Dave Schaeffer: Sure.
Nick Del Deo: First, with the Sprint IPv4 addresses, what’s the plan there? Do you sell them, do you lease them? Do you hang onto them for the business? And what might the financial impact be over time?
Dave Schaeffer: Okay, so there’s a fair amount of complexity here. So, when we acquired PSI, we got a large number of addresses, previous to Sprint, and we had some organic Cogent and some from other acquisitions. But pre-Sprint, we had approximately $28 million addresses that had zero value on our balance sheet, yet they had real economic value. Those addresses are traded every day in public exchanges for about $55 an address. You can go online and look at the quotes as we talked. When we did the acquisition of PSI net, there was no value to address this because they were still available for free. And second, the accounting rules were different, and we’ve recorded things as negative goodwill, which is no longer how you record a gain, you now record it as bargain purchase gain as we did in Sprint’s case.
In the case of Sprint, we acquired 9.9 million incremental addresses. Bring our total to about 37.8 million addresses that we own. When that happened, we actually initially were not going to focus on them. And because we had been generating leasing revenue from addresses since 2015, included in our corporate and net centric numbers, it’s primarily net centric. It’s roughly 85% net centric, about almost 13% corporate and a couple percent an enterprise. We generate $40 million a year out of leasing those numbers out. We continue to lease out incremental inventory. Today we are leasing about 11.4 million of the 37.8 million addresses that we currently have. Our average lease price per address is about $0.30 per address per month. We were somewhat unique in the market in having an inventory and being a service provider, and leasing these addresses.
We didn’t focus a whole lot of attention on it and it was just included in all of our numbers, didn’t even break it out as a separate product, it was just baked in. Now we are going to break out the unit count and the number separately. And part of the change occurred about a year ago when Amazon, which had been a serial buyer of addresses, began to compete with Cogent and lease addresses. Amazon leases its addresses on an hourly basis through AWS, but nobody really leases them by the hour. And in fact, they generate about $3.60 an address a month for 12 times Cogent’s rate. So based on kind of now a two-party leasing market and a transaction market, the accounting firm that did the appraisal came back and said, you guys have to recognize a bigger bargain purchase gain to account for these addresses.
That’s why we picked up another $254 million. The final point to this is we are going to continue to evaluate opportunities to either sell addresses, which we have not done yet, or potentially securitize the cash flows from those addresses. We’re generating about $40 million of EBITDA today off of our address leasing and that continues to grow. We’ll continue to evaluate this better at least, or should we sell?
Thaddeus Weed: Just one – go ahead.
Nick Del Deo: Sorry, go ahead Thad, go ahead.
Thaddeus Weed: Just summarize quickly on the inventory and the accounting, I know Dave covered it. So we have 38 million addresses in total. In 2002, 28 million were acquired with PSI net. We paid only $12 million in cash to PSI net. Back in those days, the accounting was you record only the assets equivalent to your purchase price. So we recorded $12 million of intangibles basically. The rules now are you record the fair value of all assets acquired. With Sprint, we acquired 10 million, 9.9 additional addresses. That is an acquired asset that needs to be valued. We had the Big4 accounting firm include in their appraisal how much these addresses are worth, and it came out with a net total per address value of $46 per address.
So they are reflected on our balance sheet in our 10-K, which we will file today at $458 million in total. The net gain for the quarter includes the 250 million that we increased the bargain purchase, includes that 458 million new address, the adjustment for the income tax impact of that, so deferred taxes, and then we have some other adjustments that we recorded, so I hope that’s a good summary as to where we are. As Dave mentioned, we are leasing 11.4 million of the addresses and generating about 35 million of lease revenue currently per year. There’s no cost associated with this revenue stream, and they are an asset that’s partly on our balance sheet and partly not.
Nick Del Deo: Okay. A lot of great detail. Thank you, guys. I guess just one quick clarification here about how many do you think you need to run the business? In other words, how many are surplus that you could sell or lease out or securitize if you wanted to?
