Here for a Q&A today is the CEO of Cogent, Dave Schaeffer, who doesn't really need much of an introduction. Since the dot com bubble Cogent has followed a rather vocal and independent path, fusing a wholesale IP backbone, a metro-fiber fed enterprise data business, and simple but aggressive pricing. He didn't make many friends along the way, actually earning the title 'the most hated man in telecom' from Forbes in a profile a few years ago. But two weeks ago, Cogent Communications (NASDAQ:CCOI, news, filings) posted a solid quarterly profit after several years of steady, disciplined growth, announced a new stock buyback effort, and appears poised to join TW Telecom and AboveNet on the list of competitive fiber operators who have made it through to the other side. With no further ado:
TR: Cogent has been steadily marching toward a sustainable profitability. Does this mean you will have greater flexibility and be able to loosen the reins a bit, or will it be business as usual? How are you putting your cashflow to work?
DS: I think it's business as usual. We've been pretty consistent in producing free cash from operations since mid '06. Over the course of the past four years we've used that cash for different things. First we bought back a significant amount of stock in '06, '07, and early '08. We then shifted in mid-2008 and started buying back our convertible debt at a deep discount, and we really bought back all we could get our hands on. Then in late '08 we shifted gears yet again and started accelerating our footprint expansion, buying a lot more dark fiber both in terms of metro routes and longhaul routes. In late '08, '09 and '10 we almost doubled the footprint of the network, giving us a much larger addressable network.
TR: Will you be continuing that network expansion?
DS: We do expect that the footprint expansion will slow, just because we've reached most of the markets that make sense. Today we're in about 160 markets across North America and Europe. There are probably about another 15 or so that fit our criteria. In terms of countries we're up to 30, with the addition of Greece, we'll add another 6 or 7 countries and then we'll have optimized our footprint against our addressable market. We've been pretty consistent in adding buildings to the network at about 120-130 per year, and we expect that to continue.
TR: On your earnings call, you mentioned the purchase of fiber into Greece, do you have any more details? And what other European markets do you have your eye on?
DS: We bought fiber from Sofia in Bulgaria down to Thessaloniki. We do anticipate extending to Athens eventually, just as there are some other gaps in our network. For instance, in Poland we go to Warsaw but not to Gdansk, we do not yet go to Lithuania, Latvia, Russia, Turkey, or Macedonia - we consider these holes in our addressable market for longhaul extensions. And then obviously we'll continue to evaluate metro markets to determine which other cities fit our criteria.
TR: Do you have any plans to enter Asia?
DS: I don't think so at this time for several reasons. First, the regulatory climate is not conducive in most of those countries to an open internet. Second, there is a lack of infrastructure, i.e. dark fiber, available for purchase. And third, while these are rapidly growing markets, they still are relatively small. They will continue to grow in scale, and at some point that may make us reevaluate our decision. But I think at this time we're going to be focused on the markets that generate the majority of the traffic - North America and Europe.
TR: Historically, Cogent has purchased many assets as part of its growth. Last year, we saw a surge in consolidation amongst fiber operators, but Cogent did not participate. What's different this time, and are you actively looking at such opportunities?
DS: There are three things that are different. First, there is a large number of suppliers that are willing to sell us dark fiber in areas we may not have ample fiber or any fiber, so we are able to expand our footprint through the acquisition of fiber IRUs. Second, a lot of our acquisitions were driven not only by the need to acquire the fiber but also the active equipment to light it, i.e. the routers and transport gear. Most of our needs were satiated at the right price points in the first wave. What's been for sale lately is not equipment but rather infrastructure. And third, and most important, is price. Cogent exists today in large part because of our very disciplined price structure in terms of what we would pay for assets. We reviewed a lot of the transactions in the market and the prices that the sellers were looking for, and we concluded that we were not going to participate, as our prices were far lower than what the sellers were expecting to get. That could change in the future, but for right now I think it's fair to say we've been priced out of the market.
TR: For your corporate-centric business, you have been adding buildings at a very steady clip. What sort of buildings have you been focusing on?
DS: In terms of multi-tenant office buildings, we're in a little over 1,100 buildings today and we see that number continuing to grow at least another couple hundred buildings. Our multitenant business is almost exclusively a North American business simply because we have such stringent criteria on the type of building we go after. We're looking for very large buildings that are tightly clustered in a central business district and have lots of unique tenants in them. So we won't go after either smaller buildings or single tenant buildings, and there is a somewhat finite universe of those types of buildings we seek. But we think that at least for the next few years we'll be able to continue to grow the multitenant or corporate footprint at the same rate as we have historically.
TR: Do you foresee expanding your focus to other types of buildings at some point, or is this the only type you are aiming at?
DS: It really is all we're aiming at. We're very focused on our return on incremental capital invested. We think that based on our product set and our pricing model, smaller buildings or buildings with less tenants in them will not provide us an adequate return on capital. Today in our multitenant office footprint, we have about 9.6 customer connections per building. We think we will continue to grow both by adding additional buildings but also over time doubling that penetration.
TR: You have also been adding off-net connections rapidly lately, are these to the same types of buildings in advance of bringing them on-net?
DS: Our off-net buildings actually look very different than our on-net buildings. We have today approximately 3,520 off-net customers in slightly over 3,400 buildings. Our typical off-net building is about 25,000 square feet and would have about 3 opportunities in it. For off-net, we are typically first selling someone on-net services where they would have a branch office in a building that will probably never meet our return on capital criteria. So we will then offer them an off-net service.
TR: For this off-net connectivity, have you been participating in the new Ethernet exchanges or do you prefer direct NNI’s?
DS: It's actually through direct purchases usually through the ILEC. We do not participate in the Ethernet exchanges, and quite honestly I don't see a lot of value in them for us. We have direct NNIs with the major carriers in each of the markets in which we operate. Then we provide either TDM or Ethernet services based on both customer requirements and relative costs. The exchanges are designed to help someone who purchases a relatively low amount of connections per market or is trying to purchase from a large number of providers. While we have off-net purchases from over 180 suppliers, the vast majority of our off-net purchases do come from the ILEC. To justify the cost of buying an interface into an Ethernet exchange for that one-off chance that someone other than the ILEC would have it at a lower price and we could not deal with them directly - it just doesn't seem to make a lot of economic sense for us.
TR: Do you anticipate alternative metro providers will start to make up a greater share of your off-net connectivity?
DS: I hope that becomes the case, although I'm very doubtful it will. The reason is that many of those other parties have the same economic constraints that we have given the cost to build into those facilities versus the revenue opportunity that is generated. For the ILEC, they have ubiquitous facilities within their territory and can generally justify that as capital avoidance as they are decommissioning copper plant and also because their extension costs are relatively low. For competitive carriers I think it is going to be more challenging. There will be some opportunities, but most smaller buildings will continue to have facilities based services only from the ILEC for the foreseeable future.
TR: Thank you for talking with Telecom Ramblings!
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