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Duo to Face Off With NTT

Light Reading
News Analysis
Light Reading
7/25/2002

TOKYO -- Japan’s data communications market faces its first major shakeup in a decade, after Internet Initiative Japan Inc. (IIJ) (Nasdaq: IIJI) announced last week that it was talking to utility Tokyo Electric Power Co. (Tepco) and its PoweredCom Inc. and Tokyo Telecommunication Network Co. Inc. (TTNet) subsidiaries about integrating their trunk data businesses.

Local media immediately framed the talk as a potential combination of players that could take on the Japanese market’s Godzilla. Otherwise known as NTT Group (NYSE: NTT), the monster has something like a 50 percent share of Japan’s ¥1.5 trillion (US$12.8 billion) enterprise data communications market. According to this scenario, the team would meld the more entrepreneurial IIJ -- which helped create Japan’s modern data communications market by bringing the Internet to enterprises -- and staid old utility Tepco to take on NTT and deliver new services and lower prices.

”If our merger plans materialize, I'm sure we'll be able to take a share matching that of NTT in the [data communications] market,” IIJ President Koichi Suzuki told a press conference Thursday.

Initial reaction to the news by analysts was positive, but the protagonists have since gone strangely quiet.

“We think that the integrated company’s corporate data services business could pose a significant threat and allow for low cost services. This should put significant pressure on… telecom carriers,” wrote Morgan Stanley Dean Witter & Co.’s Hironori Tanaka in a July 19 research note.

But IIJ spokeswoman Junko Higasa says all the speculation has caused a “confusing situation.”

Last Thursday, the usually loquacious Suzuki and putative partner PoweredCom CEO Takeshi Taneichi avoided making any concrete statements about the talks except to say they would finish chatting in December.

Dispensing the usual platitudes about synergy, they wouldn’t discuss whether the integration means a merger. IIJ’s public relations department, which meticulously updates media on the smallest of network enhancements, will only refer to a bland company statement on the issue. TTNet refers inquiries to PoweredCom. PoweredCom PR refers media back to IIJ’s statement, although spokesman Ryounosuke Takanori helpfully hints that talks might end before December.

So what’s really at stake? Well, first off, it’s technology and cash.

IIJ’s got the technology (see Japan's Ethernet Elite) but needs more cash, according to J.P. Morgan Securities Asia Pte. Ltd. equity research analyst Keiichi Yoneshima.

The IIJ Group is leading Japan’s charge into wide-area Ethernet, carrying some cutting-edge IP technology and a sophisticated network management infrastructure. But IIJ and affiliate Crosswave Communications Inc. took a ¥20.8 billion ($178 million) loss on ¥49.4 billion ($423 million) in sales last year. Yoneshima says IIJ is in danger of making a profit, possibly next year, but still accepted a ¥20 billion ($171 million) loan this spring to tide it over.

Tepco has also been trying to boost its communications business, with TTNet (and its 200,000 kilometers worth of access and backbone fiber optic networks) at the center of these plans. More importantly, TTNet made a ¥7.9 billion ($67 million) profit on ¥180 billion ($1.54 billion) worth of sales.

“IIJ and Crosswave need financing to grow. The ¥20 billion loan is enough to keep them going," says Yoneshima. "Their long-term financial situation is weak, and if they have the alliance, these problems will disappear.”

Secondly, the “integration” is as much about scaling as survival. Yoneshima contends that a combination of moderate IT spending after years of caution here could drive data market growth 20 to 25 percent per year over the next half decade. KDDI Corp. the number two player, takes 20 to 25 percent of that market, while number three, Japan Telecom, takes 10 percent. Combining with bigger partners would give tiny IIJ the means to grow with the market, he says.

“Market share does not depend on superior technology but brand names. IP-VPN, which IIJ has left behind, is growing dramatically. This is a defensive move by IIJ.”

In fact, the move has an air of inevitably about it, says HSBC Securities (Japan) Ltd. analyst Ben Wedmore, who has had IIJ pegged for several mergers over the years:

“If you want to be a small player, that’s fine -- if you are an engineer. IIJ is probably very happy, as is Crosswave, to become part of a larger conglomerate under Tepco. The gas, telecom, and road utilities have the economies of scale. I could never understand how they [IIJ] could build a national network and service. They can leave the larger capex issues to a larger company.”

— Paul Kallender, special to Light Reading
http://www.lightreading.com Want to know more? The big cheeses of the optical networking industry will be discussing this very topic at Opticon 2002, Light Reading’s annual conference, being held in San Jose, California, August 19-22. Check it out at Opticon 2002.

Register now and save $500 off the registration fee. Just use the VIP Code C2PT1LHT on your registration form, and deduct $500 from the published conference fee. It's that simple!

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