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Technology Stocks : Vari-L (VARL) -- Ignore unavailable to you. Want to Upgrade?

To: sportsman who wrote (814)	10/23/1998 1:10:00 PM
From: Chris Tomas	Read Replies (1) \| Respond to of 2702

Stock of the Day Oct 23, 1998 Vari-L: A Small Cap with Big Customers Vari-L (Nasdaq:VARL - news) is hardly a household name, but its customers certainly are. This relatively tiny electronics company supplies components to most of the heavy hitters in wireless communications. On Thursday, Vari-L reported a 32% gain in net income for the third quarter and it issued upbeat comments about the future. The company is investing aggressively in assembly line automation to increase production efficiency and capacity, a move which raises the risk/reward profile of this small-cap stock. Indeed, with a market capitalization of just $38.2 million, calling it a micro-cap is more accurate. Vari-L had sales of just $19 million in the past year, but with an order backlog of $14.2 million going into the fourth quarter and a diverse (not to mention quality) customer base, the company does seem to have a bit more stability than many micro-caps. It's customer list includes Lucent (NYSE:LU - news) , Motorola (NYSE:MOT - news) , Nokia (NYSE:NOKa - news) , Ericsson (Nasdaq:ERICY - news) , and Qualcomm (Nasdaq:QCOM - news) . Last month Vari-L landed a sole source supplier agreement to supply voltage controlled oscillators for base stations in two of Lucent's wireless infrastructure programs in Europe. Vari-L makes signal processing components used in wireless communications equipment, a fast-growing market with great long-term potential. Vari-L began the nineties as a defense contractor, and it continues to provide components to the military for use in advanced radar, weapons guidance and navigational systems. But its pursuit of commercial market opportunities is really beginning to pay off now, as demand for its voltage controlled oscillators (VCOs) and other signal processing components is soaring due to their use in cellular/PCS, fiber-optic and satellite communications. In a nutshell, VCOs adjust the wireless signal to a predetermined frequency, a necessary step for any wireless transmission. The company dominates the market for VCOs used in base-stations for cellular and PCS, and now it is hoping to leverage its position in the much larger handset market. Last year it received a patent on a new VCO that uses less power than any other on the market. Lower energy consumption (i.e., less battery drain) is a vital feature for use in wireless phone handsets and pagers, so as production of this new VCO ramps up in the coming quarters, Vari-L's revenues could soar if it successfully penetrates the handset market. Vari-L picked up coverage from brokerage firm Rodman & Renshaw this year, bringing total analyst coverage to four--impressive considering its size. The consensus is for earnings to rise 24% this year to $0.53 per share, with a long-term growth rate of 30%. Vari-L has also shown significant improvement in its margins, attributable in part to the production automation effort. Vari-L has installed two new state-of-the-art assembly lines, with a third going in now. Gross margins have marched steadily higher to 55.3% as of this past quarter from 49% in the first quarter of 1997. Net profit margins were up to 15.6% from 11.7% in 1997 and 9.6% in '96. It looks like the investment in greater production efficiency and capacity is already paying off, but there's always the risk with this sort of capital spending that demand could soften because of a recession and all the new equipment sits idle. Vari-L noted in Thursday's earnings report that "unsettled economic conditions in the Pacific Rim may dampen short-term sales growth in those markets," but it went on to say "we are confident the upsurge in domestic and European sales activity, coupled with increasingly enhanced profitability, will continue to provide the Company with strong earnings growth." The company is 22% owned by management, and institutional investors own just 11% of outstanding shares. But with a market capitalization of less than $100 million, its tough for big institutional investors to get involved. Mutual funds, for example, typically have limits on the percentage of a company they can own. If sales do take off and the stock catches the attention of Wall Street, the big money can move a little stock like this up in a hurry. Unless and until that happens, though, all that investors have are a good story and a very volatile stock (its beta of 2.03 means Vari-L has been twice as volatile as the S&P 500) with limited liquidity (average daily volume of 49,000 shares). There is some reassurance in the numbers for value-oriented investors, though. For example, at its current price of $7, Vari-L isn't selling for much more than its book value of $5.67. It has a fairly low debt-to-equity ratio of 0.29 compared to the industry average of 0.49, and with a Price/Earnings ratio of 14 Vari-L is trading at a multiple less than half its earnings growth rate. Vari-L certainly has a compelling story, with the wireless communications industry expected to grow substantially in the coming decades. The company has already staked out an impressive presence in several segments of the signal processor market, and the biggest opportunity may be just around the corner--its low-power VCO for wireless handsets and pagers. Now it comes down to execution.