Cogent Buys the Boss's Network

Metro service provider buys a European network from its own CEO in a bid to survive consolidation

January 7, 2004

5 Min Read
Cogent Buys the Boss's Network

Say what you want, Cogent Communications Group Inc. (Amex: COI) has been anything but a boring story. And the company's not quite done with its surprises yet.

Dave Schaeffer, Cogent's CEO, admits openly that the company is fighting for its life. And the outspoken CEO has kicked off 2004 with possibly his most audacious acquisition to date. In a bid for long-term survival, Cogent has acquired a European network from a company owned by Schaeffer himself and by Cogent's VCs (see Cogent Expands With Euro Acquisitions).

As if that weren't a bit strange, check this out: Schaeffer plans to upgrade the European network using spare equipment amassed from a number of U.S. acquisitions, and he has already started shipping the excess kit across the Atlantic (see Cogent Munches Midwestern ISP, Cogent Acquires PSINet, and Cogent Buying Binge: Another Bubble? ).

Investors like the news. Cogent's share price is up 15 cents, more than 10 percent, today at $1.59. But the company has only a market cap of $21 million.

Why does Cogent need a European network? Furthermore, why the self-dealing? It's a matter of survival, says Schaeffer. "The market is consolidating, and we need a greater scale to remain viable. Europe is the next biggest market for Internet traffic after the U.S., so it makes a lot of sense to expand into Europe. Breadth and scale is critical to long-term survival for Cogent, and that's what this acquisition gives us."

But this was no ordinary acquisition. Here's how the deal was worked:

  • Last November, Schaeffer acquired, for an unknown sum, Luxembourg-based LNG Holdings SA, which in turn owns 91 percent of the equity in European operator LambdaNet Communications GmbH. The original shareholders were suffering from "fatigue," says Schaeffer, and wanted to rid themselves of the business.

  • Next, French bank BNP Paribas and Cogent's investors, including leading shareholder Jerusalem Venture Partners, jointly invested €2 million (US$2.5 million) in LambdaNet's French and Spanish units (LambdaNet Communications France S.A.S. and LambdaNet España S.A.). This cash gave the investors control of those operations and gave the operators "enough liquidity to meet their short-term obligations," says Schaeffer.

  • Cogent then issued new stock and swapped it for control of the French and Spanish businesses -- free of any debt, according to Schaeffer -- which were then merged into Cogent. The new stock owned by the investors accounts for a 3.5 percent holding in the new, expanded Cogent. Schaeffer is now in Germany, attempting to "restructure the debt of the German business. If that's successful, then it's likely that will become part of Cogent, too."

  • Cogent now has a European network, once part of European flameout carrier FirstMark Communications, that comprises 7,000 kilometers of intercity fiber, eight metro networks, and 27 data centers. While the facilities and fiber are mostly in Spain and France, the network does extend into Belgium, Portugal, Sweden, Spain, and the U.K. It also has 160 wholesale customers, 60 staff, and a business with annual revenues of about €20 million.

Schaeffer says that, while the French and Spanish operations have been loss-making, the acquisition will result in cost savings, including a dramatic cut in U.S. termination charges.

The next step is to add the second-hand Cisco Systems Inc. (Nasdaq: CSCO) kit shipped from the U.S. to the European transport network, which is primarily Nortel Networks Corp. (NYSE/Toronto: NT) equipment. Adding the Cisco gear will involve ripping out a small amount of Juniper Networks Inc. (Nasdaq: JNPR) equipment. (Note: Cisco is the second biggest shareholder in Cogent after Jerusalem Ventures.)

By addding the Cisco gear, Cogent will offer Layer 3 access services in addition to the Layer 1 transport services in Europe.

Cogent plans to offer Ethernet services in Europe at the same aggressive price points it uses in the U.S. market. Cogent is known for its offer of 100 Mbit/s for $1,000 a month in the U.S., and it plans to offer access at between €10 and €30 per Mbit/s per month in Europe. "We're going to price aggressively to capture market share," says the CEO.

That might work for Cogent on paper, but Yankee Group European vice president Chris Lewis believes Cogent faces a tough battle to win business. "People are always looking for a good deal, but price is not the main purchasing criterion for European companies. Customer service and technical competence are the key issues, and the users want to buy from a company they can trust. Cogent might be seen as a risky option."

Cogent faces competition from incumbent carriers that are ramping up Ethernet services. "The incumbents control the markets -- they're very strong in Europe," says Lewis, who points to their success in dominating the DSL access market.

Lewis adds that it'll be costly for Cogent to market the services and find sales channels, as well as keep the costs of last mile access to an affordable level.

Cogent needs to make something happen quickly. In the nine months to September 30, 2003, it had revenues of just $44.9 million and operating expenses of $92.2 million, amounting to an operating loss of $47.3 million. These losses are always chewing away at its balance sheet. At the end of 2002 Cogent had $51.1 million in current assets, including $39.3 million in cash, but by the end of September that had shrunk to $27.8 in assets, including $11 million in cash.

— Ray Le Maistre, International Editor, Boardwatch

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