Morningstar | Cogent's Network and Lack of Legacy Products Make It Attractive; Launching Coverage With $53 FVE
We are launching coverage on Cogent with a narrow moat rating, stable trend, and $53 fair value estimate, which implies an EV/adjusted EBITDA multiple of 15 based on our 2019 forecast. In addition, our exemplary stewardship rating is based on what we see as very responsible us of capital throughout the firm's existence and shrewd network investment decisions. Our enthusiasm is tempered by challenging evolution in Cogent's industries, but we believe the firm is better positioned to succeed than most competitors.
Cogent provides Internet and private network connections for enterprises, and it carries Internet traffic for Internet service providers, content-producing companies, and other websites. Technological advances and software solutions allow those functions to be performed at lower cost, resulting in deflationary pricing and cannibalization of more lucrative legacy services. Although Cogent has never provided the legacy services that are currently being driven toward obsolescence, we believe the nature of the industry results in constant risk that today's solutions will be upended.
Cogent's advantages arise from its leased, low cost, Internet-specific network and the opportunistic buying it did to form its network. Rather than building a network itself by putting fiber into the ground, which we think often fails to justify the steep expense due to oversupply over many geographies, Cogent has signed long-term leases to procure the rights. We believe the firm is paying below-market rates because it added major portions of its network during times of industry distress and before technology allowed so much capacity on fiber strands. When combined with a network architecture that was optimized for the Internet and a lack of legacy products to support, it is in a superior position to most competitors, which include major telecom companies.
Cogent's network connects to roughly 1,700 high-rise buildings in North America. It serves enterprise customers in those buildings only, as its model is not profitable in less dense areas. Enterprises typically seek connections for both Internet service and private networks. Private networks have evolved significantly in recent years, as firms can use Internet-based, virtual solutions rather than more expensive legacy products. This shift is shrinking the market, but Cogent's lack of legacy offerings leaves it with more opportunity rather than the shrinking prospects of the industry.
Internet transit is a small addressable market--about $1.5 billion according to Cogent--and rapid price deflation mutes market growth despite the huge increases in data consumption. The small market has driven some competitors away and likely will keep others at bay, as they wouldn't be able to compete without an existing, low-cost network like Cogent has.
In addition to its vision at the turn of the century to build a network catered solely to Internet traffic, we give management credit for how it deploys capital--generally keeping its powder dry and pouncing only when prices are overly attractive. Cogent bought 13 companies in the wake of the telecom bubble from 2001 through 2004. It also nearly doubled the size of its network footprint from the end of 2007 to 2009. In other periods, it has been pretty quiet, not acquiring any companies and expanding its network only marginally. It has taken a similar tack with share repurchases. The firm spent $60 million on share repurchases during the bear market of 2008 and has not exceeded that level since. Instead, it has continually increased its dividend.