Earnings Primer for Cogent Communications

November 5th, 2008 by · 3 Comments

Hello all. Rob has given me the opportunity to write the Cogent primer! Cogent Communications (CCOI) reports earnings before the bell on Thursday. As readers of this blog and the IV board may know, as the market melted down I took positions in CCOI, TWTC, and Q, along with my core position in LVLT. As a consequence I have done a fair amount of research on Cogent and thought it might be interesting for me to put up some info that I have found compelling in supporting my long position. So, just to be official: DISCLOSURE – Long CCOI.

Ok, with that out of the way, let’s talk turkey.

On the Q2 conference call CCOI was forced to cut guidance across the board. The consequence of that cut, along with the market meltdown has taken the stock from $11.22 to $4.54 as of close yesterday; a drop of gulp…60%. Furthermore, the ev/ebitdas multiple has contracted from around 9 to about 4 during that same period. Suffice to say, it’s been a long ride down.

So what should we expect on the Q3 call tomorrow? Well first off, here’s a base model showing Q1/Q2 results and my projected Q3 numbers.

Est

q1

q2

q3

on-net

42811

44215

45109

off-net

7994

8459

8884

non-core

1305

1185

1009

total rev

52110

53859

55001

Cogs

21958

22952

23641

gross profit

30152

30907

31361

sga

15550

14448

14860

ebitdas

14602

16459

16500

one-time gain

16

126

0

adj. ebitdas

14618

16585

16500

interest

671

1986

2500

working cap

2439

250

211

cash flow operating

11492

14223

13789

Capex

9778

9029

7193

FCF

1714

5194

6596

repay cap lease

-6396

-3638

-7000

mature short term invest

0

650

0

disposition

22

44

0

stock option

53

47

0

exchange rate

245

100

0

adj. FCF

-4362

2397

-404

stock buy

-18054

-27994

-11984

debt buy

0

0

-9900

change in cash

-22416

-25597

-22288

begin cash

177021

154605

129008

end cash

154605

129008

106720

Below are some thoughts on what I think might impact the numbers:

  1. Slower growth on on-net traffic. The company reported, for the first time in its history, that Internet traffic had actually decreased in Q2. This was quite a shock as traffic had been growing 100%+ compounded year over year since the company went public. Consequently, I went looking for data-points to make sure that this wouldn’t happen again in Q3. What I found was that in the transcripts of the Q2 call, as well as during a Q&A session during an investor conference with Kaufman Brothers on Sept 4th the CEO made comments that traffic had actually grown 1% for July and August and said that because a large part of their on-net base was educational they expected traffic to pickup as kids went back to school. Consequently, I believe that the risk of on-net traffic falling, and as a consequence on-net revenues falling, as overdone and believe we should see about 2-3% growth for the quarter.
  2. Accelerating growth in off-net traffic. The company has forecasted around 5% growth in off-net traffic vs. approx. 2% in on-net for the Q. This rate is higher than in the past which leads me to wonder if they are being too aggressive. What I found was the following: 2/3rd of the sales force, which has nearly doubled over the last year or so, focuses on corporate customers who almost all need off-net service. Further, a vast majority of these corporate customers/targets are serviced by ILEC’s whose predominate service offering is T1’s, which are orders of magnitude more expensive than the Ethernet based services of CCOI. Also, the addressable market is huge so there is quite a bit to shoot at. AND, of course CCOI is the low cost provider by a margin of around 2.5 – 1 which should play well in the current environment. When I add all this up I have a feeling of comfort that they will meet their projection.
  3. Hedging, or lack thereof. CCOI doesn’t hedge and since they get around 30% of their revenues from Europe and Canada I wonder how bad they will be hurt by currency devaluation. I pointed this out to Rob, who made the off-hand comment that perhaps, due to their large recent investments in Eastern Europe, they actually might have higher COSTS than REVENUES which would mean the impact would be muted. Now there is simply not enough data to support this thought, so I suspect that we will see some sort of “currency adjustment” which could mean that their revenues fall short of their project but the impact on ebitdas is not drastic as their costs also come down in a big way. Keep in mind that a lot of the loss in the Euro actually happened in October so perhaps the impact on Q2 won’t be that big.
  4. Capital Leases and “Unconditional Lease Obligations.” One of the largest expenses below the ebitdas line is for capital leases. I spent a fair amount of time trying to forecast this number as the company gives almost no clarity on this line item. What I found was the following: on page 33 of the 10k the company says that they expect 15.651M of Cap Lease Obligations in 2008. If you look at the 2Q cash flow statement you see that they have already taken 10.034M of that expense; so they I believe that have approx. 5.617M to go. But it doesn’t end there. On page 62 of the 10k they also point out that they have a minimum payment of approx. 8.4M in “unconditional lease obligations” which I take to mean in addition to the 15.651M in capital lease obligations; or said another way, I believe that they may have up to 15.651 + 8.4 or 24.051M for all of 2008. Since they have already paid 10.034 I believe they have approx. 14M to go or 7M per quarter. Rob and I spoke on this item and we are unsure if the 8.4 is already baked into the 15.651M or somewhere else that we cannot separate out, I don’t believe so, so I add them, but I might be too conservative on this point. It’s just not clear
  5. Stock Buy Backs are coming……..whether you read the above and got a sense of comfort or not, what you absolutely should expect is that regardless of how well the company does it will be buying A LOT OF STOCK in the near term. Based on the latest 8k, they have $32.1M of cash available to buy stock by year end. The last slug of stock (1.232M shares) was purchased for an average of 9.72 per share, with the stock trading at half that number you can expect the number of shares to be purchased to increase dramatically. The company has said that they will not buy back stock until Q3 numbers are made public, so tomorrow would be the first day that they can get back into the market. So what sort of impact should we expect? Well, there are around 600k shares traded daily, however, over the last few weeks that number has been cut in half. So we are seeing around 300k share per day, with most lots going off in 00’s share blocks. In fact, you see most activity in the last 5 minutes of trading, where I believe you see traders who have been accumulating shares all day make 25k or 50k share trades as that’s the only time there is sufficient volume to clear their positions. By my count CCOI can step in and buy around 7M shares which would take all the volume for around 23 days! What this tells me is that when you have NO volume and you have a HUGE buyer we will see price spikes. I would add that we’re talking about a reduction of more than 15% of their shares outstanding. That’s big.

