEO of Cogent. Dave, great to see you.
Hey.
Thanks for being here.
Brandon, always thank you for hosting me. I'd like to thank investors for taking time out of their day, and maybe most importantly, KeyBanc for yet another beautiful venue.
Okay, we're going to start with a little scorecard, Dave. It's been a little bit over three years since you closed the Sprint Wireline acquisition. How would you rate Cogent's execution of this acquisition, knowing what you know of the business today?
Probably a B, Brandon . On the cost cutting, I think we have done well. We actually increased our target and are running ahead of schedule. On the integration of the customers into our systems, processes, and naming conventions, as well as the migration onto our network, I think we have done well. On the conversion of the TDM voice network to a Wave Network, we did well.
Where I think we have underperformed is on the wavelength growth on that network. It took us almost two years to convert that network to Wave enable 1,139 locations. We were pretty much on schedule for that component. Where we have been behind is on the generation of revenue on that Wave network. We have provisioned Waves to approximately 2,500 unique wavelengths. That is to 608 of the 1,137 locations, and as of quarter end, 548 unique customers.
Those are all impressive metrics. The fact that the Wave business grew 9.2% sequentially and 68% on a year-over-year basis is impressive, but what is disappointing is the aggregate size of that base. We anticipated being able to get to 25% of the North American inter-city wavelength market within a three-year period of selling. Based on the pacing we have now, it will probably be longer than that.
I think we are still confident in our ability to gain share, and we actually are encouraged by the fact that I think the wavelength market turned out to be a bigger market than we expected. The other area of disappointment has been in the enterprise customer base that we acquired. Just to remind investors, there was $485 million of revenue at acquisition. It was previously declining at 10.9% year over year.
It was about 10% non-core products, and it was 93% off-net. We went through a very deliberate process of converting as many customers to on-net, to squashing those non-core products, and to improve margin. We have been able to get the margins on that acquired customer base from - 60% margins to breakeven. I think that's an impressive task. The fault, however, is that the revenue stream from those acquired customers has declined to about $150 million run rate.
I wanted to ask you about your long-term guidance philosophy. Cogent Communications has never provided intra-quarter or even annual guidance. You've always focused on longer-term guidance. But along the way during this acquisition, you've given us some intermediate steps, such as wavelengths getting to $80 million-$100 million. That target's got pushed twice. Sprint revenue base stabilizing, that has not happened. You told us you'd get back to growing the business. That hasn't happened. So how do you think about improving the communication with investors, improving that say-do type of ratio?
I think there's three parts to that answer. One, our general philosophy is to give long-term, multi-year guidance to remind investors for 18 years, Cogent was a public company with no quarterly or annual guidance, and we grew an average of 10.2%, and we delivered 220 basis points a year of average margin expansion. We could do that because we had operating experience in the products we were selling and the customers we were selling to.
The second point is, when we acquired Sprint, we needed to put some markers in the ground because I think investors rightly said, "Something is wrong if a smart company like T-Mobile is paying you $700 million to take an asset." And we needed to explain what we were going to do with that asset and how we were going to repurpose it.
To that end, we laid out a market share gain in wavelengths, which is a relatively concentrated market where customers are frustrated with the current suppliers and said we could replicate what we did in the IP market, and we thought we could do it quicker. I still do think we will do it quicker, but I also think we were too aggressive in the pace at which we would get there.
Again, going from zero to a run rate of $65 million is impressive in a year and a half, but it is still not $500 million. I think we got wrong the pacing of that growth in Wave businesses. The third point is the guidance we gave around cost-cutting. There, I think we were very accurate. We actually exceeded our objectives and have been able to grow margins better than we and investors had anticipated.
I think it's important to look at our business through three discrete lenses. The lens of the legacy Cogent business. That is corporate on-net, corporate off-net, selling both VPNs and DIA services, on-net transit services, and then the sale or leasing of IPv4 addresses. The totality of that business, which had been the business that was growing at 10.2% a year, was negatively impacted by the pandemic.
The pandemic slowed the growth in the corporate segment of that business, and it is now closer to a 5% growing business. With that slower growth rate, the rate of margin expansion in that business has slowed from about 200 basis points to 100 basis points. Still a good business, but not as good as it was pre-pandemic. We had hoped that the impact on office occupancy and employee number of days in the office was going to revert to pre-pandemic levels.
