Outlook: Why this telecom madness has a way to run yet

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The Independent Online
THE PHONEY war is over and battle proper has commenced. In this reversal of historical position, the cricket-loving Chris Gent is cast in the role of empire-building aggressor, with Mannesmann the underdog defender of the German fatherland. Already Mannesmann's Klaus Esser is promising to fight them on the beaches and fight them in the hills. He will never surrender, and he will use every tool at his disposal to frustrate his one time ally turned enemy.

Dramatic and awe-inspiring stuff, but Vodafone's record breaking pounds 79bn hostile bid is also just the outsized and most immediately visible tip of a much wider telecommunications frenzy, affecting both mobile and fixed line. Rarely have stock markets seen anything like it. It's wild out there, and with the valuations seemingly more fanciful by the day, it's hard to know how to respond. The question on everyone's lips - is this a dangerous financial bubble in the making, and if it is, when will it go pop?

On one level, the City's love affair with anything to do with technology and telecommunications is perhaps just as well. Many traditional stocks are bombing and were it not for the boom in these "new economy" sectors, overall stock market performance would look very different - we'd have a bear market on our hands. So what on earth is going on?

Whether justified or not, what we are witnessing is no less an event than a new investment paradigm in the making. Like most modern trends, it started in the US and is now washing up on these shores with a vengeance. Shares are polarising into two categories - those that might gain from the new economy and those that will lose from it. Besides the winners and losers, there is also a third middle category - shares for whom the Net is unimportant.

Look at the traditional industries where share prices are holding up well, and you find that they are mainly wholesale and commodity based. Whatever the Internet does to the price of consumer goods, however much it destroys traditional channels of distribution, it is going to have nil impact on the price of oil, commodity metals, water or electricity.

Similarly, there will always be a demand for automobiles, beer and sun- dried tomatoes. These industries may not gain very much from the Net, but nor will they lose from it. As a result, their stocks continue to perform according to traditional investment criteria - quality of management, market position, barriers to entry, profitability and the like.

Now look at high-street retailing. Some smaller, niche players are doing amazingly well, but many of the big traditional high-street names are in deep trouble. In some cases this is as much to do with management failure as anything else, but in the new economy they are also likely to be losers big time. Only the stock market's faith in the cost-cutting powers of consolidation is preventing similar collapse in the banking sector.

So where are the winners? As ever, the winners are much harder to identify than the losers. Nobody knows who will still be in the race at the finishing line, even if we can be a lot more certain about those that won't. However, there is one winner we can be sure of, and that's telecommunications. Telcos are modern-day equivalents of the railroad barons of the past - they provide the bandwidth down which the new economy flows.

This is as likely to be the case for mobile as for fixed-line telecommunications. Eventually there may be as much e-commerce taking place over mobile networks as through PCs and fixed lines. Whatever the medium, telcos are destined to become the toll-gates of the new economy. Of course, there is only so much economic activity which can go on in the world, but within that overall, finite whole, an awful lot is expected to swing from the old to the new.

One example suffices. At the moment it costs about pounds 3 to hire a video. The rental outlet often doesn't have the video you want and in any case it's time consuming and burdensome to hire the movie, and then, more importantly, to remember to return it. Only a small fraction of this pounds 3 ends up with the producer of the movie - let's call it 50p. The rest goes on packaging and distribution costs.

Soon, possibly from next year, most households in Britain will be able to access the same movie down their telephone line at the touch of a mouse or press of a button. The marginal cost to the telco of delivering that film will be virtually nil. Even if the telco charges as much as 50p per movie, it undercuts the video producer by pounds 2. Add in the convenience factor and the theoretical degree of choice - the world's entire library of films, past and present - and there's no contest. Losers; video distributors. Winners; yes, of course, the consumer, but also the telco, which has gained a huge stream of revenue it didn't have before.

Multiply this out into the myriad of other possibilities allowed by the new technologies - both business to consumer and business to business - and it is easy to see why telecommunications data traffic is roughly doubling every three months and likely to continue doing so far into the future. Here then is the justification for the hectic pace of mergers and acquisitions, and for those apparently fanciful valuations. Old established players and new entrants alike are jostling for position, the better to take advantage of the explosive growth going on all around them.

However, even in an industry as fast-growing as this one, not everyone can win. Take the example, sometimes quoted by Warren Buffett, of the early years of the automobile industry. Investors and entrepreneurs correctly forecast explosive growth, and at one stage there were a staggering 2,000 car makers in the US. After much carnage and grief, there are today just three, and even they don't make huge amounts of money for their investors. Yes indeed, sifting the three survivors from the original line up of 2,000 would have been a next to impossible task.

Superimposing this model on today's stalwarts of the information age and fast forwarding to the tail end of the next century, it is possible to envisage a world in which the vast majority have long since gone, only a few, low margin, commodity goliaths remain, and the investment craze is for, say, inter-galactic space travel. In the meantime, an awful lot of money will have been made and lost. Since spotting the eventual winners is such an impossible task, investors seem to have adopted the wholesale approach of betting on the lot. Even the obvious old duffers enjoy glamour ratings - just in case, you understand.

So is there a bubble? Yes, of course there is. And is it going to burst any time soon? No way, Jose. We are only at the beginning of this bright new industrial revolution and this is a particularly thick-skinned bubble. Caution and cynicism are at this stage for wet blankets only. They come later with the next recession.