I’m looking forward to the numbers and if you have a counter point of view feel free to share it. I’m not saying that CCOI is a company that will last the next 50 years, but certainly in the short-term I think the selling is WAY overdone and I think that regardless of whether the market is willing to increase their multiple, CCOI has the cash to make it happen regardless. I’m prepared for a much higher stock price in the very near future.

thejuice.

PS: Following the initial drafting of this primer the following data came to light that I wanted to make sure we included. On the Q2 con call the CEO said, " during the quarter, we announced an increase in our stock Buyback Program of an additional $50M, with a purchase authorization through the end of the year" which I take to mean 2008. however, if you look at the 10k for the most recent quarter, on pg 10 they say, "in June 2008, the company's board of directors approved an additional $50.0M of purchases of the Company's common stock under the buyback program to occur prior to December 31, 2009.

So there's a conflict.  On the call they say the end of 2008 and in the filing they say end of 2009.  So i don’t’ know what the right answer is.  I just called IR and expect someone to call me back with the answer and will update shortly.

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Categories: Financials · Guest Posts · Internet Backbones

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3 Comments So Far


  • Rob Powell says:

    Juice, thank you for putting in all that work, you’re going to make my usual earnings posts look skimpy and weak! 🙂

    I’d offer a quick explanation that Cogent accounts for much of its expenses for leasing fiber as a capital lease, which differs from many others in this sector and makes it hard to compare because it hits as both interest and principal payments rather than in ebitda. This is why thejuice has an ‘adjusted cashflow’, it’s a derived number for our own use rather than something the company might report.

  • jeremy drane says:

    no word back from IR re the issue around timing on the buybacks. my gut tells me it’s 2009? but i believe they will buy a fair amount at these levels. hope to get clarity on the call tomorrow.

    also, i did a bit of checking and it appears that the euro moved from 1.58 to 1.41 euro/usdollars during Q3. CCOI gets approx. 112.5M from europe so we should expect a REDUCTION in reported revenues of about 10%. of course, as discussed above the question is what’s the impact on the costs?

    CCOI doesn’t break out the revenues generated in Canada, whose currency also took a 10% haircut vs. the dollar over the quarter so we are left to guess the impact there. my guess is that we will see revenue reductions associated with fx rate changes to the tune of $2M. cost impact is anyones guess.

  • jeremy drane says:

    not 112.5M but 12.5M – sorry about that!

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