Cogent Looks Expensive Given Uncertain Long-Term Future

Summary

• Although the market totally believes wireline services are here to stay, there are exponentiating risks.
• Peering network effects will mean exponential pressures on IP transit companies as colocation builds and IX points increase.
• Although data volumes will rise, especially with 5G, we don't think the premium foots for Cogent, and it likely is being fed by the general hype around datacenters.
• We'd rather take the risk with more discounted peers like Lumen.

Cogent Communications (NASDAQ:CCOI) has attractive elements. The yield is high and arguably sustainable on FCF, and it seems to be an infrastructure play linked to attractive trends in data and 5G. Indeed, it's a facilities-based ISP, Tier 1 in the ISP hierarchy. Their revenues have been stable and cash generation decent, with opportunities to grow as data volumes rise with 5G, and the continued adoption of ML/AI and other data-intensive work. However, peering remains a risk to these businesses, with an uncertain order of propagation and risk for the business due to the many opportunities to drive its penetration on top of the substantial current CAGR together with stocks like Equinix (EQIX). We think that Cogent is not worth putting money on. If you want to put down your chips on a stock in the sector, Lumen (NYSE:LUMN) is probably a more conservative choice, with Cogent coming across as expensive.

The ISP Hierarchy

It might help to understand how the internet works before we discuss the company specifically. Telecoms infrastructure, such as that operated by Cogent, is the physical medium that accommodates the abstraction that we know as the internet, and it includes all the hardware that is necessary to transfer and receive data from one location to another. The internet works by packets being sent from one location to a server destination, where the data of interest is being contained. Then, the process is reversed where packets of data are sent back containing information, which may or may not travel the same route.

The cables that form the internet’s infrastructure are controlled by Internet Service Providers or ISPs, which can be divided into 3 tiers based on how far away they are from the backbone of the internet. Lumen and AT&T are examples of a tier 1 provider, which owns under-sea cables

Analyst’s Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.