Report
Matthew Dolgin
EUR 850.00 For Business Accounts Only

Morningstar | Cogent's Decent 1Q Keeps Our Long-Term View Intact, So We Don't Plan to Change Our $53 FVE

Cogent forged ahead with its clearly articulated vision in the first quarter, so although it fell a bit short of consensus revenue and EBITDA estimates, it is still tracking our full-year forecast. More importantly, we saw nothing to change our belief that the firm has a narrow moat and is well positioned to benefit from increased Internet traffic growth and a greater need for corporate connections as companies' connection needs become more dispersed. We don't expect any changes to our $53 fair value estimate, leaving the shares looking fairly valued.

Revenue grew 5% year over year, tracking a bit behind the 6% we projected for the full year, although a 90-basis-point currency headwind accounted for almost the entire difference. There were a few positive indicators that could bode well for future revenue. First, Cogent's Internet traffic grew by over 40% year over year for the fourth straight quarter after almost two years in the 20%-30% range. With perpetually contracting prices for Internet traffic, such levels of growth are crucial to attain the mid-single-digit average annual revenue growth we project for the firm's netcentric business long term. Also encouraging, price per megabit on new netcentric contracts was down only about 2.5% year over year. We expect double-digit declines to return, but if this is an indication that traffic growth is coming from higher-revenue customers, the historical mid-20% level could moderate. Corporate connections grew about 20% year over year, a bit ahead of our full-year 15% forecast, while we estimate price per corporate connection was down midsingle digits, consistent with the 7% decline we forecast in 2019.

Adjusted EBITDA margin expanded 160 basis points year over year to roughly 36%, but that was a slightly lower level than the company reached in the back half of 2018 (by 20-50 basis points). EBITDA margin in the first quarter is typically down sequentially, however, leaving the long-term margin trajectory still up.

The firm believes it can expand its EBITDA margin 200 basis points annually over the next seven or eight years until it reaches about 50%. We have yet to see evidence that such optimism is warranted. We do think incremental profits are high when the firm adds connections and traffic to its existing network, and a shift toward on-net service and higher productivity from its salesforce should also increase margins. However, the business has recently been operating below a level that would lead to such a significant expansion opportunity, and we are not convinced that such a level will return. We think Internet traffic growth would need to get closer to 50% annually and pricing deflation would need to continue to moderate to make the company's target achievable. Until we see a consistent trend in this direction, we are likely to see the firm's target as overly optimistic. We project adjusted EBITDA margin to rise by about 100 basis points annually throughout our five-year forecast, reaching 41% in 2023.
Underlying
Cogent Communications Holdings Inc

Cogent Communications Holdings is a facilities-based provider of Internet access, private network services, and data center colocation space. The company's network is designed and optimized to transmit packet switched data. The company provides on-net Internet access services through its own facilities, which run from its network to its customers' premises. The company's on-net service consists of Internet access and private network services offered at speeds ranging from 100 Megabits per second to 100 Gigabits per second. In addition to providing its on-net services, the company provides Internet access and private network services to customers that are not located in buildings directly connected to its network.

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Matthew Dolgin

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