Japan's Ethernet Elite

Internet Initiative Japan, the company that pioneered dial-up access, is in danger of making money -- on Ethernet

May 27, 2002

6 Min Read
Japan's Ethernet Elite

TOKYO –- At last, some good news? In 1992, Internet Initiative Japan Inc. (Nasdaq: IIJI) created Japan’s first ISP service. Ten years later, it appears to be in danger of turning a profit.

Yes, Japan’s old corporate monoliths are waking up to the potential of wide-area Ethernet and megabits-per-second bandwidth. So argues IIJ President and CEO Koichi Suzuki, who believes he has outmaneuvered some other lumbering old oligopolies -- Japan’s major telcos -- to steer Japan’s corporate data networks out of frame relay and IP-VPN and onto the Ethernet.

"We see a different kind of gigantic market,” he told analysts on IIJ’s May 22nd conference call. “We have the best strategy in Japan, and nobody can stop the trend of technical innovation,” he reiterated to Light Reading today.

Ethernet WANnabe?

Suzuki is betting that from nothing, wide-area Ethernet will take a sizeable chunk of today’s corporate WAN market and that IIJ, a tiny company with revenues of ¥39.9 billion (US$320 million) last year can take on and beat behemoth telecoms such as NTT Communications Corp., KDDI Corp., and Japan Telecom.

This seems a pretty brave prediction for a company where the net loss ballooned to ¥7.5 billion ($60 million) last year from ¥4.6 billion ($36.8 million) the previous year. Such optimism seems even less grounded when IIJ’s 37.9 percent affiliate Crosswave Communications. (Nasdaq: CWCI) -- the company supposed to advance into Ethernet -- just posted a net loss of ¥13.4 billion ($107 million), 23.5 percent more than the previous year.

Meanwhile, wide-area Ethernet takes up about 2 percent of Japan’s 300,000-odd corporate WAN data communication lines, with Frame Relay taking up about 70 percent, and IP-VPN the remainder, according to J.P Morgan Securities Asia Pte. Ltd. Equities Research analyst Keiichi Yoneshima.

At the same time, the body count of U.S.-based companies delving into Ethernet services is rising. Yipes Communications Inc. is now exploring the intricacies of Chapter 11. Is Suzuki a hopeful visionary or a brave fool?

Neither of these, argues Yoneshima, who has IIJ and Crosswave at Buy ratings. The reason is that Japan’s stodgy old corporate WAN market needs a quick fix. A simple-to-roll-out protocol such as Ethernet could be just the trick, and Crosswave could be the just the outfit to do this.

To date, Japan’s WAN market has been on a leash, held back by stingy corporate IT budgets, high costs, and lack of competition, says Kirk Boodry, director of equities research for telecom at Dresdner Kleinwort Wasserstein in Tokyo. While the industry is currently shifting from 128-kbit/s access rates to 512 kbit/s, Layer 2 services did not emerge until 1999, and Japan’s big three, Japan Telecom, NTT, and KDDI, did not launch their IP-VPN services until, respectively, May, July, and October 2000.

And in Japan, as elsewhere, IP-VPN has proved a mixed blessing, says Credit Suisse First Boston Securities (Japan) Ltd. analyst Kentaro Kimura.

"Frame relay is huge," Kimura says, "but it was all occupied by KDDI, NTT, the power companies, and Japan Telecom, and it has had terrible problems, with chipsets, with enterprise IP departments not understanding the technology."

In fact, the market is waiting for corporations such as Crosswave to step in to rescue them, he says. "System integrators are familiar with the Ethernet and they understand it can be a great service."

According to J.P. Morgan’s Yoneshima, Japan’s fixed-line data communications market has grown more than 50 percent annually since 1999 and could reach about ¥10 billion ($80 million) in 2005, with wide-area Ethernet taking about a quarter of that.

Founded back in 1992 by Suzuki and a handful of the best engineers he could nab from Japan’s IT industry, IIJ has managed to steer itself around Japan’s low-key bandwidth expansion, picking sweet spots in network management, content design and maintenance, security, and hosting. The IIJ group has seen 67 percent CAGR (compound annual growth rate) for the last eight years.

Indeed, IIJ's finances look like they might finally have a chance to turn the corner. Kimura of Credit Suisse points to the fact that IIJ is the only ISP with positive cash flow in Japan. “It’s because of their high-end enterprise focus," he says. "They are aggressive, they have Sony, Shinko, the [8,000-branch convenience store] Lawson chain and other big names. Where Crosswave leads, others must follow."

Found Fiber

IIJ saw Ethernet as the Next Big Thing back in the late 90s, and now Crosswave’s CEO Akio Onishi thinks the company’s competitors are too late. Founded in 1998, Crosswave skipped IP-VPN completely and shot straight for Ethernet in October 1999, with its telecom rivals not following until 2001. Over that 30 months, Crosswave has secured 224 major corporate customers, 188 of which are using the wide-area Ethernet platform, including, just recently, major trading company Shinko Securities Co. Ltd.

This speed, says Yoneshima, has given IIJ/Crosswave something like 80 percent of the nascent market.

"IP-VPN is not proving profitable, but Ethernet networks are cheaper and easier to install. Ethernet has become a de facto brand of Crosswave and IIJ,” he says. But the biggest benefits to these companies, paradoxically, may come from the crash of the U.S. long-haul market and some powerful friends.

The Japanese government finally managed to get NTT to unbundle its vast cable and fiber networks, opening up cheap dark fiber access, while international backbone costs decreased more than 62 percent last year. This March, Crosswave got KDDI to modify its 1998 IRU to lower Crosswave’s total cash payments by about ¥25.3 billion ($202.5 million) for the seven-year period through March 2009.

Despite its startup pretensions, Crosswave is a company two-thirds owned by Sony and Toyota Motor Corps, with 23.9 percent each. This, notes Dresdner’s Boodry, not only helped knock down corporate firewalls. It gave the loss-making company the muscle to secure a ¥15 billion($120 million) six-year loan and a ¥5 billion ($40 million) short-term line of credit last month from a consortium of Japanese banks led by Sumitomo Mitsui Banking Co. Ltd.

Crosswave today said it will add a new wide-area Ethernet services platform on July 1 in Tokyo, Osaka, Nagoya, Sendai, and Fukuoka, with 10-Mbit/s offered nationwide. The next major target, says Suzuki, is, perhaps unsurprisingly, Japan’s banking system.

Analysts like the prospects. “If you thought they are going to stay broke, why did four major banks just give them financing?” asks Kimura.

— Paul Kallender, special to Light Reading

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