Outlook: Markets dial into the cellular dream

TEN YEARS AGO, hardly anyone had heard of Vodafone. Just five years ago, still fewer had heard of AirTouch Communications. Today these two companies are merging to create a mobile phones behemoth with a larger stock market value than British Telecom. By any standards this a sprint to the top of quite astonishing speed. Add in the fact that this market value is more than ten times bigger than present revenue, and that on conventional accounting measures, the new group won't be making any profit for at least three years, and most people might reasonably wonder what's going on here.

There are two ways of looking at it. A cynic would see it as classic top of the bull market froth, the sort of breathless merger mania that invariably engulfs investors and managements alike when all around them have lost their valuation sense.

Alternatively, you can take Chris Gent, Vodafone's chief executive, at his word. He believes the future of telephony is largely mobile, and by positioning himself as the world's biggest pure mobile operator, he is set to trounce traditional fixed line phone companies like British Telecom and AT&T. This deal and these apparently crazy valuations, then, are all about a new generation of communications technology taking over from an old one. The parallel is with the American craze for internet stocks; this is the future, the argument goes, and it therefore has to be discounted in the price.

To see the effect of this just consider the following. Orange, Britain's newest mobile network, is now worth more than 30 per cent more in stock market terms than Marks & Spencer. What's more, if the future is going to be a combination of mobile telephony and electronic commerce, this may be justified. All the evidence is that while M&S's sales were going into a pre-Christmas tailspin, people were instead spending their money on PCs and mobile phones.

The only problem with this analysis is that dinosaur like though the old national telephone monopolies are, they are not completely stupid and nearly all of them are involved in mobile telephony to some degree. In other words, they are hedging their bets. BT not only has a half share in Cellnet, Vodafone's main UK competitor, it also has stakes in a host of mobile operators across the Continent and the Far East. Plainly its mobile prospects are not as good as Vodafone AirTouch, but they are not so far behind as to justify such a valuation gap.

The assertion that ten years from now the world will be mainly mobile is in any case a highly debatable one. Wireless communications has a symbiotic relationship with fixed line telephony, which is the middle man in most mobile calls. What's more, the economics of fixed against mobile communications mean that in the absence of some undreamt of breakthrough in technology, fixed will always be cheaper.

All that said, the boom in mobile telephone stocks doesn't look like ending any time soon and there is no doubt that Vodafone AirTouch makes a mighty powerful combination. For the first time there is the prospect of a genuinely global mobile telephone company, which ought to hold real attractions to customers as well as yielding not insubstantial cost and purchasing power benefits. Other mobile operators will have to scramble to catch up.

In relative terms, Vodafone also seems to have secured an exceptionally good deal. Vodafone shareholders get more than half the group even though the company accounts for only 45 per cent of its present cash flow. And though AirTouch's longer term prospects may not be as good, for the time being it is growing more rapidly than Vodafone.

One other interesting feature of this deal is that it is structured as a Vodafone takeover, not the more usual no premium merger. This was something that was previously thought of as next to impossible because of the degree of goodwill that needs to be written off in such cases - pounds 2bn a year for the next 15 at Vodafone. Not so. Investors barely blinked at this whopping great piece of accounting mumbo jumbo. Who knows? At this rate we might even get a hostile bid in the banking sector. No wonder the stock market is dancing. It seems that these days it is indeed possible for investors to walk on water.