LONDON – Eastern European telecom stocks are riding high on Internet-related buying and are set to soar further, but analysts say that with few locals online they cannot approach the stunning valuations seen in the west.

The incumbent operators, many of them former state-owned monopolies, are in an ideal position to reap the rewards of the new market, but will have to branch out into content and services if they are to survive against foreign competitors.

"I think, in general, the main telcos, the incumbent telcos, are very well-placed to benefit from any drive in Internet. We believe that while the Internet is coming from a very low base, it will continue to rise quite rapidly over the next couple of years," said Eugene Klerk, telecom analyst at ABN Amro.

Polish shares hit record highs last week driven by heavy buying of Internet-related stocks, Hungary's telecom operator MATAV is outperforming the Budapest bourse and Czech telecom shares have been trading well above analysts' target values.

At present, Internet penetration remains low, with some 5 percent of Hungarians, Czechs and Poles online and only 1 percent of Russians. In contrast, mobile phone penetration has already reached around 20 percent in parts of the region.

"It will grow, but the pace of growth will be slower than cellular penetration," said emerging Europe telecom analyst Sergei Arsenyev at Flemings investment bank.

"The high (Western) European valuations don't really make any sense here because Internet penetration in Eastern Europe is very, very low," he added.

Salomon Smith Barney says overall market growth accelerates once a critical mass has been achieved. "We believe that the emerging European Internet market is approaching this phase in its development," it said in a research note.

While forecasts of future contribution from the Internet to telecom revenues and earnings are, at this stage, highly speculative, Salomon "guesstimates" it is likely to grow to 5-15 percent of total sales in 2003 and 15-50 percent by 2009.

It has upgraded target prices for Hungary's MATAV, Czech operator Cesky Telecom, Polish TPSA, Greece's OTE and Russia's Rostelecom, believing that the rerating of the European telecom sector will spill over.

But price is seen as a major barrier to any fast increase in the rate of penetration. A decent personal computer can cost several months' salary in Eastern Europe.