Minicase

Cogent Communications and PSINet

In $1999,$ entrepreneur David Schaeffer founded the networking firm Cogent Communications, and thereafter served as its Chairman, Chief Executive Officer, and President. Schaeffer initially wrote a business plan under the premise that the Internet was going to be the only network that mattered. At the time, most of the networks that carried Internet traffic were telephone and cable television networks, but their architectures were inefficient for carrying Internet traffic. Schaeffer$$s plan was to construct a global network to deliver the Internet efficiently that worked like a cheap office network, essentially built around nothing more than routers manufactured by Cisco Systems along with some fiber optic cable. He estimated that constructing such a network would cost approximately $$2$ billion.

Cogent initially raised $$26$ million from six venture capital firms, which led many large equipment manufacturers to offer the firm generous vendor financing deals. Schaeffer accepted an offer from Cisco whereby for every $$1$ of Cisco gear that Cogent purchased, Cisco would lend Cogent $$1\mathrm{.}40.$ As a result of this arrangement, Cogent had a $$409$ million credit line.

In the autumn of $2000,$ an economic downturn in the wake of the collapse of the dot.com bubble led many network firms to experience financial distress. In $2001,$ drawing on its credit line, Cogent acquired the assets of the firm NetRail. In early $2002,$ Schaeffer merged his firm with Allied Riser, which wired large office buildings with fiber optic cable, effectively trading $13$ percent of Cogent for $$132$ million in net cash and $100$ percent of Allied Riser$$s fiber network.

In April $2002,$ Cogent acquired PSINet, a firm in bankruptcy, with an interesting history. PSINet went public in $1995$ and raised $$46$ million. Shortly thereafter, PSINet began to serve business customers, establishing $100,000$ business accounts in $27$ countries. The firm undertook a strategy to run one of the world$$s largest networks, linked to a massive number of PSINet$-$owned web$-$hosting centers.

At the time, PSINet$$s debt load increased $36-$fold, from $$112$ million to $$4$ billion. Its annual interest obligations went from being $$5$ million in $1997$ to being $$400$ million in $2000.$ In April $1998,$ for the first time in its history, PSINet issued debt that was below investment grade $($junk$),$ selling $$600$ million in bonds paying $10$ percent.

The firm then made a series of large investments: It spent $$34$ million for new headquarters, purchased a corporate jet, and agreed to pay $$90$ million in order to have the new Baltimore Ravens football stadium bear its name. The cover story in the May $28,2001,$ issue of Forbes magazine describes how PSINet$$s CEO, William Schrader, and its board of directors assessed the firm$$s financing strategy.

$$We knew we were going to be heavy on the debt side, light on the equity side,$$ says William Baumer, a board member and an economist who heads the University of Buffalo$$s philosophy department. $$The assessment was that the debt markets are wide open, the equity markets not as good, and if we are successful here, we won$$t have any trouble retiring this debt.$$ Schrader insists Wall Street would have been cool to additional stock offerings, despite PSINet$$s lofty price. $$Wall Street says when you can raise equity,$$ he claims.

In the two years leading to the peak of the technology bubble in March $2000,$ PSINet$$s stock price rose from $$7$ to $$60.$ Between $1997$ and $2000,$ PSINet made $76$ acquisitions.

After a period of very rapid growth in the second half of the $1990$s$,$ the telecommunications sector began a sharp decline in the autumn of $2000.$ On May $1,2001,$ PSInet began to default on its $$400$ billion debt. It missed a $$20$ million interest payment and announced that it would likely seek bankruptcy protection. Its stock fell to $18$ cents a share and was delisted, as the firm did file for bankruptcy.

PSINet$$s CEO and founder, William Schrader, resigned in May $2001.$ The Forbes story contains an interesting description of Schrader, stating that $$implacable self$-$confidence helped Bill Schrader transform a few leased phone lines into a sprawling global network.$$

In $2002,$ when Cogent was considering acquiring PSINet, then still in bankruptcy, PSINet$$s secured creditors and unsecured creditors were in a protracted negotiation about the terms of settlement. At the time, PSINet had $$4\mathrm{.}3$ billion in debt, of which $$3\mathrm{.}7$ million was unsecured, and $$300$ million in cash. Cogent offered to buy the firm for $$10$ million and shut down the business, which both groups of creditors accepted.

Cogent CEO Schaeffer made a complicated deal with the unsecured creditors. Once he had control of PSINet, he took physical possession of its assets and placed the most valuable components into a series of warehouses. He then offered to provide these to secured creditors instead of selling them; however the secured creditors refused the offer. That refusal allow