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Cisco, VCs Take Over as Cogent Restructures

Washington, D.C.-based Cogent Communications Friday filed a restructuring plan with the SEC. The plan reduces the company's debt significantly and lengthens the payment terms on the debt that remains.

The company urgently needed to restructure the debt because it was had defaulted on covenants on the majority of the debt, which consists of equipment finance from San Jose, Calif.-based Cisco Systems. Cogent owed Cisco $262.8 million, and had about $39 million in cash at the start of the year, which was down to $12 million on March 31, 2003. Under the agreement, Cisco was allowed to demand all of the money it was owed or take over the company.

The restructuring will convert 5 series of preferred stock (series A through E) into common stock, and issue several more series of preferred stock (Series F, G, H, and "Investors Preferred") to Cisco and to venture capitalists who are injecting $41 million into the firm, giving the company enough cash to survive the year.

So can Cogent survive? It has reduced its ongoing debt costs to nearly nothing, but it still has substantial costs. The company does not own all of the fiber it uses, and ongoing lease costs for local and long distance fiber remain considerable, given the company's cash situation.

Over the coming year, from March 31, 2003 to March 31, 2004, the company will incur significant expenses. It will pay $7.915 million for dark fiber IRUs. For office space and data centers, the company will pay $17.396 million during the same period. For backbone, connectivity, and transit, the company will pay $5.718 million. The total of these commitments is $31.029 million over the next year—and these expenses do not include the costs of people, marketing, and network expansion. It seems probable that Cogent will have to renegotiate some of its leases and fiber commitments, but is not under immediate (day to day) pressure to do so.

CEO Dave Schaffer says that costs are dropping fast at Cogent. "During the first quarter we were expanding rapidly, and although, due to the lead times on construction, some of that will continue into the second quarter, we are now focusing on growing the revenue base on our existing network."

Schaeffer is proud of the network Cogent has built. He says, "we have over 750 buildings on net, 7,400 miles of metro fiber, and 139 operational rings in 21 cities."

He says that Cisco's acceptance of the deal is an endorsement of the company. "The strength of our relationship with Cisco is proven in that they were willing to take an equity position in the company [instead of cash]. We are remaining a 100 percent Cisco shop, and use no other vendor."

Asked for guidance about future costs, Schaeffer claims, "we never gave guidance. We meet reporting requirements but do not market our securities through forward looking statements. We do report our historical progress."

The right price for your fiber diet The price Cogent charges remains low, and its rivals, who charge higher prices, allege that it will never be profitable. Schaeffer counters that Cogent's network, designed like a corporate LAN, avoids telco costs and inefficiencies. However, as noted above, he does have leasing commitments to providers of dark fiber and metro Ethernet connectivity.

Cogent will need to add customers over the coming year, and it will do so by connecting more commercial buildings. Schaeffer says that his company looks for buildings with many tenants. The profitability of a fiber network, according to Schaeffer, is this simple, "the capital cost is directly proportional to the number of nodes passed and the revenue is proportional to the number of customers served."

Cogent looks for buildings with at least 400,000 square feet of space and at least 50 tenants to maximize the number of customers per building. Schaeffer adds that the company looks for particularly well known buildings, which he called, "trophy buildings."

Adding buildings, however, is not cheap. Schaeffer says that if you take into account the cost of in-building work, fiber to the building, equipment at the CO, and a portion of the fiber ring dedicated to that building (Cogent's promise is that is does not oversubscribe the network, a promise the company's rivals find foolish), the cost of adding a building with current technology is about $75,000, although that is a very rough calculation.

At a time when the RBOCs are claiming that they will build fiber to every neighborhood, these numbers make it seem that the bells will not actually be able to deliver on their commitments. Schaeffer says the networks are not built for fiber performance. He says, "if you look at the cable companies or the phone companies, the architectures they deployed to date (branch and tree in the case of cable companies, hub and spoke in the case of the phone companies) will not allow them to meet the price points or the performance of a true ring architecture. All connections have been through single threaded connections that will not provide the reliability or throughput than can be achieved through a ring architecture."

As Cogent's fiber struggle continues, and its unique network grows or perishes, it will be seen by many as a test case for the viability of business Ethernet. If it fails, its rivals will say that they were right to claim that the company should have been charging at least 10 times the prices it has charged so far (it charges $1,000 per month for 100 Mbps and $10,000 per month for 1 Gbps, with higher prices for intercity connections). With bravado, Schaeffer says Cogent's prices are not going up. He says, "we believe that based on our cost structure, we can deliver services profitably at our current prices or even lower prices in the future."