There’s Another, but Far Quieter, Hot Stock in O.C.

For a hot market story, not much could beat Newport Beach-based Comparator Systems--until regulators arrived last week to shut down trading in that dicey little stock. Meanwhile, another Orange County firm has been attracting far less publicity recently, but far more serious money.

Shares of Tustin-based PairGain Technologies have doubled since March 1 and now are up more than fivefold from a year ago. On Tuesday the stock rose $2.25 to a record $116.50.

PairGain is an 8-year-old business whose technology has just begun to catch on in a big way--or so Wall Street is betting, in an increasingly high-stakes bet (more on that later).

PairGain makes systems that rev up the speed with which information travels over copper phone lines. The Baby Bell phone companies, and others, have beaten a path to PairGain’s door, lifting its sales from $36 million in 1993 to $107 million last year. Sales are expected to double again by 1997.

On a basic level, PairGain owes it success to another technology’s limitations. Fiber-optic cable was supposed to be the information transmission line of the future. But as Pacific Bell and other phone giants have recently acknowledged, the cost of replacing the entire phone system infrastructure with fiber-optic cable is still prohibitive--at least in the case of the “last mile” of existing copper wire into millions of individual businesses and homes.

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That is the market PairGain has targeted, primarily the business end of it so far. “We make copper . . . act like fiber” in that final stretch of wire, says PairGain Chief Executive Charles Strauch. The former Bell phone monopolies have embraced PairGain’s technology because it represents the mantra of Corporate America today: Do more with less, and do it now.

PairGain’s management also gets high marks on Wall Street. The firm has limited patent protection, but has outspent all of its rivals on research. It offers a broad range of products while competitors’ range is limited. And PairGain continually cuts prices to keep competitors scrambling. If that sounds familiar, it’s the aggressive management style of computer chip king Intel Corp. “Intel is our model,” Strauch says proudly.

In many ways, PairGain itself is a model of what keeps the aging stock bull market ticking: Investors are hungry for true growth stocks, especially anything related to technology, and they are willing to pay extraordinarily high prices to buy into fast growth. Investors also seem willing to quickly forgive and forget transgressions by genuine growth companies, as the bounce-back in many tech shares has demonstrated since a rash of earnings disappointments last winter.

PairGain, too, has been guilty of a transgression: It was forced to take a $16-million charge against 1995 earnings after now-defunct investment firm Capital Insight, which handled PairGain’s corporate cash, mismanaged those funds.

When that story broke earlier this year, PairGain’s stock was whacked--but only briefly. Last year’s earnings may be gone, but Wall Street is focusing on the future, and it expects stellar growth from PairGain for years to come. Analysts’ consensus estimate is that PairGain will earn $1.47 a share this year and $1.90 a share in ‘97, a 30% growth rate.

Joe Noel, analyst at Hambrecht & Quist in San Francisco and one of PairGain’s biggest boosters, argues that the firm is in a particularly sweet spot: It dominates a technology that many phone companies have decided they must employ to satisfy customers’ needs for more and faster information, and no more cost-effective technology is likely to appear within the next couple of years at least.

Yet as the stock rockets higher, the question is how much a rational investor should pay for PairGain’s growth rate. At $116.50, the stock is priced at 60 times the consensus 1997 earnings-per-share estimate. By any yardstick, 60 times earnings is nosebleed territory. CEO Strauch admits as much. Valuation of the stock is “a valid question. It’s the big question,” he says.

H&Q;’s Noel has been using $120 as his near-term stock price target and retains a “strong buy” on it. Like other analysts, he now must either raise his target or lower his rating. Isn’t 60 times 1997 earnings a very risky price to pay? “PairGain is not the only stock priced like this,” Noel reminds.

That’s true, but investors might want to take heed from Strauch and some of his fellow PairGain executives, who have been trimming their personal holdings of the stock in recent months. However solid a business this is, there is a fair price to pay, and then there is overpaying. If you overpay and trouble strikes or expectations wane, the wait just to get back to even may be a long one.

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How High is Up?

PairGain Technologies’ stock has nearly quadrupled since last fall, on excitement over the company’s growth potential. Closes every other week on Nasdaq, since Sept. 1:

Tuesday: $116.50

Source: Bloomberg Business News