That has not happened. It is not appropriate for us to keep talking about the pandemic. This is the new reality that we face, and that legacy business, unless something changes, is probably a 5% growing business. The second lens to look at Cogent is to look through and see the acquired enterprise customers.
We actually accelerated the rate of revenue decline due to our termination of non-fiber delivered off-net services, the decision to focus on higher bandwidth, the decision to terminate non-core services. So what was going into the acquisition declining at about 11%, accelerated to nearly a 25% annual rate of decline for the past several years. That business has gotten relatively small, but even in its current state, it is sufficiently large at that rate of decline to mask the growth in the other segments of the business.
The third piece is new businesses, something that Cogent had never done before. The most important of those is wavelengths. Sprint was not in the Wavelength business. Cogent was not in the Wavelength business. We took that asset, enabled it to sell wavelengths across the entire footprint at any of three speeds, and do it with rapid provisioning. We are encouraged by the market receptivity, as witnessed by the number of customers, but we have a ways to go.
The legacy market for wavelengths is relatively static. The growing portion of that market are both neoclouds and hyperscalers. We have been frustrated by the fact that Wave that have been installed are not always accepted due to supply chain constraints, equipment availability, space availability, power availability, or even things as simple as the business model not yet being fully mature with our customers.
With that said, we think that these added applications of agentic AI inference and training will allow the totality of the wavelength market to grow. Many of our competitors have been at conferences such as this, touting anecdotally their growth, but have been very reluctant to provide the granularity that we provide.
We provide granularity in unit number of Wave, ARPU, total revenue, and most of our competitors bury wavelengths into a larger set of products with anecdotal statements rather than specifics. So it is a mixed bag on Wave. We wish it was better. In absolute terms, it is doing well, but we need to see some of these constraints be alleviated so we can accelerate the quarter-over-quarter growth rate, year-over-year growth rate, and hit our multi-year target.
Right.
What we are not going to do is give quarterly guidance.
Okay. I have to ask because the Sprint business was a business that had $500, I think, and $60 million in revenue at the time of acquisition.
485, actually.
485. It's down to about $130 million annualized as of this last quarter, plus or minus. Is that business just going to go to zero over the next couple of years, or should we think about it stabilizing?
I wish I could completely answer that question. I would've expected that with the enhancement of on-net services, we would've stabilized that business at a larger number. What we did not anticipate is the customer reaction to terminating gross margin negative services. There is a reason why Sprint, under T-Mobile's ownership, was burning $1 million a day, and it is why T-Mobile paid us $700 million.
When we imposed a unit-by-unit profit discipline around products, locations, and services, many customers terminated service, some intentionally by us, others as collateral to what we had done. I think there is a stability. I don't know when it's going to come. It does appear that the rate of decline is moderating. Today, it's probably at about 17% or 18% in the Sprint business, down from that peak of 25%, and it does appear to be slowing.
With a slowing growth rate and decline of that business, the underlying two businesses that are growing, Wavelengths and Legacy Cogent, will shine through, and it remains our guidance over a multi-year period to deliver 6%-8% total top-line growth, which is, in fact, slower than what we did for 18 years as a company without Sprint.
On the Wave business, it's fits and starts, and there's always been something that sort of happened to slow the growth that we've sort of wanted to see. Is it enough to say that it's structural at this point, that that business is sort of going to be sort of at this level? What can you do to sort of clear these structural hurdles that it seems like are coming in your way?
The impediments, first, were of our own making in that we did not have enough sites Wave-enabled. We worked diligently and hit the target we laid out of 800 sites by December 31st of 2024. We actually ended at 802, just a 15th of a percent over our target. Subsequent to that, we've grown that footprint to 1,137 as of the end of the quarter.
Two, we sold a lot of Waves to customers who were trying Cogent out. We had a lot of credibility in the transit business, but we were a new entrant in Waves. The fact that in this last quarter, 77 of our existing Waves, or almost 4% of our base, chose to upgrade to a larger Wave is demonstrating that we are gaining that customer confidence. I think we are overcoming customer inertia. Two, I think customers are increasingly considering us a credible supplier of wavelengths. I think we will accelerate our gain and market share. What that exact pacing is, we don't have enough data to indicate.
Was there an operational or strategic pricing change that you made during the quarter that drove that upsell?
