Serious Money: Many investors will be hoping that one way in which 2006 does not end up as a repeat of 2005 will be the performance of telecommunication stocks.
Shares in companies like France Telecom, Deutsche Telekom and Vodafone had a truly horrendous year, confounding the views of many pundits who believe that the cash flows generated by these businesses are worth a lot more than markets currently seem to think. Regular readers of Serious Money will know that the bear case for telcos rests on the emergence of disruptive technologies and ever-increasing old-fashioned competition. Fans of telcos will have been dismayed by the near 9 per cent drop in France Telecom on the day that it suggested revenue growth may not be quite as high as previously forecast (by the company).
What the Financial Times's Lex column describes as the "lazy parable" of internet telephony accounts for much of the industry's problems. Voice over internet protocol (VoIP) may have become a bit of cliché but it would be wrong to dismiss this key driver as one that is over-hyped by the geeks.
The trouble with clichés is that while they may be familiar, they can often be spot on. Internet telephony has come a long way in the last year or two and has overcome many of the quality issues that many sceptics often cite when dismissing the threat posed to telco revenues.
I now regularly exchange video calls with my brother in Canada where the picture quality can still leave something to be desired - for the purists at least - while the sound quality is actually better than anything offered by a normal telephone. (For those interested, www.skype.com is where the necessary software can be quickly downloaded.)
These video calls come at zero cost. Just how any telephone company is supposed to compete with this is completely beyond me. Skype, now part of eBay, does charge if you want to make a call to someone not hooked up to Skype and asks for 1.7 cent per minute for any call to any landline in the world. For most calls - other than some local calls - this is below the rate offered by many companies, even the alternative carriers.
France Telecom cited the growth of internet telephony as one of the reasons why revenues were likely to disappoint. But it is not just about VoIP. Fixed-line telephone companies are threatened by the ongoing switch to mobile: as the cost of mobile calls slowly declines (in some countries at least) people are giving up the land lines altogether. This trend is most pronounced in Scandinavian countries but it is happening to a greater or lesser extent everywhere.
Incumbent telcos are not going to just stand there and let their revenue base be eroded. They will have to respond to this competitive threat. And this is another area that has the market scared. Both France Telecom and Deutsche Telekom have recently stated that they will have to spend money on customer retention.
This means lots more marketing spend and plenty of extra cash being devoted to the development of new products and upgrading of existing networks. Those precious cash flows, so beloved of the bulls of telcos, could be eroded very quickly if these hints become a trend.
Spending money on new products and services is actually not a bad idea - provided people buy them. Telcos have proved to be spectacularly useless at working out what the customer actually will pay for. Their core product, voice, is in decline and the only growth area in recent years has been with SMS (texting), something that happened entirely by accident. Telcos have no history of being able to deliver innovative products that yield decent returns. Just think of the commercial failure of picture messaging.
The industry is now pinning its hopes on "triple play" (voice, data and video). All of these services will undoubtedly be demanded by customers, but we have already seen with voice that returns can fall very quickly. Lots of data and video will certainly be piped across the networks but it is by no means certain that revenues from all of this will live up to the hopes of telco executives.
Competition is a bit like that: all of these services can be provided by just about anybody. The current scramble in the US over the next hot product - video over the net - is a classic indicator of what is about to happen next. Companies think that they are going to grow rich by delivering video over super-fast broadband. The problem is that lots of companies think this and there are few, if any barriers to entry. You don't need to be a financial wizard to work out what is likely to happen to pricing and margins.
In the US, telcos are fighting back by attempting to change the rules of the game. Some phone companies are uttering dark threats about disrupting Skype-type phone calls when they see the traffic crossing their networks. "These are our pipes and you have got to pay to use them" may be an understandable threat but one that stands little chance of working.
This may slow the competition, but to the extent that the incumbents succeed in stifling competition it will only be a matter of time before the outcry from consumers forces a legislative response.
And if your pipe is the expensive one, someone will set up a cheaper one - such is the falling cost of networking technology.
The hope of some telcos is that one response from the incumbents will be to start another wave of merger and acquisition (M&A) activity. Companies likely to be bought - even though this might prove financially disastrous for the acquiring company - will see their share prices do relatively well (think Eircom).
But even here the market will inevitably work out that most of these kinds of mergers will be acts of desperation and the resulting fall in the share price of the acquirees (think Telefónica) will act to stymie most managerial dreams of M&A salvation.
Telco stocks were doing quite well during the early days of 2006 - they were being bought on the grounds that every dog has its day. But France Telecom shows us that this is not always true.
Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.