Dave Schaeffer: Virtually none. Probably 100,000 you could run the network. You would use some to number your own network devices. Today we have about 60,000 network devices in the network, and customers can bring their own. Between 2015 and mid-year 2022, we actually would only lease addresses to people that bought bandwidth from us. Anticipating Amazon’s entry into the market, we relaxed those rules, and we saw a significant spike up in leasing activity by leasing addresses to people that don’t buy bandwidth, as well as those who do continue to buy bandwidth. We could sell those addresses above that roughly 100,000 or run the company. Many other service providers have very limited pools of addresses.
Nick Del Deo: Okay. Okay. Thanks, Dave. And then the last question I wanted to hit on, I’m sorry for this being so long, I’m not sure what you can say or would want to say about the peering dispute with NTT, but I’m interested in what you can share and whether you think it’s going to have any customer revenue impacts in the coming quarters?
Dave Schaeffer: Happy to talk about it. It was actually something initiated by Cogent. So we have had a peering relationship with NTT since 2001. They are the fourth largest network in the world. As we continue to gain market share in Asia, NTT refused to give us connectivity in Asia. We remain connected in the U.S. and in Europe. We had multiple conversations with NTT technical and management individuals, and they basically said they did not welcome Cogent’s entry into the Asia market and refused to add ports in Asia as our peering required. In retaliation after multiple attempts to get them to connect even outside of the home market of Japan, we were willing to take Singapore, Australia, Taipei, Hong Kong, a number of other Asian locations being sensitive to the protection of their home market.
They continued to refuse. So as a result, we peered them, but only in Europe. They do have a European business, and they were forcing Asian traffic to trombone to the U.S. Basically, there’s still connectivity. It was just customers had to go from Japan to L.A. and back. We kind of implemented a similar strategy in Europe. Their European customers have to come to D.C. or New York and back to Europe. I know it sounds almost childish and it’s a tit for tat, but unfortunately, there are still bad actors in the world who don’t embrace net neutrality. Now, I’ll expand one point further. We have a similar situation with Deutsche Telecom, which has been public, and they continue to expand capacity in Asia, but refused to expand in Europe. So they’ll expand connectivity in the U.S. or in Asia, but they want to protect their German market.
So while they may meet the four corners of a net neutrality order in their country, they are absolutely violating the spirit. And it’s actually somewhat encouraging that the FCC may finally codify this in a way to stop people from playing these games.
Nick Del Deo: Okay. I’ll stop there. Thank you, Dave.
Operator: Your next question comes from Tim Horan with Oppenheimer. Please go ahead.
Tim Horan: Thanks, guys. So, Dave, if AWS is 12 times the price, I mean, why wouldn’t you increase your prices like 6x? I mean, where are customers going to go if you think you would lose those customers? And, you know, if I do the math, if you have a 6x price increase, that’s obviously $40 million, goes to 240 of free cash flow. You know, what’s preventing that? Thanks.
Dave Schaeffer: Yes. So, first of all, we didn’t have AWS as a benchmark with a pricing umbrella in 2015 when we started leasing addresses. And we have never changed our pricing on addresses while our bandwidth pricing has declined at 23% a year during that same period. Second point is, you are absolutely correct in your statement that customers probably are pretty sticky. The expense is small and the labor involved in renumbering is pretty significant. Amazon doesn’t disclose its numbers from this particular product, so I can’t tell exactly how successful they are. What I do know is that their inventory of addresses which have been acquired, they were not organic to Amazon, is about comparable in size to Cogent. Actually, both Microsoft and Amazon have been serial buyers for the past decade and each have address inventories about equivalent to Cogent.
We are evaluating. Should we do something that is quite honestly foreign to our thought process and raise prices. We’re conscious of that and we are going to evaluate over the next few months what are the best ways to maximize the value of these addresses and whether that includes securitization, that includes raising prices or it includes the ability to sell addresses. We’re evaluating all of those opportunities. And we understand, we were lucky that we just have a big asset that turned out to be valuable. Like I explained to one investor, it’s kind of like Bitcoin with a purpose, so it’s sometimes better to be lucky than smart.
Tim Horan: Well, I guess they’ve related to this, you know, what everyone’s a bit frustrated about is the complexity in accounting. Can you just give us a sense of what the adjusted EBITDA should look like in ’24? You know, is the 110 a good run rate? I mean, I know there’s a million moving parts and if you can’t talk about that, maybe you can talk about maybe the $220 million in expense savings. How much — how does that kind of pace out over the next three years or any more color would be helpful?
