IN the run-up to the first Eircom flotation in 1999, the government was keen to paint any investment in the telecoms sector as safer than houses. Five years later thousands of small shareholders unfortunate enough to have swallowed the hype are still nursing devalued pieces of paper while their peers who invested in bricks and mortar are laughing all the way to the bank.

After the internet bubble burst in March 2000, the balance sheets of telecoms all over Europe were littered with worthless write-offs. Believing themselves under attack from a brave new technological assault led by nimble-footed entrepreneurs, the managements of state-run telecoms had fallen over themselves to invest in one hare-brained scheme after another.

But hold the line. Having been dragged through the mire, many of the behemoths appear to have emerged relatively unscathed. Moreover, they are leaner and have managed to divest themselves of much of the state baggage that constrained their operation in the free market. Companies that once appeared more civil service than corporate are being recognised for the fundamental quality of their assets, particularly their virtual monopoly of the fixed-line telephone business in their respective countries.

The big investments are off, costs have been cut, staff numbers have been reduced, executives’ heads have rolled and new senior management teams are in place.

Franz Weis, a director of F&C in London, uses an analogy from Monopoly, the board game, to describe how fund managers are now viewing the fixed-line business.

“The telecoms are back to utility status,” he says. “They broadly have a stable, highly predictable business model so there is a lot of safety while the high dividend yields are also very attractive.”

Fund managers no longer regard telecoms as a high-risk bet on internet technology. It is now apparent that, far from disappearing, the former state-run companies have substantial networks built over years by taxpayers. The barriers to entry for would-be competitors are high and they are likely to lease lines from the dominant companies rather than pay the prohibitive costs of duplication.

“The reality is that the big operators will remain dominant,” says Kevin Walsh, the Bank of Ireland portfolio specialist, who dismisses fears that would-be competitors will erode margins substantially. “We’ve been hearing about this for almost 10 years now.”

Telecoms are back in vogue but fund managers are keen to differentiate between various stocks rather than recommend the sector as a whole. Pat Hinkson of Anglo Irish Bank says high dividend yields of 3% or more are a good reason for buying into certain telecoms, regardless of the prospects for growth in the share price. British Telecom (BT) for example is paying 6% and Eircom 7%.

But Pramit Ghose of Bloxham Stockbrokers also says BT, currently trading at about £1.80 (¤2.72), could provide the best of both worlds and recommends buying in at £1.70. Walsh says Bank of Ireland has been buying Spain’s Telefonica, France Telecom and Telecom Italia since 2003 as well as BT. “These firms have been through the cycle and are definitely more rational than they were even two or three years ago,” he says.

Walsh is particularly keen on France Telecom, which he says is focusing on capital spending cuts and cost reductions. The company also owns Orange, one of the world’s largest mobile operators.

Ghose agrees with Walsh on France Telecom’s prospects.

“It has fallen quite a bit in recent times and over the past year it has bounced off ¤20 or just below on 10 occasions.”

Telefonica is also finding favour because of its exposure to the rapidly expanding markets in South America, particularly Brazil and Argentina.

Hinkson says Deutsche Telecom also merits reassessment, although the stock still leaves a bad taste in the mouths of many Irish investors who lost money on its flotation when it was marketed to local investors. Its American mobile phone business gives it a good growth profile, he says. Likewise Norwegian firm Telenor has strong revenue growth on the back of its portfolio of mobile assets.

Closer to home, the jury is out on Eircom. Although Bank of Ireland did purchase a tranche of shares in the recent flotation on the basis of its dividend yield, Ghose dismisses the stock as “a particularly expensive version of the same business” of other telecoms stocks.

Weis acknowledges the dangers from within the industry for anybody purchasing shares.

“The risk is now that telecoms have repaired their balance sheets they could be tempted to look at acquisitions, thus spending, rather than returning money to shareholders,” he says.

He advises investors to be wary of any announcement of a share buy-back, which he says may indicate the company is about to make a “strategic investment”. This, as seasoned telecoms investors know only too well, is a phrase that should set the alarm bells ringing.

But the enemies massing at the gates cannot be dismissed either, according to a recent report by IDC, the market intelligence and advisory firm.

“The number of residential connections per western European household peaked at 103% in 2002 and is now in decline. The (value of the) total number of minutes of traffic generated by west European residential users in 2003 was $988 billion (€817 billion). This also peaked in 2002. The reason for the decline will be continued migration of traffic from fixed to mobile networks and the migration of heavy dial internet users onto broadband services. More significant is the fact that overall combined fixed and mobile minutes will peak in 2004 as users move to more use of both fixed and wireless online solutions for day-to- day communications.”

Ovum, a London-based consultancy, is similarly pessimistic. A recent report states 2004 “is likely to be the last good year for many fixed incumbents before a period of decline beginning in 2005”.

“Revenue growth from data services is insufficient to offset the decline in fixed voice revenues while incumbents also face tougher competition, price erosion and threats from competing technologies,” the company says.

The lesson for would-be investors in telecoms stocks appears to be clear: if you are going to make that call, be prepared to hang up at a moment’s notice.