No. Prices remained identical. These were customers that either took 10 gig or 100 gig services and elected, partially through their contract, to upgrade those to either 100 or 400 as they gained confidence. We did not change our pricing model during the quarter.
Okay. Do you feel good about the bookings activity? Pricing has always been a lever that you guys can pull in order to really drive bookings growth. Do you feel that bookings activity is healthy enough, or do you want to use the pricing lever soon?
On average, today, we are pricing at about a 20% discount to the market. We measure the value differentiation based on the uniqueness of the routes, the diversity, the reliability, the breadth of the footprint, and the pricing. We will be more aggressive if need be, but today, I don't think being more aggressive will materially change our uptick rate.
If the customer can't get the components from their vendors they need to utilize the Waves, even if we lower price. They're not going to take them. If you can't get the GPUs, you can't get the pluggable optics, you can't get the memory for your servers, and maybe what's the biggest constraint in this ecosystem, the power. If we look across existing data centers, not new data centers are being built, those data centers are running at over 99% power utilization.
It makes it very challenging for an existing tenant in those facilities to say, "I want to add more capacity." Now, there's been $1 trillion invested to date in constructing new data centers. There is $6 trillion that are earmarked for new data centers. But most of these new facilities have yet to become operational. Even that $1 trillion that's actually been spent, only a small fraction of it is fully operational today.
How do you think about capturing the opportunity of Waves between some of these new facilities? I hear you on the power density challenge. That would actually lead more customers out of a facility into a newer facility, right? How much of a headwind is that towards Wave growth?
Today, Cogent sells services in 60 single-tenant locations, either data centers or buildings. This is above our carrier-neutral data center footprint and our multi-tenant footprint. We chose to go into those facilities because the customer adequately de-risked it for us. They either funded the build or they gave us a large enough commitment.
We have been shown dozens of new build opportunities and have declined virtually all of them due to the fact that the IRRs on those builds are low single digits. There are other companies that are actually willing to make those builds. Some of them are our competitors. The good news is when those builds are complete, the tenant of that single-tenant facility retains many pairs of fibers to get back to a carrier-neutral or a splice point onto our network.
I think increasingly, we will be serving those facilities by using dark fiber tails from the customer. That is a fairly common method outside of the U.S., and because of this limited fiber availability into these purpose-built facilities for third parties such as ourselves, we will rely on companies that are typically the core tenant of that facility to then enable us and therefore meet their needs. What they appreciate is the fact that when they get to that carrier-neutral to the next city, the Cogent route is diverse from what they have with their existing vendor.
Okay. I wanted to ask in the core Cogent business with the few minutes that we have left, if we exclude Waves, exclude IPv4, that business seems to be growing maybe low single digits. How do you get back to a mid or high single-digit growth rate over the next year or two?
I think the corporate segment, which is about 40% of that on-net business, is probably not going to accelerate unless we see a change in occupancy in our footprint and a change in employee in the office behavior.
We could've hypothesized, we could've hoped, but the reality is we're four years past the pandemic, and whatever structural changes have been made to employee in the office work have happened. On the net-centric side, we are absolutely seeing an acceleration in traffic growth. If we look at the internet over its 35-year history, this is the sixth wave of traffic growth acceleration. The last wave came from streaming. At the beginning of the pandemic, Cogent was a disproportionate beneficiary.
Our net-centric business accelerated from being a 3% grower the year before the pandemic to a 26% revenue grower year-over-year, and traffic growth accelerated to 100% off of a large base, almost exclusively driven by streaming. We have seen streaming continue to grow, but that application has matured. The next wave of growth is coming from agentic AI.
Internet traffic growth troughed at around 7% for the entire internet about a year ago. It is back at about 8.5% today. These are numbers as measured by third parties such as OpenVault or Cisco Visual Networking Index. We also know that Cogent's growth accelerated in what is traditionally a slow sequential season to 3% quarter-over-quarter, but more importantly, 16% year-over-year. Any industry eventually matures, and the law of large numbers slows growth.
The reason that has not happened to the internet over 35 years is this wave of new applications, and I'm very much encouraged by AI being embedded in every application being delivered over the internet, driving increased traffic growth, and I think we'll accelerate from here, and as a result, our net-centric component of our business, which is 90% on net, will accelerate.
Well, Dave, with that, we're out of time, but thank you for being here, and thanks for doing this.
Hey, thank you, Brandon.
I appreciate it.