How to profit from the 3G mobile phone revolution

Major telecoms companies are convinced it will herald a new era in mobile phone communications and have spent billions of pounds since the beginning of the decade on licences to offer 3G services. Vodafone, for example, splashed out a staggering £6bn just for the privilege of accessing the UK market. Unfortunately, progress has been painfully slow. Technical problems, poor network coverage and unattractive handsets have hampered development. In fact, it's only been in the past year that the industry has shown signs of delivering on its promises.

Along with 3 - the operation owned by Hong Kong-based conglomerate Hutchison Whampoa - which started offering services back in 2003, rival operators Vodafone, Orange, O2 and T-Mobile have launched their networks.

As a result, customers have started to take notice. Of the 64 million UK mobile phone users who were registered during the summer, around 3.5 million have embraced 3G, says Julian Hewett, chief analyst at Ovum. "By the end of 2005, this number could be up to 7 million and next year it could even double," he says. "People are likely to choose a 3G phone when they next upgrade, as it will be more future-proof, and this means 2006 could be a big year."

Companies have been quick to cash in on this new-found enthusiasm. Vodafone, for example, has just announced that a new range of phones will be released in the run-up to the festive period. "We are confident that this is going to be a 3G Christmas," insists Peter Bamford, the company's chief marketing officer. It's a widely held view.

A string of content providers have also been appearing in recent months, with the most determined ploughing millions of pounds into marketing and promotion. Music videos, interactive games and sports highlights are available, while a flood of new services are expected in the coming months.

Dan Winterbottom, senior research analyst at Informa, says: "There are plenty of good ideas in the marketplace, but they're all dependent on consumers upgrading. Overall though, the outlook appears to be very healthy."

Among the most prominent content providers are Mforma, Index Corp, Jamdat, Jamster and iTouch. But how much potential does the 3G arena offer investors? Should we be piling into any company associated with the sector, or is there a risk that the dotcom boom-and-bust fiasco of the late 1990s could be repeated?

If 3G does go from strength to strength, as expected, which firms are likely to offer the best returns - those involved in the technology, the content providers or the mainstream operators? Just how can investors get exposure to the story?

Respected industry consultant Steve Jones, who runs www.the3gportal.com, says investors should focus their attention on the infrastructure providers - involved in areas such as base stations and phone masts - along with handset manufacturers and mainstream network operators. These, he says, include the likes of Ericsson, Nokia and Motorola, who, as well as being involved in potentially lucrative infrastructure operations, are household names.

As well as having worked so hard on developing the technology, these companies have the required size, economies of scale and global presence to take advantage as customer numbers increase. "Two years ago would have been the best time to invest money in this sector, because everyone was very gloomy about the prospects for 3G, but this has changed," says Jones. "Looking ahead, it's likely to be the big boys that will be the principal beneficiaries if 3G does start to take off."

No investment can offer a guaranteed route to riches, so what are the potential downsides of 3G? Well, network coverage is rather patchy in some parts of the country, while there's still work to be done in finding the right level for tariffs.

"3G has been stifled by the fact that there aren't many handsets in the market, coverage has been quite poor and that it often takes people at least a year before they consider upgrading their phones," says one analyst. "It makes it a long process."

Subscription services also have an image problem. "Some companies have abused these services," claims another industry observer. "Customers thought they were buying one ring tone, but they had unwittingly agreed to a monthly contract and ended up receiving large bills. This has made people very cautious."

Also, will the major operators fully recoup the billions of pounds lavished on the licences? Britannic fund manager Ralph Brook-Fox says they won't, but that doesn't make them poor investments. "The licence fees are a cleverly designed windfall tax by the Government," he says. "The companies were criticised for paying such high amounts, but they didn't have much option. It happened when everyone was going dotcom mad and companies had to bid for licences to stay in the game. Any operator without 3G now would be at a huge disadvantage and their share price would suffer."

The key to success, says Ovum's Hewett, will be discovering the next "killer application". At one stage there were high hopes for photo messaging, but this failed to catch on. "There isn't a really compelling reason to have 3G at the moment, apart from faster internet connectivity and one or two other extras," he says. "No one knows what is the best future use of phones."

But content providers are unlikely to be major winners for investors, suggests Jones. "Providers of music download and video files are only making small margins - despite charging prices that most mobile phone users see as expensive," he says. "Only at high levels of 3G ownership - say more than 50 per cent of the market - will they be able to make good money."

Paul Mumford, who manages the UK Opportunities fund for Cavendish Asset Management, believes investors may be able to benefit from future merger and acquisition activity.

"The whole industry is ripe for consolidation and a lot of people are recognising there are opportunities within the telecoms market," he says. "I would expect that 3G is likely to increase the speed of this process."

Five companies for investors to watch in a 3G phone boom

Vodafone - Its valuation is very low at the moment, due to widespread concerns over its long-term growth potential. But the successful take-up of 3G could change these perceptions and provide a much needed fillip to the telecoms giant.

Motorola - The US company delighted investors with record third-quarter sales figures earlier, which stood at $9.42bn (£5.33bn) - up from $7.5bn achieved during the corresponding period in 2004.

O2 - Shares in the former BT mobile telephony operation, which operates in the UK, Germany and Ireland, have been surging in recent months - due to takeover rumours - but it could still benefit from 3G by being a major player in the market.

Monstermob - One of few digital content companies that is already in profit, Monstermob has the added bonus of being a strong play on the growing market for wireless internet access.

Bango - Bango helps companies that have digital content for sale to market their wares, so they can build users more quickly. The company floated on the Alternative Investment Market (AIM) in June.