As long-time readers know, I’ve often commented on the hand wringing of communications industry analysts, which is in some ways as bad now as it’s been at any time during the sector’s now six-year-old bear market/depression. The comments we’re hearing now relate to slightly different subjects, but their tenor is basically the same.

The consensus is that communications industry players are locked in mortal combat in which they have no choice other than to tear each other limb from limb. In this light, all investments by sector companies in growth are treated with deep skepticism. Numbers pointing to strong growth in one area or another are summarily dismissed as fleeting. And every new technology to hit the scene is viewed as a potential death sentence for service providers.

As we enter first quarter earnings season, the pessimists are turning up their volume again. Ironically, the numbers look set to come in as good as or better than anyone could have expected.

Let’s start with the telecoms and the first company to report earnings, BELLSOUTH (NYSE: BLS). The company released a very strong report with profits excluding hurricane costs hitting 57 cents a share, well above Wall Street projections of 53 cents. Revenue was in line with estimates and benefited from record growth in operations serving the small and medium-sized business market.

BellSouth’s 40 percent-owned Cingular Wireless unit posted strong subscriber growth, and overall wireline revenue rose as well.

In addition, the company’s proposed merger with AT&T (NYSE: T) continues to proceed smoothly. The deal proposes that each BellSouth share be swapped for 1.325 shares of AT&T when it’s completed, probably by March 2007.

Predictably, however, shares of neither BellSouth nor AT&T --which is slated to announce earnings April 25--got much benefit from BellSouth’s strong earnings news. No matter what the numbers show, it seems skepticism of the communications industry remains fashionable on the Street, and nothing will shake it.

The cornerstone of the bears’ case against telecom is continued loss of local phone connections. The annual rate of loss was about 5 percent in the fourth quarter, as customers cut their landline connections in favor of using solely wireless phones or converting to broadband connections such as Voice over Internet Protocol (VoIP). Similar rates of line loss are expected for the first quarter as well. BellSouth, for example, lost approximately 1.2 percent of its basic phone connections in the first quarter, for an annualized rate of 4.8 percent.

That looks like a bad number on the face of it. But it didn’t stop BellSouth from posting solid revenue growth at its wireline operations, in large part from signing up 45 percent of its retail lines to product bundles. Profit margins too remained solid, factoring out damages from Hurricane Katrina.

More interesting, a recent study by Fitch indicates that roughly two-thirds of line losses industry-wide are caused by substitution to wireless phones. Since BellSouth is a 40 percent owner of Cingular--the nation’s leading wireless company--it makes sense that they’re grabbing more than their fair share of these nationwide.

The bulk of the rest of the losses were former UNE-P (unbundled network elements platform) customers. UNE-P was a system set up by the Clinton administration Federal Communications Commission that basically required owners of phone networks to lease lines to competitors at preferential rates. UNE-P was eventually undone after a lengthy court battle and the sector died a quick death. As a result, many of today’s line losses are of customers who left the system in the early days of deregulation.

VoIP is fast arriving as a technology, but the ultimate impact on big telecoms should be extremely positive. Adopting Internet technology is already cutting operating costs and it’s yet another service for big telecoms like VERIZON (NYSE: VZ) to roll out on their broadband networks.

Verizon is rapidly constructing the nation’s largest fiber optic network for the purpose of providing an extremely wide range of services. To date, much of Wall Street has focused on the billions of dollars of expense and expressed deep skepticism that the company can ever hope to make it pay off. Verizon, however, is not only exceeding expectations with broadband and even television service sales, it’s actually continuing to cut overall levels of debt even as it makes this historic expense.

Communications industry skepticism doesn’t stop with the big telecoms. It also extends to their chief rivals, large cable television companies like COMCAST (NSDQ: CMCSA). As we’ll no doubt see in this quarter’s results, cable providers are having a field day up-selling basic service takers to more advanced services, including Internet phones. That’s pushing revenue and cash flows continually higher.

Nonetheless, the tenor of analysis remains fixated on such issues as growth trends in the number of basic cable television subscribers.

Ironically, many are deeply worried about the ability of Verizon and others to steal these customers away; at the same time they’re concerned Verizon won’t take enough business to make its network investment pay off.

PRETZEL LOGIC

Taken together, it’s easy to see the huge contradictions in prevailing analyst opinion on the communications industry. On the one hand, the pessimists argue cable companies are taking away the phone companies’ business, on the other they fret about phone companies eating cable’s lunch.

They remain fixated on a single statistic--the loss of basic local phone and cable lines--even as overall revenue growth numbers remain strong for both telecom and cable companies. And they ignore the fact that the primary places those lines are going are the wireless units of the phone companies themselves, actually a far more profitable connection for a company to have.

In short, the communications industry is a victim of pretzel logic.

And unfortunately, until Street people begin to view things in a more rational way, telecom and cable stocks are going to be frustrating to own, aside from the big dividends they pay.

The important thing to remember is the stock market is a popularity contest in the near term but a weighing machine in the long term.

Telecom and cable certainly aren’t winning any popularity contests now. In fact, despite leading the market in the first quarter, it’s safe to say they’re among the most detested sectors.

On the other hand, companies with growing sales and profits don’t go out of business. Neither do companies operating in an industry where overall sales are growing at a torrid clip, as consumers and businesses become increasingly interconnected. The search is still on for the killer application to really spark the market for, say, wireless Internet phones. But sales and technological capability are growing, and so are consumers’ appetites. In short, communications is still one of the best possible industries to invest in.

The most important point the bears have yet to grasp is the meaning of the industry’s rapid consolidation of recent years. Too often, commentary has focused on how telecom and cable mergers are basically desperation moves to get bigger, so they can compete with an ever-bewildering array of competitive and technological challenges. Yet every deal builds a larger and more powerful company.

The biggest advantage of consolidation is it removes potential competitors from the market. For example, VoIP provider Vonage is enjoying some success piggy-backing on others’ networks at the moment. But long before it’s large enough to really challenge big tel and big cable, it will either be squashed competitively or bought out, which is actually management’s current strategy.

In contrast, AT&T prior to the SBC takeover was large enough to mount a serious threat to other big telecoms. And it had the lobbying clout to get its way in the contentious Washington regulatory arena, as did MCI as it emerged from Chapter 11 to challenge SBC, Verizon and others. Now those companies are part of even larger, still more powerful entities.

A shrinking number of players in a growing market: that’s a formula for dramatic business success in coming years. Best of all, telecom and cable television stocks are selling for a song, thanks to the overwhelming but increasingly out of place skepticism still rolling the sector.

The current sector pessimism was born when what was then a high-flying industry crashed in 2000. At that point, the survivors began a long and sometimes painful transition from a business model based on simple wireline connections to one focused on selling advanced services over increasingly high-capacity, high-speed networks, wireless and wireline.

Each successive earnings season has brought with it growing evidence of the survivors’ success. Even QWEST COMMUNICATIONS (NYSE: Q), which was nearly taken down by overly aggressive and possibly fraudulent management, is following the formula of up-selling customers and cutting debt. We’ll see how this plays out over the coming weeks as more profit reports come out. But judging from the BellSouth report, this season should show more progress still.

Some in the market are starting to recognize that this telecom/cable transition is at last bearing fruit, and that there’s plenty of room for growth in this sector among the remaining players. It’s not either big cable or big tel that will be successful, but the best companies of both.

I suspect that realization is what was behind telecom’s outperformance in the first quarter. But in my view, that’s only the tip of the iceberg. If you’ve owned these stocks for a while, now’s certainly not the time to abandon positions. If you don’t own telecoms, there’s no better time to stock up than when the crowd is still looking the other way.