Cogent Communications Holdings, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

A global internet service provider, specializing in high bandwidth, Internet access and data transport services for businesses.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Cogent Communications Holdings, Inc. (CCOI) operates a global, all-optical Internet network, targeting businesses, and communications service providers. Unlike consumer-focused ISPs, Cogent provides high-bandwidth connectivity and data transport services.

The company’s network stretches across North America, Europe, and Asia, with a significant amount of their infrastructure present in major data centers. This strategic focus on core networking infrastructure enables them to provide highly scalable and reliable services to businesses of varying sizes, from small firms to large corporations.

Revenue Distribution:

The majority of the company’s revenues, around 99.2% are attributed to internet access service (referred to as “On-Net services” which has a huge margin than off-net which is their other offering, and this is where most of the earnings are from) while a smaller fraction, 0.8%, are generated from non-core service revenue (“Off-net service” which includes services outside their own direct network)

Trends in the Industry:

The demand for high-bandwidth services has been steadily increasing due to the proliferation of data-intensive applications and cloud computing. This includes more video and collaboration products. The increase in Internet traffic drives the demand for CCOI services.
Consolidation in the telecommunications and fiber network providers space has been significant, as the industry becomes more capital intensive.

Margins:

Gross margins are high, typically around 70%, due to a low cost model and the scalability of their services.
Operating margins have improved markedly in the most recent quarter but are still lower than before, due to increased expenses because of large acquisitions and strategic investment in the infrastructure, with these costs expected to stabilize in a few quarters.
CCOI has demonstrated a long-term goal to achieve a 60% adjusted EBITDA margin.

Competitive Landscape:

The industry is competitive, with many players offering similar services. CCOI competes with both traditional telecom companies and other network providers. Key differentiators for CCOI include their high-bandwidth, scalable network and aggressive pricing.
CCOI does not compete much with local providers, rather with more global providers.

What Makes CCOI Different:

CCOI has a large proprietary network which spans several continents, this allows them to provide high-bandwidth and scalable services for both their customers and their partners.
Their business is structured for large amounts of business-driven traffic and for high amounts of traffic, and they don’t sell to consumers.
The company focus is on their own network, this has allowed them to build a very cheap network and business model.

Financials In-Depth:

CCOI has shown a continuous history of growth, driven by steady increases in their number of customers, specifically from “On-net” services.
Revenue has experienced strong growth even after the company sold off a large number of its lower-margin services. As of most recent earnings, revenue is increasing by 6-7% year over year, and is expected to continue growing that fast, if not higher.
In the last 2 years, many new customers have also started to have higher spending with CCOI.
CCOI’s debt level is considerable, with the debt-to-equity at 0.85x but leverage has been going down recently. They have reduced their debt level since a high point in 2020 (with debt to equity of 1.38)
The company’s goal is to return its leverage ratio to be around 4x to 5x of adjusted EBITDA.
The company had $1.13 billion in debt and $1.6 billion in total assets, with $1.3 billion equity as of Sep 30 2023, making it a more stable company.
CCOI has recently gone under a massive expansion of its network and services, which is a drag on profitability right now, but management is confident they are all going to be profitable in the long term. Their capex is also up due to all the investment in new infrastructure.
Free cash flow for the first 9 months of 2023 was $132 million. The management believes that this will grow to be consistently in the $300-$400 million range as they finish their expansion.

The most recent report showed a 53.6% jump in net income, with a GAAP profit of $178 million. Their free cash flow has also been growing strongly and the company is expected to become a “cash cow”. The management is focusing on growing its higher-margin “on-net” revenue in order to increase earnings and cash flows.

Moat Analysis:

Intangible Assets (Brand): CCOI does not have any recognizable brand, and their customers have very little connection or loyalty to the brand.
Switching Costs: Switching costs are relatively high for CCOI’s customers due to the reliance on their network for high-bandwidth requirements. But these are easily replaceable through competitors who offer similar speeds.
Network Effects: CCOI benefits from economies of scale when it comes to bandwidth. The more customers they have, the better the business is and the cheaper and higher quality it becomes.
Cost Advantage: CCOI has an all-optical backbone network that is able to reduce cost for all its customers.

Moat Rating: 2 / 5 While CCOI has some structural competitive advantages stemming from its network and scale, they are easily replicated by competitors. As of right now, there is a reliance on their low-price model which is not sustainable in the long run, which means they do not have a sustainable moat. If they are able to show consistency in profitability over the long term with their current investment model, the moat could increase.

Legitimate Risks to the Moat:

Competition: The industry is highly competitive, and new entrants could potentially threaten CCOI’s market share and profitability.
Technological Obsolescence: If new technologies emerge that provide cheaper and faster broadband, CCOI’s infrastructure may become obsolete.
Market Volatility and Macroeconomic Factors: Changes in the overall economy and interest rates can impact profitability, revenue, and the company’s ability to refinance its debt.
Regulation: Changes in regulations and licensing of fiber networks could adversely affect the company’s operations.
Pricing Pressures: Because a main strategy of CCOI is the low price, if competitors lower prices more, they could cut deeply into the company’s profits.
Debt: With the company’s debt being at a high level, they could experience problems if interest rates go higher or revenue suffers.

Business Resilience:

Although CCOI is a high-growth company, they are also in a very stable sector that has a lot of demand, giving some resilience.
The services they offer are essential for many businesses, which means there will always be demand.
The customers of CCOI are usually large companies with high retention rates, which limits losses.

Understandability Rating: 2 / 5 CCOI’s business is quite complex due to its international scope and reliance on complex infrastructure technologies. There is also a lot of jargon and terminology that is difficult to understand unless you already know a lot about networking infrastructure. However, the core concept of providing high-bandwidth internet is relatively straightforward, and its growth potential is generally understandable. Balance Sheet Health Rating: 4 / 5 While CCOI has a lot of debt, the debt is managed well, with the company generating steady revenue and having high growth potential. They also have a considerable amount of liquid assets which helps to pay back their debts. The company’s financial structure is stable, and with rising cash flows, the debt risk is lowered. Management also has plans to bring its debt level to a much lower level.