Cogent Communications Group, Inc. -- Moody's assigns Ba3 to Cogent's senior secured notes

Rating Action: Moody's assigns Ba3 to Cogent's senior secured notesGlobal Credit Research - 29 Apr 2021New York, April 29, 2021 -- Moody's Investors Service (Moody's) has assigned a Ba3 rating to Cogent Communications Group, Inc.'s (Cogent) proposed $500 million senior secured notes due 2026. The net proceeds from this offering, together with cash on hand, will be used to finance the redemption in full of the company's outstanding 5.375% senior secured notes due 2022 (2022 Notes), with any remaining net proceeds to be used for general corporate purposes and/or to make special or recurring dividends to Cogent Communications Holdings, Inc. (Cogent Holdings), the public holding company parent of Cogent. All other ratings, including Cogent's B2 corporate family rating (CFR) and stable outlook, are unchanged.Assignments:..Issuer: Cogent Communications Group, Inc.....Senior Secured Notes, Assigned Ba3 (LGD2)RATINGS RATIONALECogent's B2 CFR is supported by a strong liquidity profile and Moody's expectation for mid to high single-digit revenue growth and solid margins due to robust internet traffic growth, its expanding and diversified customer base, and a productive and growing sales force. The company's low cost structure and targeted niche product sales approach continue to make it a nimble and formidably persistent competitor against larger companies burdened with more complex, higher cost legacy structures. Pro forma for the senior secured notes financing Moody's expects debt/EBITDA (Moody's adjusted) at year-end 2021 to approach the mid 5x range and fall closer to 5.0x by year-end 2022, supported by upward revenue pressure beginning in late 2021 and into 2022 accompanied by margin expansion. The company is constrained by slightly negative to potentially neutral free cash flow generation which results from its use of targeted debt leverage to optimize shareholder returns largely through its dividend policy. Today's senior secured debt issuance will ultimately facilitate a dividend to Cogent Holdings and extend the maturity profile of Cogent by repaying debt coming due in 2022. While liquidity currently offsets some of the risks inherent in this financial policy, Cogent's relatively high leverage, moderate scale and highly competitive end markets could also pressure the company's future credit profile absent the balanced approach to this policy that exists today.Cogent has a simple strategy that focuses primarily on selling high speed internet access to on-net customers, typically by leasing dark fiber between its network and its customers' locations, with limited pursuit of off-net solutions for specific customer needs. Cogent's focus on internet service allows for a streamlined cost structure and uniform network architecture. Technology trends continue to be favorably aligned with Cogent's architecture, as enterprise and net-centric customers' networking and transit needs still remain heavily reliant upon dedicated internet access. Older, complex network IT architectures face obsolescence risks in favor of low cost IP networks. This trend benefits Cogent and will continue to support its growth. Cogent's revenue growth slowed in 2020 as new and existing customers in its corporate segment were more cautious about upgrading or adding services as a result of the Covid-19 pandemic. However, solid underlying demand and continued traffic growth support the return to stronger, longer term revenue growth.During the first quarter of 2021, Cogent began a process of reducing its consolidated leverage (as defined within the indenture governing its existing 2022 Notes) to below 4.25x. The company sought this consolidated leverage reduction in order to meet the indenture's terms for enabling the transfer of available funds from Cogent to Cogent Holdings, its public holding company parent. These funds, once transferred to Cogent Holdings, can be used for dividends, share repurchases or certain investments. The consolidated leverage (as defined within the indenture) reduction began with open market repurchases totaling $115.9 million of the existing 2022 Notes during Q1 2021. The next step in this process was the issuance of a conditional call in early April 2021 for $45.0 million of the existing 2022 Notes. The combination of these repurchases and this conditional call will reduce Cogent's consolidated leverage under the terms of its indenture to less than 4.25x, which allows for the transfer of available cash funds to Cogent Holdings.As a key part of this capital transfer, Cogent is offering $500.0 million of senior secured notes due 2026. Once these new senior secured notes due 2026 are priced, Cogent will redeem the $45.0 million of the 2022 Notes as part of the conditional call, which effectively reduces indenture-defined consolidated leverage to below 4.25x and allows for the reclassification of certain funds to the company's restricted payments basket. Following this consolidated leverage (as defined within the indenture) reduction to below 4.25x and the reclassification of the funds, Cogent will close on this new $500 million senior secured notes transaction and simultaneously place a portion of the proceeds with the trustee for the 2022 Notes sufficient to pay the principal of, and accrued and unpaid interest on, at the December 1, 2021 call date, which will extinguish Cogent's obligations under the indenture and effectively cancel the 2022 Notes. Moody's would expect to withdraw the ratings on the 2022 Notes at the time of this extinguishment, which is expected on or around May 7, 2021.The instrument ratings reflect both the probability of default of Cogent, as reflected in the B2-PD probability of default rating, an average expected family recovery rate of 50% at default given the mix of secured and unsecured debt, and the loss given default (LGD) assessment of the debt instruments in the capital structure based on a priority of claims. Cogent's new senior secured notes due 2026 are rated Ba3 (LGD2), two notches above the B2 corporate family rating to reflect their senior position in the capital structure. The senior secured notes are guaranteed by Cogent's domestic subsidiaries and secured by a pledge of stock of 100% of Cogent's US subsidiaries and 65% of the Company's non-US subsidiaries. In addition, the new senior secured notes due 2026 are guaranteed on a senior unsecured basis by Cogent Holdings. However, Cogent Holdings will not be subject to the covenants under the indenture governing these new secured notes as it is not a party to the Indenture and is not governed by the indenture. Cogent's $430 million (USD equivalent) of senior unsecured Euro notes due 2024 are rated B3 (LGD5), reflecting their junior position to the new senior secured notes due 2026. Cogent's bond indentures will continue to restrict certain payments, such as dividends or share repurchases, if consolidated leverage (as defined within the indenture) is above 4.25x.Moody's expects Cogent to continue to maintain very good liquidity. As of March 31, 2021 and on an aggregate basis pro forma for the new senior secured notes transaction and associated capital management process, $389 million in cash is expected to be held on a consolidated basis at Cogent Holdings, with the bulk of that cash remaining at Cogent, the operating entity. Moody's expects Cogent to generate slightly negative free cash flow during the next several quarters with cash balances expected to decline due to the company's equity stakeholder returns. We believe that Cogent will likely supplement its regular quarterly dividends with share buybacks and/or special dividends. As of December 31, 2020, Cogent had $30.4 million available for stock buybacks under its share repurchase program which is authorized through December 2021. Cogent does not have a revolving credit facility. While cash balances will shrink steadily, Moody's expects Cogent to maintain at least $60 million of cash at all times, a level believed to be the minimum required to run the business prudently.The stable outlook is based on Moody's view that while Cogent's earnings and cash flow will continue to grow, equity stakeholder returns -- in the form of dividends and share buybacks -- will increase in tandem. Moody's expects the company will maintain sufficient liquidity while debt levels remain relatively constant. Cogent's low cost structure and niche sales approach, in conjunction with its aggressive equity stakeholder return policy, will prevent the company from generating meaningful positive free cash flow for the near future. The top 20 equity stakeholders of Cogent's public holding company parent own approximately 70% of outstanding shares and are primarily large institutional managers, with Cogent's CEO and founder controlling approximately a 10% stake.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSMoody's could upgrade Cogent's ratings if leverage is sustained below 4x (Moody's adjusted) and free cash flow is positive. Moody's could downgrade Cogent's ratings if leverage is sustained above 5x (Moody's adjusted).Cogent Communications Holdings, Inc., with headquarters in Washington, DC, is a multinational Tier 1 internet service provider. The company offers dedicated internet access and data transport over its fiber optic, IP network to corporate and net-centric customers. Cogent, as one of the top five largest carriers of internet traffic in the world, generated $568 million in revenue in 2020.The principal methodology used in these ratings was Communications Infrastructure Industry published in September 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1076924. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. 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Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1263068.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Neil Mack, CFA Vice President - Senior Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. 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