Sea Change at Cogent?

In Cogent Communication’s latest earnings release and conference call lies an indication that their multi-year bandwidth honeymoon may be in danger. Specifically, they reported that traffic growth in Q1 was only 7% above that of Q4, and nearly all of that was in January, with February and March almost flat. They then mentioned that April’s sequential traffic growth was also about 1%, although they expect traffic to continue to grow through the year.

What happened then? Cogent’s on-net business has two components – net centric and corporate, the former being to sites like YouTube on down at major datacenters, the latter utilizing its metro footprint. For years now, Cogent has been selling its 100Mbps for $1000 product to both segments, deliberately undercutting the market by a substantial amount in order to grow revenue as quickly as possible. Last month, BearOnBusiness and Telecosm argued over whether bandwidth growth is now exceeding pricing declines, and Cogent was used as an example. However, it wasn’t really a good example because Cogent’s pricing has not been declining at the industry rate, therefore they have enjoyed greater revenue growth on the same traffic growth than their peers.

This is still true in their corporate market because they compete only with the ILEC in that space, but it is not true in the datacenter anymore. The industry pricing has finally caught up to them. In the major internet hubs of the USA, there are many carriers at the $10/Mbps level and everyone else is close, and Cogent is struggling to remain the pricing leader by doing something they have not had to do in a long, long time: lowering their prices. Simple math then shows that their net-centric business will likely grow revenue slower than it has in the past on the same traffic growth. However, the corollary is that because the difference between pricing at Cogent and the field is now small at best, it is less disruptive and drives less revenue from their net-centric customers. It is a double whammy that may partially explain their very anemic traffic growth so far in 2008, and ought to be watched carefully.

In response Cogent is focusing more and more on its corporate customers where they remain very strong and are spending to bring more buildings on-net, and for its net-centric business it is buying datacenters and leasing fiber in markets with less competition where the pricing remains a bit higher. And one must say that Cogent’s earlier disruptive pricing had to end someday, it has served its purpose: bringing Cogent’s IP backbone to its current top-10 size and its cashflow back into balance. Now their profile may be changing, but we all grow up I guess.

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Categories: Financials · Internet Backbones · Internet Traffic