Telephone companies have talked for decades about the possibility of sending television signals down thin fibre-optic lines to millions of homes. Finally, thanks to a series of developments, it’s starting to happen.

These developments include:

> the availability of optical chips and components that are inexpensive and relatively easy to install;

> intensive competition from cable firms, which have been pushing a “triple play” of TV, phone and Internet service;

> a key reform to the U.S. Tele-communications Act that now lets telephone companies deny competitors the right to share fibre-optic lines and increases the incentive for phone companies to deploy fibre.

The upshot is that telephone carriers have sharply stepped up their spending on fibre-to-the-home (FTTH ) gear. And as a result, investors are facing a fresh wave of investment opportunities.

With fewer than 1% of homes in Europe and North America connected to fibre-optic lines, it’s a wide-open market. The number of households with FTTH systems is expected to almost double to 11 million in 2007, according to a research affiliate of Light Reading Inc., a respected source of intelligence about the optical industry. By 2011, 85 million homes will be connected to fibre, Light Reading predicts.

At the moment, FTTH is a peculiarly Asian phenomenon. More than 70% of FTTH subscribers today live in Japan and South Korea, although this ratio is expected to drop in coming years as European and North American carriers play catch-up.

There are several ways for investors to play the FTTH rollout. The most conservative is to buy shares in the larger companies that sell complete FTTH systems (fibre, modules, chips) directly to the telephone companies most committed to fibre.

Thanks to Japan’s early lead in FTTH, the globe’s three biggest suppliers are Mitsubishi Corp., Sumitomo Corp. and Hitachi. Tellabs Inc. of Naperville, Ill., is the next biggest player, courtesy of its tight relationship with New York-based Verizon Communications Inc., which is aggressively deploying its fibre-optic services (FiOS) network. Verizon added 111,000 subscribers in the second quarter, giving it a total of 375,000.

Verizon, which began offering FiOS in late 2004, appears to be well on the way toward meeting its targets. Of the customers who have had the option of signing up for FiOS for at least one year, 15% have done so. Verizon expects 30% will sign up within five years. At current rates of capital spending, Verizon will be able to offer the service to six million potential customers by the end of the year and to nine million by 2007 yearend. The company has 55 million subscribers in total.

The telephone giant recently tendered a contract for upgrading its FiOS technology. Tellabs will play a big role, but so, too, will Paris-based Alcatel SA and Chicago-based Motorola Inc.

Alcatel is also a significant supplier to SBC Communications Inc., the Texas-based regional giant that began building its FTTH network this year and expects to be able to offer high-speed FiOS — 10 megabits per second and up — to four million of its more than 50 million subscribers by the end of next year. (SBC recently became a part of New York-based AT&T Co.)

Buying shares in Tellabs and the other large suppliers is an indirect way of playing the market because FTTH product sales represent a small percentage of each supplier’s total revenue. However, the best way to gain exposure to the home fibre market is through smaller companies that make the bits and pieces that go into FTTH systems.

Certainly, the narrow market for FTTH components and modules is accelerating. CIR Inc., a consulting firm based in Charlottesville, Va., estimates telephone companies will shell out US$1.5 billion by 2011 for FTTH, vs an estimated US$629 million this year.

One of the riskiest — and potentially most lucrative — investments is Ottawa-based Enablence Technologies Inc., which began trading on the TSX Venture Exchange in late July. The two-year-old start-up has a surprisingly good position in the business of making integrated optical chips that go into the optical modems that homeowners rely on.

Enablence is run by Arvind Chhatbar, a former manager at the National Research Council of Canada. His top engineers cut their teeth at Optenia Inc., an optical start-up that failed several years ago but left a strong legacy in the form of good relations with a state-of-the-art semiconductor plant owned by NKT Holding A/S. Enablence and NKT jointly developed technology and manufacturing processes related to optical chips.

@page_break@When NKT sold its semiconductor plant early in 2005 to Ignis ASA of Norway, the event triggered a clause that made Enablence very happy. The upshot: Enablence wound up inheriting all the intellectual property it had jointly created with NKT. That included laser diode and photo detection technologies that NKT had created in collaboration with Samsung Electronics Ltd., the South Korean electronics giant. Chhatbar turned down Ignis’ subsequent attempt to buy Enablence — he says he was offered US$28 million — and instead took Enablence public after raising almost $17 million from private investors.

Among Enablence’s key strengths is a low-cost all-optical chip, one of the critical components for the FTTH industry. The chips are packaged together with other pieces of technology to make transceivers that direct the optical signals.

Daniel Kim, an analyst with Toronto-based Paradigm Capital Inc. — which helped Enablence secure an $11-million private placement this past summer — wrote in a Sept. 7 report that the company “is receiving enormous interest from a broad array of potential customers.” Enablence raised its credibility a notch or two in late September, when it revealed it had signed a deal with Sanmina-SCI Corp. of San Jose, Calif. — a leading contract manufacturer.

As Sanmina will be investing more than US$1 million to prepare its manufacturing line to handle Enablence’s transceivers, this suggests the latter company has either secured a high-volume customer or is on the verge of doing so.

Enablence is marketing its technology to Tellabs, Alcatel and other top-tier suppliers of FTTH systems, as well.

Kim is forecasting Enablence will generate losses through 2008 as production volumes escalate. By 2009, he expects the firm to make 5¢ a share on sales of $39.4 million. He has a 12-month target share price of $2; recent trades have been at slightly less than 50¢.

Needless to say, with a pre-revenue company with no customers at the moment, the risks are many. They include possible manufacturing glitches, marketing failures and competition from other start-ups, including NeoPhotonics Corp. of San Jose, Calif., and Xponent Photonics Inc. of Monrovia, Calif.

There are a variety of other companies that make components for the FTTH market, each with varying degrees of exposure. Two of the leading firms are:

> Exfo Electro-Optical Engineering Inc. Vanier, Que.-based EXFO makes fibre-optic test equipment. Verizon, a key customer, accounts for 15%-20% of EXFO’s quarterly revenue, according to Paul Howbold, an analyst with Desjardins Securities Inc. who rated EXFO a “buy” in a report published Sept. 6, when EXFO’s shares were trading at $5.46 a share, with a 12-month target of $7.82.

“Given the rapid uptake of the FiOS service, Verizon is likely to accelerate the FTTH,” he wrote.

Five out of six analysts surveyed by Bloomberg LP also rated EXFO a “buy.”

> MRV Communications Inc. Tim Savageaux, an analyst with San Francisco-based Merriman Curhan Ford & Co. , rated MRV of Chatsworth, Calif., a “buy” in his Sept. 11 report. This assessment was based in part on the solid prospects of MRV’s optical subsidiary, Luminent Inc., which supplies optical triplexers for Verizon’s FTTH network. Savageaux notes that MRV’s share price weakened during the summer over concerns that Luminent orders would slow as Verizon shifted from one generation of FTTH technology to the next.

But Savageaux sees this as a short-term problem with the advantage of offering investors an attractive price for entering the market. He predicts the company’s revenue next year will jump to US$400 million from US$344.4 million in 2006, with net income moving up to US20¢ a share from a loss of US2¢ a share in 2006.

The big risk is that Luminent will be vulnerable if Enablence’s technology hits the mark in terms of price and performance. IE