Ikanos Communications: How Big is The VDSL Market? (Part II)

Japan is considered as one of the most advanced telecom markets in the world, especially in terms of average bandwidth allocated per each subscriber. Although there are many European countries with higher broadband penetration, subscribers in these countries can get up to several Mbps, while the standard in Japan is at least several tens of Mbps. This is thanks to years of infrastructure buildout mainly by the country’s leading incumbent, NTT, which has deployed a massive fiber network that covers the majority of population in Japan.

The high fiber penetration and population density made Japan Ikanos’ (IKAN) largest market. Accounting for more than 35% of the market, there were more than 10 million FTTH subscribers in Japan in mid 2007, with the remaining of the broadband market dominated by DSL. During recent years, there is a clear trend among Japanese subscribers who migrate from DSL services (mainly ADSL) toward FTTH services. In fact, the number of FTTH subscribers is expected to surpass the number of DSL subscribers somewhere in 2008. In Q1 of 2007, for instance, more than 800k subscribers signed up for FTTH services, in contrast to a 200k drop in the number of DSL subs.

Allegedly, the Japanese market is irrelevant for Ikanos, as there are only FTTH services. However, in Japan the term FTTH refers to both pure FTTH architecture as well as FTTB, where fiber reaches to the basement or within a short distance from each building. Although we could not find any official numbers, more than half of the Japanese FTTH lines are estimated to be FTTB, which rely on VDSL for connecting each apartment to the basement. The vast majority of these VDSL deployments are based on Ikanos’ chips.

Ikanos’ business was flourishing in Japan in the first half of 2006, but in the second half of the year things changed dramatically, as carriers decreased orders for VDSL equipment, leading to a devastating drop in Ikanos’ revenues. There are two contradicting views regarding the reasons for the sharp decline in orders. Ikanos claimed that this is a typical Japanese inventory correction, as carriers realized they have sufficient inventory for supporting VDSL deployments for the coming quarters. This pattern characterizes most access deployments, as carriers typically buy large amounts of equipment in advance in order to meet any possible demand from customers. Another factor weighing in was the transition from Ikanos’ 4^th generation VDSL chipset to its 5^th generation chipset that had been introduced earlier in 2006. Although these platforms had already been qualified by most of Japanese vendors like NEC and Sumitomo already in 2006, as well as Korean OEMs, carrier qualification took longer than expected. These platforms, when used in FTTB settings, have comparable performance to pure FTTH, as they can deliver symmetric 100Mbps connection (100 Megs for both download and upload).

Company’s management repeatedly claimed that this is only a push out of orders, as the trend of using VDSL is still intact. It even revealed the company was in close contact with its Japanese customers and had received indications from the Japanese carriers, especially NTT, that in the 2^nd half of 2007 there should be an uptick in orders.

The violent market reaction, which shaved more than 80% of the stock price, implies the market interpreted things quite differently. Many observers thought that the drop in orders was part of a strategic shift in Japan from FTTB to pure FTTH, which basically means, that most new deployments would not utilize VDSL. If true, this shift is clearly a major blow for Ikanos. Another factor which turned many investors against the company (but eventually saved it from an even harsher crisis) was a secondary offering that was closed during Q1 of 2006 at a price of 20.75$ per share.

Although it is still premature to decide how strong the Japanese VDSL market is, the truth probably lies somewhere in the middle. It is likely to assume that eventually, the number of pure FTTH installations will increase, especially in the cases of new buildings or single dwelling units (SDUs). On the other hand, Ikanos’ recent quarterly reports paint a more encouraging picture about the Japanese VDSL market. Sales to Japanese customers plummeted from over $17 million in Q1 of 2006 to just over $9 million in Q4 of that year. In Q3 of 2007, however, sales to the Japanese market were $15.5 million, which definitely implies that operators intend to use FTTB+VDSL in a substantial portion of installations.

