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Net Phone Threat May Ring Hollow for Bells

Thanks to this year's most talked-about new technology, the cable man will be ringing doorbells to pitch a new offering: telephone service. But getting a foot in the door may prove trickier than investors expect.

The phenomenon that threatens to crash the gates of telephone companies is known as voice over Internet protocol, or VoIP. Proponents have proclaimed that this development will remake the landscape, giving big cable TV companies such as Comcast (CMCSA), Cox (COX) and Time Warner (TWX) the final leg of a triple threat -- the ability to offer consumers television, Internet and now telephone service together, cheaply and reliably.

The cable companies are racing to show investors that they're riding the VoIP wave. Comcast says it hopes to be selling phone service to 40 million customers in 2006. Time Warner says that just this month, it extended its own offering to a 10th city, Houston.

And just this week, Cablevision (CVC) rang a few bells by announcing it would offer new customers cable, Internet and phone service for $90 a month. The one-year promotional price effectively charges standard prices for TV and cable modem service and throws in phone services for free.

Wall Street has been swept up in the frenzy, viewing the march of cable as another stake in the heart of the regional Bell phone companies. The cable sector's expansion plans are unmistakably aimed at a market dominated by local phone titans Verizon (VZ), SBC (SBC) and BellSouth (BLS). Some observers have gone so far as to compare VoIP to the early days of cell phones, which continue to be the paramount threat to the Bells' livelihoods.

But beyond the screaming headlines, some hard facts suggest that the so-called VoIP revolution is a long way from victory. The number of actual VoIP users remains minuscule, despite strong growth this year. (See charts on the next page.) Service quality falls far short of the phone industry standard, reducing its appeal. The cost advantage could be fleeting as cash-strapped states consider new tax measures.

Most strikingly, even VoIP's much-ballyhooed technological advantage is a slippery subject. For now, most of the cable industry's phone offerings rely on the very same century-old copper-wire system that they are reputed to make obsolete. Nearly all Net calls at some point must hitch a ride on the phone networks to make a connection.

Indeed, while the perceived threat of VoIP has cast some shadows over the Bells, it hasn't done much to lift the shares of cable operators. For the year, the Bells are down an average of 8%, but big cable outfits Comcast, Cox and Cablevision are down about twice as much. According to a recent Smith Barney report, the cable sector's stock performance this year has lagged the S&P 500 by 10%.

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