CFO Intelligence Magazine – Winter 2022
Sean Wallace
Cogent Communications Group, CFO
Taking the path less traveled: Internet provider Cogent Communications and CFO
Sean Wallace blaze their own trail to success
Cogent Communications (2020 revenue $568 million) is one of the world’s largest Internet Services Providers
focusing on the wholesale and business markets.
Founded in 2000, Cogent built its own data network to provide clients with online access instead of piggybacking on local phone or cable companies. The Company’s all-optical IP network provides services in more than 215 markets across 50 countries. This global model enables Cogent to offer highly reliable services at competitive pricing, says CFO Sean Wallace. A focus on business customers in multi-tenant office buildings across North America and Internet Application Service Providers, or Netcentric customers, in Carrier Neutral Data Centers represents another key Cogent strategy. This focus has enabled the company to continue to serve some of the largest, fastest growing business segments in the telecommunications sector. “If you are watching a movie on a streaming platform, it’s likely that part of that movie’s journey to your home was spent on the Cogent network,” says Wallace.
Coping with a deflationary environment
But Cogent also operates in a service industry that is experiencing consistent and constant pricing pressure. “As a result of this deflationary environment, we have been highly focused on being the low-cost operator and we look to drive out unnecessary costs in virtually every aspect of how we deliver services and operate our business,” he adds.
Examples of this low-cost mantra can be found in nearly every part of Cogent’s activities. “No one in the company has a secretary, and Cogent has steadfastly refused to expand its product line — an activity that would probably dilute the company’s focus, service excellence, and drive up its costs structure,” he explains. “As part of this low-cost effort, the finance team is highly focused on systematically identifying and eliminating excess costs. The recent implementation of process improvements and successful vendor negotiations related to leased circuits enabled Cogent to significantly reduce its circuit costs.”
Additionally, investigations into solar energy “led to the installation of a solar array on Cogent’s largest data center, which should reduce the company’s electricity costs by close to 5% when operational. We find that our finance team can be an exceptional partner with our operations team in the requirement to reduce our cost base.”
Listening to the market
Wallace and his team also apply that low-cost outlook to the debt market. In the second quarter of 2021, Cogent’s wholly owned subsidiary, Cogent Communications Group, Inc., took advantage of the low interest rate environment to issue $500 million of 3.50% senior secured non-callable notes due in 2026. The proceeds of the notes — which represented the largest float in the company’s history, at the lowest-ever interest rate — were used to retire more than $300 million of existing 5.375% debt obligation, as well as for general corporate purposes and for special or recurring dividends. Other risk management strategies executed in coordination with this financing produced additional savings and enabled Cogent to reduce its annual interest expense by close to $10 million.
To prepare for the successful debt road show, which targeted accredited institutional investors, Wallace and Cogent CEO Dave Schaeffer spoke with numerous owners of the company’s existing bonds, and capital markets desks.
“Dave and I listened to the market,” says Wallace. “We settled on the size of the notes and the non-call feature after broad feedback. We also signaled a desire to limit the size of the transaction to $500 million to ‘create scarcity’ and we believe this helped drive the exceptional execution. The market really responded to that clarity on the size of the deal.”
Another factor that helped was the “two-notch” upgrade by S&P’s from a B+ to a BB. This upgrade represented almost a year’s worth of work by Schaeffer and Wallace to convince the rating agency of Cogent’s unique strategy and significant business momentum. “A double BB rating by two rating agencies put Cogent in a different category with investors and materially increased the number of investors who could own a Cogent bond,” Wallace says. He notes that Moody’s assigned a Ba3 rating to the notes, the third-highest rating of speculative grade debt. Wallace says that the company is open to expanding its product offerings, but the two-pillar focus of businesses and Netcentric providers leaves plenty of room for growth.
The COvid Challenge
The company’s tight focus on business customers has benefits and costs, but seems to be working. The target audience, which includes law firms, consulting companies, accounting firms and hedge funds, “collectively took up close to 1 billion square feet of office space across over 1,800 large multi-tenanted office buildings in major North American cities alone,” Wallace recalls. “When multiple companies are located in a single high-rise, one connection can serve a lot of people, which enables us to scale our network and drive cash flow.”
Still, that focus has exposed the company to some COVID-linked growth setbacks. “In 2020, we saw more churn and the rate of growth of our corporate business slowed as some companies went out of business,” said Wallace. “Over the past six quarters our corporate business has struggled along with the COVID-related lockdowns of commercial office buildings. Despite the challenges to new sales due to COVID, we did see an incredible amount of resiliency in our client base as they view internet service as a mission critical service for their business. We are optimistic about a return to office which we believe will lead to lower vacancy rates and greater opportunities to sign up new customers.”
SIDEBAR:
A return to business normal?
Over the long-term, “the office space will not remain empty,” notes Cogent Communications CFO Sean Wallace. “We anticipate a long-term return to office usage, even if companies with large blocks of space end up subleasing their unused footprint.”
A third-quarter 2021 research report by JLL confirms that, noting “Gross leasing volumes rose by a further 7.8% in Q3, approaching 40 m.s.f. [million square feet] for the first time since the onset of the pandemic. As a result, total transactions are up 1.7% compared to this time in 2020,” although they’re still 43.8% below 2019 levels.
Wallace is upbeat about the company’s prospects despite the fact that the office market came under pressure as the COVID pandemic spurred more companies to reduce or abandon their office presence. In the third quarter of 2021, Cogent announced a $0.025 per share increase to its regular quarterly dividend, the thirty-seventh consecutive quarterly dividend increase. The company also announced modest sales and cash-flow increases
for the current-year quarter compared to 2020.
And the rise in work-from-home employees also means that “more people are connecting from their homes to the office,” Wallace notes. “That means extra bandwidth requirements and more VPN (virtual private network) activity. So, either way, we’re likely to see more business activity.” <