Who will win the broadband wars?

Carphone Warehouse's 'free' broadband offer was a phenomenal success. And now that BSKyB is entering the fray, the broadband wars are hotting up. Now is the time to invest, but which service providers have the most profit potential?

Love him or loathe him, that modern icon of bad taste, David Hasselhoff, is rarely off the television. But his latest role has nothing to do with rescuing struggling swimmers or busting crooks, although there are still plenty of bad perms on display. Instead, the Hoff' is fronting the advertising campaign for broadband provider Pipex, and in doing so is taking part in a game of very high stakes.

The broadband wars: how it went mainstream

Until recently, broadband was the province of businesses and households that used the internet extensively. But now, with the entry of BSkyB to the market, it has entered the mainstream. BSkyB, which gained broadband capability with its £211m acquisition of the Easynet internet service provider (ISP) last year, is now offering free' broadband under the slogan "uploads, downloads, save loads". This follows the recent promotion from Carphone Warehouse, which is also offering free' broadband; its deal now boasts a three-month waiting list to be connected, a sign of the offer's great success.

Why all this interest in broadband? With all the services offered over the web nowadays such as VoIP for making cheap telephone calls, the internet downloads websites such as Myspace.com and YouTube.com, and the planned video-clip service from Google it has now become a necessity. Old-fashioned connections can't cope with that volume of traffic. As a result, BT, NTL, Orange and O2 are all making big pushes into the market.

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The broadband wars: the convergence trend

So far so good, then. Well, not exactly. The free' deals are not really free, of course. In Sky's case, to get broadband free you have to subscribe to their pay-TV packages. And Carphone Warehouse's deal is only available as a package with its own landline telephone service. So while the broadband itself is free, that's just a promotional tool to ensure customers purchase other media and telecoms services from the same firm.

This is known as convergence' and more and more companies are offering such bundles. These are commonly known as triple-play' packages and comprise pay TV, internet and telephone services. One UK operator, NTL, even offers a quadruple play' by adding a mobile service. This deal is soon to be marketed under the Virgin brand; inevitably, that master of marketing Richard Branson has already dubbed it four-play'. Apart from the benefit of selling more services, firms also think that getting people signed up to broadband at an early stage will help them retain customers; switching between service providers is quite difficult in practical terms.

The broadband wars: will it work?

That's not to say that the providers will make money from this approach. Convergence is not a successful model in most business areas, so it's not a foregone conclusion that customers will opt to go to one company for all their telecoms needs.

It may be that they want the cheapest price for every individual service rather than pay for one package, for instance. But regardless of whether convergence succeeds or fails, it does seem certain that there will be a considerable shakeout in the broadband business as it matures. There are more than 250 ISPs in the UK at the moment, and you might expect there to be just half a dozen major survivors in a decade's time. So picking a winner at this early stage could be very profitable for investors. Below, we take a look at three of the contenders.

The broadband wars: three likely winners

Pipex (PXC:Aim) is not among the most high-profile broadband providers, although it hopes the Hoff' will change this. But its Homecall broadband and hosting offerings are doing well. First-half sales were up 86% and the firm says that profits for the year will beat previous estimates. Pipex has now launched a cheaper bundled broadband-and-voice package at £19 per month, undercutting Carphone Warehouse's £21.

It's a likely takeover target with good growth prospects, meaning that its forward p/e of 15.4 looks very reasonable.

The market was spooked when BSkyB (BSY, 540p) said that entering the broadband market will hit its operating profits by £400m over the next three years.

However, the firm expects broadband to boost earnings by 2010, and to bring significant benefits to its pay-TV subscriptions service. Of all the new entrants to the market, it looks the most certain survivor. The stock trades on a forward p/e of 17.4 and yields 2.4%.

Carphone Warehouse (CPW, 265p) is doing well with its broadband and fixed-line businesses, but the mobile side is underperforming. The firm is popular with analysts, who almost unanimously rate it a buy. It seems

set to win plenty of the broadband market, but a forward p/e of 28 looks steep.