Pacific Growth Report (Joe Noel)2/3/00: STRONG BUY, 12 month price target: $22 Note: this was published prior to earnings being released, however, all points appear to be right on (worth posting).
Summary and Investment Recommendation:
We consider shares of PairGain Technologies to be a bargain at current levels. We believe the company has seen the worst of their problems and is heading in the right direction. Additionally, doing a simple sum of the parts calculation, we believe shares of PAIR are worth at least $18. This calculation includes $2.75 per share in cash, at least $3.75 per share in Globespan stock and convertible debt, $5.00 per share valuation being placed on the HDSL/HDSL2 business and a conservative $7.00 per share being placed on the Avidia business.
It is unclear at this time where actual revenues and earnings will come in for PAIR's Fourth Quarter of 1999 and analyst predictions for the quarter point out this confusion. It appears that most investors who are involved in this stock are prepared for a short fall to published estimates, but still remain believers in this story because they expect a recovery of PAIR's business during 2000. We believe the earnings or losses for Q4: 99 are virtually irrelevant, except, in the case of the company reporting a significantly larger loss than is expected. We believe this to be unlikely.
We expect that the company will give a positive assessment relative to the developing Avidia business. We believe this will include a few status reports on the sales progress at some of the larger CLECs and traditional telecommunications service providers. It is our opinion that investors are not recognizing the potential value of this new product line if it were to be spun off. We estimate the value of this division at more than $500 million or $7.00 per share.
We believe that investors who listen to the conference call will hear about how the company's operations are being slimmed down. We expect the Company to state that the company's efforts will be mainly directed toward the ADSL access market and that Avidia will become their main flagship product. With these cost cutting efforts and the fine-tuning of its market direction, we believe that the Company will need to discuss the implications that such changes will have on the Company's business model. In particular, we believe that management will discuss how the sale of its Microelectronics Division will impact future balance sheets and income statements. Via this sale, PAIR now owns 1.080 million shares of GlobeSpan stock, plus the value of the convertible and the cash already on PAIR's books, yield an impressive cash and marketable securities value of more than $6.50 per share.
Despite speculation that PAIR may also consider selling its HDSL and small loop carrier products, we believe that management will indicate that this is very unlikely. We expect management to continue to attempt to turn things around in the HDSL and HDSL2 markets, competing head to head with Adtran (ADTN) and ADC Telecom (ADCT). We are modeling approximately $182 million for these product lines during 2000, and believe the businesses should be valued at least 2x to 3x these revenues. This would yield an additional $5.00 per share value for the Company. We would expect the company to discuss their HDSL status relating to several RBOC accounts, with most of management's comments being directed toward the account status at Bell Atlantic (BEL).
Based on a combination of what we believe to be an ultra-conservative sum of the parts calculation, the potential to realize new orders and sales from the Avidia line, and significant cost cutting measures, we believe shares of PairGain Technologies are worth considerably more than the current trading price of $12 11/16. We believe there is likely to be upside to our recently upgraded estimates for 2000 as the company begins to recover from their recent problems. Considering that the sum of the parts calculation and the spin off values are well ahead of the current market capitalization, we can easily see our $17.00 short-term price being realized. Allowing for some upside to the 2000 estimates and Avidia being added to the 2001 estimates, we can easily see a 12 month price of $22.00, or five times our conservative 2001 revenue estimate of $338 million.
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