Dear Mr. Berko:

I want to invest in a voice over Internet protocol company and thought that Net2Phone might be a good choice. Please tell me about this company, and if you think there are better equipment makers, please tell me about them. And would you also give me a simple explanation of VoIP? From what little I know, I believe that it will be the biggest new telecommunications business in the world. The costs are much less, the concept has tremendous flexibility and maintenance is really cheap compared to regular land lines.

W.R., Norman, Okla.

Dear W.R.:

Voice over Internet protocol converts your unique speech sounds and patterns into a digital format and sends them over a data network such as the Internet alongside Web and e-mail traffic. Unlike traditional phone calls, which need dedicated circuits to connect callers at each end of the conversation, VoIP uses software. The software converts analog signals (continuously varying voltages, frequencies and phases) into digitalized data formats (using binary codes 1 and 0) that are sent over a data network. The data are then converted back to analog so the message can be understood when it reaches the other end.

Note the fascinating parallel here between the transistor, which replaced the inefficient vacuum tube in the late 1950s, and VoIP, which is replacing today’s inefficient (and expensive) dedicated telecommunications circuits. There’s little doubt that within the next dozen or so years, VoIP will replace most of the current telephone service. In another dozen or so years, the current phone routers and bulky network system will be as rare as the green and white Sinclair dinosaur signs that used to dot the highways all over the country.

Cisco Systems Inc. (CSCO-$19.55) may be your best investment bet to participate in the VoIP revolution. Management used the tech downturn of the past four years to make the company “lean and mean.” CSCO’s management eliminated 33 percent of its staff, greatly improved its efficiencies and significantly reduced the time required to move inventory.

Cisco is the 800-pound VoIP gorilla and dominates the corporate telecommunications business. It has the most advanced “end-to-end” networking products with reliability that provides new and reluctant new corporate users a great deal of comfort. This burgeoning technology may make impressive contributions to the company’s revenues and earnings in the coming few years.

CSCO is a classy communications company with tentacles in almost every form of corporate and government data networking systems. Its routers are considered to be the best and most advanced in the industry. Cisco’s $22 billion in revenues produced $5 billion in net income last year, or 70 cents a share. This year, revenues might reach $25 billion, and net income could come in at $6 billion, or 97 cents a share. CSCO has zero debt, a good cash position and superb management. Andrew Bensinger at Standard & Poor’s has a “strong buy” rating on CSCO, and Timm Bechter of Legg Mason and Inderber Singh of Prudential have “buy” ratings on the company.

Avaya Inc. (AV-$9.08), with $4 billion in 2004 revenues and net income of $296 million, or 64 cents a share, might be the second-best choice. AV is expanding its VoIP business into Europe, Asia, Latin America and Mexico, where VoIP growth is faster than in the United States. Even though VoIP growth in the United States is much slower, Stuart Plessing at Value Line thinks AV should be a $35 stock in the next three to four years. VoIP is a fantastic future technology and AV (a September 2000 spinoff from Lucent Technologies Inc.) does business with 80 percent of the Fortune 500 companies. Frank Marsala of First Albany and Jason Ader of Thomas Weisel have “buy” ratings on the company.

Net2Phone Inc. (NTOP-$1.63) is a leading provider of VoIP installations and service, and primarily markets VoIP services to cable operators in the United States, Latin America and Europe. It also provides this service to consumers both directly and through more than 500 resellers in more than 130 countries. NTOP does not make equipment but competes with the big telecommunications companies for customers. In fact, I have VoIP via my cable company; the service is immediate, the sound quality is clear as gin and the cost is much lower than my traditional phone line. Net2Phone sells phone cards that access its VoIP platform in more than 30 countries and even offers a prefix code similar to the “10-10” service in the United States. But this isn’t a company you want to own. NTOP, whose stock once traded in the high $90s, has yet to earn a centime, and revenues won’t reach $100 million this year.

So I’d suggest that you take that $5,000 and purchase 100 shares of CSCO and 200 shares of AV. Then use the remaining funds to buy 300 shares of NTOP just in case.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.