In 2008 there may be an additional VDSL opportunity in Japan. Softbank has been evaluating Ikanos-based VDSL for FTTN deployment for over a year in order to upgrade its DSL subscriber base. The operator commands more than one third of the Japanese DSL market with 5.2 million subscribers, 70% of whom have bandwidth of 26 Mbps or less. After acquiring mobile provider Vodafone K.K. for US$15.6 billion in early 2006, Softbank can offer its customers both wireline and wireless services, similarly to NTT and KDDI. However, despite the strong momentum in the 3g market, it will have to offer more attractive broadband packages to its customers in order to fend off competition.

If Softbank decides to upgrade its subscriber base using VDSL, we are looking at a 3+ million port opportunity. It is still unclear how committed is Softbank to VDSL, especially considering the fact Ikanos has been hinting about this project for quite some time, without any substantial orders. Nevertheless, during the 3^rd Q conference call, Ikanos’ CEO revealed that “a major Japanese carrier” had finally begun deploying FTTN using the company’s chipset, so there is room for cautious optimism.

In addition, Ikanos expects to start shipping its highly-anticipated VDSL residential gateway chipset, the VX180, to Japan in the second half of 2008. The VX180, which will be discussed in the next article, combines multiple functionalities, making it a more profitable product, in comparison to the VDSL CPE chipset Ikanos is currently shipping. As a result, even if there is no growth in the number of VDSL lines deployed in Japan, there might be a nice increase in the average price per line.

In summary, it looks like the worst is behind Ikanos, at least in the Japanese market. Now that demand has finally stabilized, quarterly revenues of $15+ mil from the Japanese market are likely to be seen during 2008. Still, Japan will certainly not be the main growth engine in the coming years for Ikanos. For that, Ikanos will have to turn its attention to Europe and the US, where the VDSL market is only beginning to evolve. Unlike Japan, in Europe and the US, Ikanos faces tough competition mainly from Conexant (CNXT) and Infenion (IFX).

Disclosure: Author has a long position in IKAN

Comments

[nphrn]

Very nice series. Looking forward to part III. For me it both answers and raises a lot of questions. I'm not expecting you to drop everything to answer all of them but the following is my wish list. Any help would be appreciated.
One thing I'd love to get a sense of is where the different broadband alternatives sit in a quantitative way from the perspective of the carriers that need to purchase them. For instance, if you have a "typical" 100 unit apartment building which already exists what would be the cost of going FTB with VDSL vs FTH? What would be the difference in mainainance costs? If FTB/VDSL gets 100mb/s what would FTH get?
It seems like a lot of investors are treating VDSL as a transitional technology with decreasing revenues. To the extent that this is true I wouldn't touch it. But it seems like the difference in price of laying down fiber in an existing building would be huge and give a fairly small increment in speed. On the other hand Verizons decision to go with FTH would seem to validate that approach. Are they actually doing this on a large scale with existing structures?
Regards
Andy

[Ohad Hammer]

Hi Andy

I think that VDSL is a transitional technology, however, the transition is going ot take quite a while...
According to estiamtes, the number of broadband subs in 2010-2011 is expected to top 500M, but only 10-15% of them will be FTTH. What will happen with all the other DSL subs (300+ million )? In addition, some of the FTTH users will actually be FTTB, like we've seen in Japan and like we're going to see in the US.

Regarding the comaprison of pure FTTH to FTTB+VDSL, it depends on who u ask. FTTH is definitely cheaper and easier to maintain, and bendable fiber will likely make it easier to deploy, but wiring every apartment in high risers directly to fiber doesn't seem like the ideal solution imho.
Actually, according to one research company, even in Japan with its high fiber penetration and competitive market, there was a trend towards VDSL in the 3rd Q:

"The dominant Japanese market continues to move towards a higher percentage of MDU subscribers, increasing the number of VDSL ports while reducing the number of FTTH ports."


lw.pennnet.com/display.../


Best,
Ohad