Success Is Near

Just over two weeks ago, two brainy guys from UCLA took their Irvine company public in one of the most spectacular offerings of this or any other year. The firm, Broadcom Corp., develops silicon chips for high-speed data transmission, placing it squarely on the leading edge of Internet technology, the sector that’s been generating a heat wave on Wall Street.

Broadcom’s shares were originally priced in the low teens, but that was pumped up to $24 before the debut. First trade: $62. Recently the stock was changing hands at about $53, bestowing upon Broadcom a market value of $2.3 billion--a sign of great expectations, considering that it took in only $37 million in revenue last year.

Clearly, it’s not just the northern half of California that incubates small companies with big futures. Investors, look around you. If, as Peter Lynch said, it pays to take a stake in companies whose quality can be observed firsthand, then it can be profitable to live in Southern California.

The region has more than regained its footing after the early1990s recession and aerospace collapse. If the five largest counties in Southern California were a separate country, its $476-billion economy would rank it 12th on the planet.

And the population of dynamic public companies based here not only boasts of a constellation of high-tech stars--the trademark of the northern half--but a galaxy of little-known up-and-comers in a wide range of industries.

In fact, the next huge Internet initial public offering might be launched from Santa Monica. More than 1.7 million people have joined online communities hosted by GeoCities, making it one of the most visited sites on the World Wide Web. With the ability to attract all those eyeballs, the young company is working to boost revenue from advertising and other forms of electronic commerce. At the same time, GeoCities is building up its executive ranks in preparation for going public this year.

“The region has a very robust entrepreneurial spirit and an awful lot of brainpower,” said Van Kasper, founder of the Van Kasper & Co. investment bank in San Francisco, which focuses 80% of its research on California companies.

“There are historical reasons that brought this together--I have seen it happen with my own eyes. We are trying to expand our coverage of Southern California. We think it’s more diverse than the specialized economy you have in Northern California. Perhaps the best is yet to come.”

Kasper recommends putting some of your eggs into a basket of SoCal stocks that includes thriving companies as well as those he believes soon will be.

At the top of Kasper’s list is Santa Ana-based First American Financial, which provides financial and information services to property buyers and mortgage lenders--services including title insurance, credit-reporting and home warranties.

FAF, Kasper said, is “taking off like a rocket,” turbocharged by the state’s residential and commercial real estate resurgence. Indeed, the stock, at a recent $72, has risen from $21 a year ago. The company has been reporting record results, and the merger mania in financial services hasn’t hurt.

Kasper is also high on Xylan, a Calabasas tech company that develops local-area networking gear. Trading at a recent $29, Xylan has regained some of its luster on Wall Street after product delays hurt its 1997 performance. It, like Broadcom, it had a euphoric IPO, then tumbled almost to single digits, but the promise of its technology remains intact, Kasper says.

Another innovator Kasper likes is Rainbow Technologies of Irvine. He calls Rainbow a leader in products that protect software from being pirated, a growing need as the industry pushes into new markets around the globe. It is also applying its encryption expertise to communications networks, including the Internet.

In Signature Eyewear, Kasper sees a winning demographic play. Inglewood-based Signature designs fashionable frames for prescription glasses, recently launching a line under the Eddie Bauer name. Stagnant revenues have kept the little-followed stock low. As baby boomers age and most will need glasses, however, eye wear that doubles as an accessory might be just what the optometrist ordered.

To Kevin Landis, manager of the Technology Value Fund in San Jose, the frenzy around Broadcom--and the stocks of Yahoo, America Online and Amazon.com--represents “a bet that Internet traffic will grow big time, which means that infrastructure has to grow big time.”

He emphasizes that Broadcom isn’t the only networking-chip maker out there, and some of the best-positioned are based in Southern California. Landis particularly likes Applied Micro Circuits of San Diego and Vitesse Semiconductor of Camarillo. Both sell primarily to builders of high-capacity “backbone” data networks. However, Vitesse belongs to a select group of chip makers who use not silicon but a material called gallium arsenide that speeds up electronic signals.

Landis has owned Vitesse for a long while, and it has paid off handsomely, almost doubling in the past year and scheduled to split on May 26. With revenue up 64% in the March quarter, the chip maker is in the midst of a healthy sales cycle. Applied Micro is showing similar strong growth for its bandwidth-enhancing semiconductors. Though it’s only been a public company for about six months, don’t mistake it for a start-up. It was founded in 1979 and earned a very un-start-up-like 23 cents a share for its most recent quarter.

PairGain Technologies and Cymer are the dominant players in their niches, Landis says, but those young, esoteric markets haven’t quite reached critical mass. He says patience will be rewarded. PairGain, of Tustin, provides “digital subscriber line,” or DSL, systems to telecom and Internet service providers to boost the data capacity of conventional copper wires. Analysts had expected enthusiastic adoption of the technology by the Baby Bells, and although they are all customers of PairGain, high volume has been slow in coming. Consequently, PairGain has been posting flat revenue and earnings and losing believers.

Cymer’s promise is in its virtual monopoly of deep ultraviolet laser technology, which is critical to the next generation of semiconductors. The power of chips increases as silicon circuitry shrinks from merely microscopic to infinitesimal. That’s where Cymer comes in. But the San Diego company hasn’t escaped the pain in Asia, which slammed the brakes on chip makers’ investments in new equipment. This year doesn’t look terrific for the company or the industry, but most analysts believe the malaise will pass. “Regardless of whether it’s a quick or slow recovery,” said Landis, “Cymer will have a great 1999 and 2000.”

