This article outlines how the stock of Ikanos, priced below $2, could realize explosive growth on the next wave of VDSL technology and grow earnings close to $1 per share over the next two years.
Ikanos (IKAN) is a fabless manufacturer of xDSL semiconductors. xDSL flavors consist of ADSL, SDSL and VDSL. The primary flavor of xDSL of concern for Ikanos's future prosperity is called "vectored VDSL." Vectored VDSL cancels the crosstalk between pairs of copper wires and enables bandwidth of up to 100Mbs with existing copper wire pairs. This is the DSL flavor that telephone companies across the globe will deploy to remain competitive with high-speed capabilities of competitive cable systems while also providing viable economics compared to fiber-to-the-home (FTTH). The reality for telco companies is that 50Mbps-or-higher is becoming a necessity for the chorus of applications sucking bandwidth from today's residential connections: video-on-demand, HDTV, over-the-top applications such as Netflix (NFLX), and web surfing in the world of "I want it now."
Ikanos is perfectly positioned for the deployments of vectored VDSL over the next 18 months.
Why Vectored VDSL is Inevitable for Telco Companies
The US is rich in cable company infrastructure. The media also trumpets the growing use of wireless and fiber broadband connections. But the global facts are as follows:
- Cable companies will continue to prosper and have an inherent bandwidth advantage over telco infrastructures. But telco companies will simply not allow their networks to shrivel away. They will invest in their existing networks to be able to offer services that are competitive to cable companies.
- Much of the world residential broadband connections are still dominated by telcos and DSL. According to Q1 2012 statistics, 60% of the global broadband connections are slower ADSL and 14% are FTTX where the last leg of the connection is typically VDSL (source: Ikanos corporate presentation, Point Topic Global Broadband Statistics Q1 2012).
- There are about 1 billion lines of copper in the world (source: Ikanos corporate presentation). A significant portion of these are ADSL lines and will likely be upgraded to vectored VDSL. Europe and certain large North American carriers are particularly ripe for this upgrade wave.
- While telcos have deployed FTTH, it has become clear to the telcos that FTTH is very costly to deploy at about $1,300 per home (source: AP article, 2010). VDSL on the other hand allows the telcos to deploy broadband lines for about $250 per home (source: Ikanos corporate presentation). This trend is clear from Verizon's wind-down of its FIOS in early 2010.
- While broadband wireless access is great for cellphones and laptop / tablet access, the bandwidth is simply not high enough (15 Mbps for LTE) to be a primary broadband residential that can carry video, internet and voice.
Sizing Up the Forthcoming Vectored VDSL Market Opportunity
The following table shows a projection of the vectored VDSL market (source: Ikanos corporate presentation). The chipset market opportunity is based on a $15 average selling price for both sides of the wire (which is conservative to Ikanos's own projection of $20).
Vectored VDSL Line Installed (millions)
Chipset Market Opportunity (millions)
The skeptic will correctly point out that the table is likely skewed to the optimistic side of things since it is Ikanos's own projection. But even if the rollout projection is off by 10 million lines in 2015, the market opportunity is still 4 times bigger than Ikanos's current revenue of $120mm.
How Can One Be Certain that Ikanos is the Right Horse to Bet On?
The world was certain Apple (AAPL) stock was headed to $1,000 when it was priced at $700. The stock is now in the low $400's. Even the smartest guys in the room had a convincing argument for Apple being worth $1 trillion ($1,000 stock price). The point of the Apple story is that there is never certainty in investing. Investing is a game of capitalizing on risks that are asymmetrically skewed to one's favor.
The investment risk / reward on Ikanos stock is skewed heavily towards the reward side of the ledger. The company currently has a market capitalization of about 1 times revenue. This is close to "salvage value" for a company that has generated almost 50% gross margins in its fourth quarter of 2012 and is pumping $50 million annually in R&D for DSL. But the upside for the stock is apparent in that if Ikanos only gets 30% market share of the $600 million vectored VDSL market opportunity in 2015, the company would almost triple its revenue to $300 million and earn close to $1 per share. (This is based on 50% gross margins and the company's current operating expense level of $80mm annually and 70 million shares outstanding.)
While Broadcom (BRCM) has leading market share for VDSL, Ikanos is laser-focused on outflanking Broadcom with its innovation called Nodescale Vectoring VDSL that provides an extremely elegant technology for noise-cancellation with vectored VDSL. The only other competitor, Lantiq, had debt rated by Moody's below "high speculative." This does not instill a great deal of worry about the company as a competitor to Ikanos. Ikanos's Nodescale Vectoring is currently in lab trials with Tier 1 carriers (source: Ikanos company presentation) and, based upon positive results, could enter field trials in the middle of this year. Deployment could start to trickle in towards the end of 2013.
Evidence of Ikanos's credibility with telco carriers is illustrated with their recent success with vector-compatible chipsets for CPE which are being installed in homes prior to wide-scale carrier deployments of vectored VDSL. In the most recent quarter, Vx17X, Vx18X Fusiv communications processors were 37% of total revenue. These processors are used in CPE equipment such as the Orange Livebox 3.0 in Europe and are field upgradeable to vectored VDSL.
Getting Invested Before the Turn
How many times in investing does one hesitate to buy a stock because it is "too early" only to fail to buy once the chart has turned on the stock, "waiting for a pullback?" One of the key tenets of investing is that the best investment returns come when the positive events are just far enough out for Wall Street to ignore. With Ikanos, the opportunity is positioned as such. Vectored VDSL rollouts will not occur in large scale until 2014 though Ikanos recently stated that the company could become profitable before the end of 2013 on its initial success in this area (source: company presentation at Roth Capital Partners Growth Conference). The company has also communicated in its fourth quarter conference call that its business will be a tad soft in first two quarters of 2013 due to digestion issues with a couple of carrier end customers that are deploying its Fusiv family of processors. This patch of softness provides a compelling entry into the stock given that 2013 estimates have now been reduced while the ramp of vectored VDSL is just at the horizon.
The risk / reward opportunity and timing of Ikanos are almost perfectly set up for a potential multi-bagger while the downside is limited. There are few other investments in the technology sector where the smartphone market is maturing, PC shipments are shrinking and green energy is in need of a breakthrough innovation. Quite simply "the time is nigh" for Ikanos.