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Cogent's Reverse Prognosis

Light Reading
News Analysis
Light Reading
1/3/2002
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Tongues have wagged since Cogent Communications Inc. announced plans to merge with Allied Riser Communications (Nasdaq: ARCC) in August (see Cogent to Buy Allied Riser). And what they've had to say hasn't been entirely positive (see Cogent's Finances Revealed in Filing and associated message board).

The basic question was, and still seems to be: How can a company that's been losing money 30 times faster than it's making it achieve success?

Now, as detailed in updated filings with the U.S. Securities and Exchange Commission, the merger is set for approval by shareholders on January 31, 2002. If all goes as planned, Cogent will shortly thereafter become a public company in a "reverse IPO," by acquiring the public company.

There are several key arguments for and against Cogent's proposal to become a key provider of high-speed Internet access to small and medium-sized businesses by 2003. And the various points against leap off the pages of Cogent's latest filing:

  • Cogent's losing money -- fast. Cogent's financials highlight the extremely high costs involved in getting an in-building service provider off the ground -- including obtaining leases, dark fiber, equipment, building permits, etc. Founded in August 1999, the company didn't start gathering revenue until April 2001. By September 30, 2001, its entire net sales were $747,000. Its total operating expenses were $43.1 million. Net loss for the year was minus $45.4 million. EBITDA (earnings before interest, taxes, and depreciation -- a generally accepted measure of liquidity) was minus $36.4 million. Cogent doesn't look to stop bleeding cash anytime soon. As it adds to its customer roster, it also adds higher operations costs, including a variety of payments to building owners and other carriers to gain access where customers need it -- not to mention the costs associated with added personnel to serve a growing account roster.

  • Allied Riser's also losing money. Allied Riser posted $24.3 million in revenues for the nine months ended September 31, 2001. For the same period, its total operating expenses were $411.3 million. Its net loss was $374.1 million. In its favor, however, the company has been working to rid itself of certain leases it held, and it's whittled its employee roster from about 97 to 52.

  • The merger won't immediately improve the numbers. Even with adjustments made by both companies at the suggestion of advisors -- including Cogent's acquisition of the assets of bankrupt ISP NetRail for $11.7 million in September (see Cogent Acquires NetRail's Assets) -- the numbers still don't look good for the merged company, at least at first. With the assets and liabilities of each company adjusted and combined, the new Cogent's figures for the nine months ended September 30, 2001, will include a net loss of $55.9 million and total revenue of $5.2 million.

One could construe some of the elements as falling in Cogent's favor. The plus side includes the following key points:

  • Cogent's backed by Cisco. As noted in previous stories in Light Reading, Cisco Systems Inc. (Nasdaq: CSCO) has heavily bankrolled Cogent, most recently issuing a revised credit facility worth $409 million, up from $310 million. What's more, the covenants surrounding this facility, which called for considerable financial performance in 2002 from Cogent, are being renegotiated, indicating that Cisco is flexible on the terms. Cogent also holds 33 percent of Cogent's common stock -- although its entire holdings only give it 5.8 percent voting control.

    Indeed, Cisco has invested in Cogent's success, as evidenced in a commitment by Cogent to buy $270 million worth of equipment, the majority of it before 2004. Cogent's already bought $107.6 million worth of gear and has agreed to purchase equipment valued at $29.5 million in 2002, $42.4 million in 2003, and $45.5 million in 2004. Even for Cisco, these aren't small chunks of change, and it's unlikely that it will allow such a significant contributor of potential revenue to hit really dire straits for very long.

  • Cogent's market holds promise. Metropolitan Internet access services, particularly ones with Ethernet connectivity, are expected to heat up in 2002 (see The Lost Year and Last Mile Reaches Out ). Cogent says it sees a potential market of 56,000 small to medium-sized businesses turning to high-speed access in the foreseeable future, as an alternative to costly leased lines on the one hand or poorly performing dialup on the other. At Cogent's proposed price of $1,000 per month per prospective tenant, that's no small opportunity, even if only a fraction of it pans out.

Arguments pro and con will obviously stay hypothetical until the merger is established and the IPO is launched. But the risks are significant, including the risk that a wealth of other service providers in a range of markets will get to building owners and tenants first, or establish more favorable terms than Cogent can provide.

Cogent has some time to right its finances, but time is costly, since the metro market won't be taking off for awhile, as shown by the recent woes of Cogent's competitors (see Telseon: Running out of Road?). What's more, service providers and their vendors are still hammering out the basics of how to supply access, particularly Ethernet access, in metro areas (see MPLS Spurs Metro Ethernet Debate and MPLS: Keeping it Real).

— Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com
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dc_optics
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dc_optics,
User Rank: Light Beer
12/4/2012 | 11:06:53 PM
re: Cogent's Reverse Prognosis
Cogent should bleed out in 6 months. Even with all their layoffs the cash still flows out. I think that this has something to do with the lack of leadership by the exec's. WIth this kind of bleeding off cash one can here the grim reaper knocking at the door.
rhynerapologist
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rhynerapologist,
User Rank: Light Beer
12/4/2012 | 11:06:53 PM
re: Cogent's Reverse Prognosis
Little prediction for fun. By the time they shut down next year, Cogent won't have 200 buildings lit, and they won't have 500 customers (or $500,000 revenue per month). That's almost 5% of what they'd need for profitability.
joestudz
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joestudz,
User Rank: Light Beer
12/4/2012 | 11:06:49 PM
re: Cogent's Reverse Prognosis
I am a lot more optimistic. Last mile does not need to as costly as many people indicate. Free space optics cut the cost considerably and may even get around need to pay building owners an exorbinant amount to serve building tenants. I think Cogents acquisition with ARCC is strategic as Cogent has the backbone and ARCC has the way to reach users.
trcn
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trcn,
User Rank: Light Beer
12/4/2012 | 11:06:45 PM
re: Cogent's Reverse Prognosis
ARC assets come basically for free as they have been written off as well as the operational burden of ~800 some people.

~800 buildings worth of Cisco switches & routers are awaiting redeployment with Cogent labels. A few million dollars in cash along with constructed & deployed secured fiber raceways to 800 some of the nations tallest buildings.

If Cogent wants to run the business, a business is to be had as it's all been funded, constructed and written-off the books. It would appear that any customer should be mostly gross-margin of 70% or higher.

The question is how could Yipes Marketing be merged with Cogent's backbone/metro and ARC's in-building distribution? Then all three dreams could be realized.
cfaller
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cfaller,
User Rank: Light Beer
12/4/2012 | 11:06:41 PM
re: Cogent's Reverse Prognosis
"Cogent says it sees a potential market of 56,000 small to medium-sized businesses turning to high-speed access in the foreseeable future, as an alternative to costly leased lines on the one hand or poorly performing dialup on the other. At Cogent's proposed price of $1,000 per month per prospective tenant, that's no small opportunity, even if only a fraction of it pans out."

Has Cogent or LR (or anyone else for that matter) given any thought to the logistical challenges involved? Even if Cogent gains a 5% share of the Total Available Market of 56,000, they still do not have the sales, customer service, engineering, or billing personnel necessary to service this customer base.

There's more to running a company than paying for the construction costs, something that a lot of engineers forget. Getting the necessary people in place to support several thousand customers will take a huge amount of cash, something that Cogent is running out of.

Cogent is bleeding massive amounts of cash, and they haven't even hit their growth stage yet. Cogent is dead, period...
optigirl
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optigirl,
User Rank: Light Beer
12/4/2012 | 11:06:40 PM
re: Cogent's Reverse Prognosis
Great points.

Ever try to call AT&T, Sprint, WCOM, Verizon, etc with a tech or billing problem? They have huge staffs and still don't do such a whiz bang job.

This is a company that was launched with a serious lack of understanding of the telecom business nor the financial aspects that go with it. It's a shame because competition benefits us all.

flanker
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flanker,
User Rank: Light Beer
12/4/2012 | 11:06:35 PM
re: Cogent's Reverse Prognosis
ARC assets come basically for free as they have been written off...

What the freak are you talking about?
BuckStopsHere
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BuckStopsHere,
User Rank: Light Beer
12/4/2012 | 11:06:29 PM
re: Cogent's Reverse Prognosis
Perhaps in your death sentence you can provide some wisdom to help those of us still breathing. Why are Cogent, e-xpedient, etc, failing? The "new economical model" of Optical Ethernet should be providing them with a large enough profit margin to build top-notch customer service staffs. Why does Yipes! seem to be the only group able to figure this out? For that matter, what shape are THEY really in? What my question boils down to is this...are top managers failing at the OE business model, or is the OE business model failing top managers?
trcn
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trcn,
User Rank: Light Beer
12/4/2012 | 11:06:29 PM
re: Cogent's Reverse Prognosis
Compare their 2Q01 to the 3Q01 reports and see if the write-down doesn't "freak" you.

ARC hired ~800 people and outfitted untold sales offices. Each building came with certain obligations. In 3Q01, ARC addressed these issues to the point of shutting down operations, returning equipment to stockpiles, renegotiating equipment purchase commitments, bond buyback offers, etc. For all intents and purposes leaves some cash in the bank and a small (<20) number of employees.

It also leaves a major investment in back-office billing & provisioning systems, Constructed conduits with fiber and captive customers. Cogent appears to have spent their efforts spending on Cisco's golden gear to drive long-haul and metro IRU fiber paths.

Access + Metro + Backbone = Network

The question is: "Does Cogent intend to run a business or just cashout and dump on public investors?" Note: Network does not = business,

Yipes appears to have Marketing but doesn't have access (each customer must be physically constructed ==> delays & costs & ??) So it is inherently more difficult for Yipes to gain each customer win. ARC had customer potential but never developed a sense of what it could/would sell. Cogent ??? .... My point is that a combination is required for any successful endeavor.
flanker
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flanker,
User Rank: Light Beer
12/4/2012 | 11:06:27 PM
re: Cogent's Reverse Prognosis
Your point is well taken except the part about
"ARC assets come basically for free". For the sake of argument, a written down asset is not a "free" asset; but this is a digression from your basic argument about Cogent building networks and not revenues, and I am not going to go on record about that.

Flank
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