Dirt cheap broadband grabs market share

Cogent Communications sells bandwidth to corporate clients for a fraction of the cost of traditional telecoms and cable companies. Many of the usual suspects are not happy, says Fortune's Stephanie Mehta.

By Stephanie Mehta, Fortune senior writer

NEW YORK (Fortune) -- Dave Schaeffer seems like an awfully nice fellow. The physics major-turned-CEO has founded seven successful companies, yet he displays none of the brashness of other tech entrepreneurs. He is mild-mannered, unfailingly polite and speaks with the deliberate manner of a college professor trying to explain a particularly difficult concept.

Yet Schaeffer is the first to volunteer that he and his company, Cogent Communications (Charts), aren't exactly beloved in the telecommunications industry.

The reason: Cogent, which gobbled up a bunch of busted Internet service providers at fire-sale prices, sells bandwidth to corporate customers for as little as $10 per megabit per second per month. (In comparison, cable operators and telcos charge consumers roughly $40 a month for broadband that clocks in at 1.5 megabits per second, and businesses can pay $550 a month for a dedicated T-1 connection.)

Competitors, ranging from Level 3 Communications to AT&T, aren't fond of Cogent's bargain-basement rates, and some investors wonder how the company can make money charging such low prices. Indeed, Cogent doesn't turn a profit: last year the company posted a loss of $46.5 million, and it expects to lose money again this year.

Schaeffer and Cogent, however, do have their share of fans. Customers, especially heavy-duty data users such as Google's (Charts) YouTube and eBay (Charts), have been flocking to Cogent for cheap onramps to the Web. Picture-sharing site Photobucket recently said it would double its bandwidth connections with Cogent, and YouTube apparently increased its connections some 30 fold in 20 months, according to a report by Wachovia Capital Markets.

Wall Street has taken notice of Cogent's popularity with the online cognesceti. The company's stock now trades at about $24 a share, close to its 52-week high. Shares have tripled since August.

In many ways, Cogent is reaping the rewards its predecessor companies had hoped to sow. Back in the late 1990s, dozens of companies raised billions of dollars to aggressively build Internet networks. Some, such as Global Crossing and 360 Networks, built huge backbones to carry data traffic around the country while others, such as Allied Riser, installed fiber optic cable in and around office buildings. They all figured huge streams of Internet traffic would fill all those pipes, enriching investors along the way.

The pipe dream, of course, turned into a nightmare. The companies built much more capacity than customers could ever absorb, and many of the promising upstarts failed or sought protection from bankruptcy courts. A few, such as Global Crossing (Charts) and XO Communications, emerged from bankruptcy (though many stockholders were wiped out).

Others sought white knights: Schaeffer was one such savior, picking up the assets or operations of 13 failed providers, including Internet pioneers PSINet, NetRail and Aleron.

Today, Washington, D.C.-based Cogent is seeking to be the low-cost, high volume player in the Internet world. And that, Schaeffer contends, rankles competitors who have higher overhead or legacy telecom businesses to protect.

"I think people look at Cogent and their gut reaction is akin to the way an American factory worker might look at the Chinese," Schaeffer says in his professorial way. "They think there's something unfair about the way we do business, when in fact, they're the ones who aren't doing the right things to compete."

Cogent has tussled with a few of its competitors in the past, mostly over concerns that Cogent essentially was "dumping" traffic onto others' networks. Cogent has been "de-peered" on occasion by rival ISPs France Telecom, AOL and Level 3. Large ISPs traditionally "peer," or exchange traffic with each other for free, but a few years ago Level 3 concluded Cogent was sending way more traffic to Level 3 than Level 3 was sending to Cogent's network. Level 3 briefly pulled the plug on Cogent traffic, causing the two companies ' customers to lose connections to considerable Internet content.

Cogent and Level 3 (Charts) eventually resolved their differences, but you can bet other Web operators are closely watching the amount of traffic it receives from Cogent, with its business model built around volume.

Schaeffer doesn't seem to care about winning popularity contests in the clubby world of Tier 1 telecom players. Indeed, he stops short of accusing the other operators of collaborating on pricing. "I won't call it price fixing, I'll call it price signaling," he says. "We have not played by all the established rules that are in place that relate to price."

Nor is he interested in copying rivals' strategy of selling add-on services or getting into the business of managing customer's networks, the way AT&T (Charts) and Verizon (Charts) do. "If you're Google or Apple's iTunes or eBay, what value added service would they want from Cogent?" Schaeffer says. "They just want the pipe; they're the ones adding the value to the customer."

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.