Investing.com -- S&P Global Ratings has revised its outlook for Cogent Communications (NASDAQ: CCOI ) Group LLC from stable to negative due to weaker credit metrics. The ratings firm expects Cogent’s leverage to remain above the downside threshold of 5.25x in the next year as the company phases out noncore customers and products while streamlining its network.

S&P Global Ratings also affirmed the ’B+’ issuer credit rating and all debt ratings on the company. The revised outlook reflects the risk of leverage remaining above the 5.25x threshold due to higher debt supporting near-term discretionary cash flow (DCF) deficits as payments from T-Mobile decrease.

Cogent’s leverage increased to 5.5x at the end of 2024, up from 4.3x in 2023. The company is expected to maintain this level of leverage due to relatively flat organic revenue and EBITDA growth. Cogent is currently converting its old Sprint facilities into data center space, a process expected to conclude by mid-2025. The company also plans to phase out noncore products and customers, a process that should be complete in the coming quarters.

Despite the termination of a significant lease in 2024, Cogent’s total finance lease obligations increased by over $50 million during the year due to new leases supporting the reconfiguration of its metro networks for Wavelengths. This increase constrained the adjusted leverage calculation. The company’s leverage is expected to remain above the downgrade trigger in 2025, even after the termination of some leases upon completion of its Wavelength enablement.

Cogent is banking on significant growth in Wavelength revenue for deleveraging in 2026 and beyond. In 2024, the business represented less than 2% of total revenues. However, with a robust backlog and reduced provisioning times, Wavelength revenue is expected to enable Cogent to reduce leverage to about 4.8x by 2026.

The company’s free operating cash flow (FOCF) is expected to decline in 2025, with a forecast of about $40 million, up from roughly breakeven FOCF in 2024. Elevated expenses associated with data center refurbishment and subdued growth in its core business contribute to these challenges. These elevated expenses are not expected to decline until mid-2025.

DCF is expected to remain negative in 2025 as Cogent maintains its high dividend. The company is expected to support the approximately $180 million annual dividend through a combination of external financing and cash on hand. Deficits should improve as Cogent moderates its capital spending later this year.

The negative outlook also reflects the risk that leverage could remain above the 5.25x threshold due to higher debt supporting near-term DCF deficits as payments from T-Mobile wind down. Cogent must demonstrate solid execution in realizing synergies from the Sprint wireline assets and achieve strong growth from its Wavelength product in order to reduce leverage.

S&P Global Ratings may lower its rating on Cogent if the company encounters execution missteps from its integration of Sprint’s wireline assets, revenue growth from Wavelengths underperforms expectations, customer churn increases due to competitive pressures or an economic downturn, or leverage remains above 5.25x on a sustained basis. The outlook could be revised to stable if Cogent reduces leverage below 5.25x and maintains FOCF to debt above 5%.

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