Dave Schaeffer: Yes, I’ll try to touch on both of them. So the first point is we have been very clear that there is going to be a step down in the cash payments that we receive from G-Mobile one year from closing, so May of ’24. That will impact our EBITDA as reported. Secondly, we are continuing to achieve those cost synergies. Those cost synergies, unfortunately, are limited by some of the contractual obligations that we assumed when we bought this business from T-Mobile. And again, these are all things that were considered in the negotiation in the purchase price. Even back to the IP addresses, T-Mobile sold 2 million addresses prior to closing. It was fully disclosed to us and they recorded a $120 million gain from that sale.
Quite honestly, they could have chosen to keep more addresses and sell them. And then the subsidy check they would have had to write would have been larger. So it’s not like these are surprises they were all thought about in the negotiations. In terms of EBITDA, you should think about the current run rate is about correct for the next couple of quarters. Then it will step down when those payments come down from T-Mobile and then gradually increase as those cost savings are achieved. You know, what we have said publicly and we are absolutely reaffirming is that within five years of closing, the company will do at least $1.5 billion in revenue and have at least %500 million of EBITDA. You know, the 1.33 that we did last quarter and the 1.10 this quarter kind of says we are already on pace for that.
The reality is EBITDA will go down and then come back up. And I understand its complicated accounting and I also understand it’s hard to build a model that goes up and down. We’re trying to be as transparent as possible without giving the exact guidance on that.
Thaddeus Weed: The payments are fixed per month, so we know it’s $29.2 million per month for a year and then $8.3 million for the remaining term and the step down will occur in May. I would say that the SG&A cost run rate that we had in the fourth quarter, which was about 30%, will be less in the first quarter and we should think about an SG&A as percentage of revenues I mentioned earlier of about 27%.
Tim Horan: And in network operating expenses, what percent should that be roughly?
Thaddeus Weed: That will be relatively flat.
Dave Schaeffer: They come down slightly as well.
Thaddeus Weed: We have some experience savings, additional savings from circuits and from facilities.
Tim Horan: So it should come down slightly from the 64% this quarter?
Thaddeus Weed: Yes. Now it’s going to go up from additional on net sales, but net-net, it should decline. Yes.
Tim Horan: Thank you.
Thaddeus Weed: I should say off net sales.
Dave Schaeffer: Off net sales. Thanks, Tim.
Operator: Your next question comes from Michael Rollins with Citi. Please go ahead.
Michael Rollins: Thanks. Good morning. A few questions. Just a quick one on the IP addresses. Can you remind us what the addressable market for that is and just your share of that market?
Dave Schaeffer: Yes, sure. So when the internet was conceived, there were a numbering scheme and they chose IPv4, which is 2 to the 64th power. That is approximately 4.3 billion addresses. Those addresses were initially allocated by the Department of Commerce, then allocated by IANA as a contractor for the Department of Commerce, and then subsequently those allocations were delegated to five regional registries around the world. The U.S. government held back addresses for its own purposes, primarily DOD. So there’s been about 3.5 billion usable addresses. The registries began to run out of addresses in 2011. A market for those addresses developed and prices to buy an address at that time are about $4. In the intervening decade or 13 years, that price has gone from 4 to 55.
All of the registries ran out of addresses by 2018, and there are no more addresses to get. Now, there has been a movement to migrate to IPv6, which is 2 to the 128th power number of addresses. It’s basically the square of 4.3 billion, a very, very large number. But there have been many challenges in doing that, including literally trillions of dollars of capital that would be necessary to replace equipment to support that. So IPv6 still has a relatively small presence on the Internet, about 7% of traffic. So the market is anybody who needs those addresses and wants to reach the whole Internet. There are multiple workaround schemes, but those schemes are not easily implemented and are not as easily managed as just renting or buying IPv4. So I think for the foreseeable future, the world will run on V4.
There will be limited supply, and as a result, people will either lease or buy these to fill their needs.
Michael Rollins: Thanks. And then just a question on the business. The sales productivity look like it thick on kind of a flat FTE count. Can you unpack what’s happening in terms of sales productivity? Where there might be pluses in performance, and where there might be some minuses in performance?