Landis’ partner at Technology Value, Ken Kam, tracks the medical tech world. San Diego has emerged as the industry capital, and Kam has been buying shares of companies based there. Aurora Biosciences develops not drugs but systems that help pharmaceutical companies discover drugs. The selling point of its screening products is their speed.

“It’s like using a computer to do your taxes instead of an abacus,” Kam said, ticking off Aurora’s virtues: partnerships with Merck, Eli Lilly and other top drug companies; it turned a 2-cent profit last year, which sets it apart from the money-losing pack; and down the road, Aurora could see drug royalties on top of current license fees. Indeed, even though the shares sell for less than $10, the Street is bullish. The three analysts who cover the company rate it strong buy, according to Zacks Investment Research.

Kam has less company when it comes to Amylin Pharmaceuticals. Amylin’s primary compound, pramlinitide, is targeted at diabetics. It has been proved effective in advanced clinical trials with Type I sufferers but not with Type II. Unfortunately for Amylin, the latter are the majority. Moreover, the company has been racking up losses and was abandoned by its marketing partner, Johnson & Johnson.

Nevertheless, Kam says, Amylin has enough cash to fund its operations while it seeks final Food and Drug Administration approval of pramlinitide. And based on the drug’s success with Type I diabetes, he believes the shares, recently around $5, sell for only half their value.

Portfolio manager Robert Schwarzkopf says his firm, Kayne Anderson Investment Management in Century City, identified investment-worthy banks by their soundness during the Southern California recession of the early 1990s. They were small institutions with strong positions in their localities and were managed by their founding families. Two were San Diego Financial and Santa Barbara Bancorp. Since then, San Diego Financial was acquired by First Interstate, now part of Wells Fargo. But the latter remains among his favorites.

The resort town’s economy spurred Santa Barbara Bancorp’s net income to a 29% gain in 1997, and Schwarzkopf expects the bank’s profitability to continue to outdo the industry average.

P. Gordon Hodge, an analyst with NationsBank Montgomery Securities, is part of Univision Communications’ growing audience on Wall Street. He exuberantly recommends the Spanish-language TV broadcaster, which is so dominant that it draws 87% of prime-time viewers of Spanish-language TV, according to the most recent sweeps. That translated into strong results in the most recent quarter, with earnings up 47%. Hodge forecasts profit growth exceeding 30% annually for the next three to five years.

Henry Cisneros, the former U.S. Housing and Urban Development secretary, recently joined Century City-based Univision as president. His prestige and persuasiveness have helped loosen the purse strings of big advertisers who want to address the rapidly growing Latino population. “Cisneros has been effective at opening doors among Fortune 500 companies and elevating the profile of Univision and the Hispanic community in general,” Hodge said.

From television networks back to computer networks. When it comes to information technology, health care, arguably the nation’s largest industry, is playing catch-up. It’s now in a hurry to computerize its vast inventory of data and records and electronically link its workers. San Diego-based Daou Systems is in the forefront of designing and managing those complex networks for hospitals and large medical organizations.

The stock was a momentum play and spiked from the single digits to $34 last year. Then it took a tumble, as Hambrecht & Quist analyst Dirk Godsey put it, for “coming in half a penny per share below estimates” for the December quarter. Godsey is keeping his eyes on hospitals’ long-term, large-scale need for automation and keeping a “strong buy” rating on Daou. And he wasn’t surprised when the company reported record revenue--up 80%--and earnings at the high range of expectations in April. “They are in great shape financially and will get better throughout the year,” Godsey said.

Another thing that hospitals need more of--a lot more of--is disposable gloves. Analyst Melissa Wilmoth of Salomon Smith Barney calls those produced by Safeskin the “best gloves in the world,” particularly because they are the least likely to cause allergic reactions. San Diego-based Safeskin churns them out by the billions in Southeast Asia. However, demand still far outstrips capacity, so the company is expanding its facilities to double annual output to 8 billion by the end of this year.

Who’s buying them? Safeskin sells mainly to hospitals and just signed a six-year deal to supply giant Columbia/HCA. But Wilmoth says the potential worldwide market is much broader and in its early stages. Think doctors’ clinics, dentists’ offices and industrial settings such as the antiseptic “clean rooms” where silicon chips are manufactured.

With net income up 75% in 1997, Safeskin has been discovered by Wall Street, and at a recent $36 a share, it’s not cheap. So Wilmoth rates it an “outperform” rather than a “buy,” but says if the ramp-up goes well, her profit forecasts of $1.17 per share in 1999 and $1.52 in 2000 could easily be exceeded.

ViaSat is better than a defense-conversion story; it’s an expansion-into-commercial-markets story while its defense business continues to grow. Carlsbad-based ViaSat makes Earth-based components for certain types of satellite networks that transmit voice and data. Government contracts and deals with defense giants such as Lockheed Martin produce the lion’s share of revenue, but it is the emerging “direct-to-home telephony” business that has Needham & Co. analyst Rich Valera interested.

“In the developing world,” he said, “the most affordable way to get phone service is to actually use satellites.” There are rival designs for getting such a network to fly, but Valera calls the ViaSat approach “the low-cost solution.” Various Asian customers, notably the Indian stock exchange, have deployed ViaSat’s technology. The company’s balance sheet is healthy, and Valera expects 20% to 25% annual growth, while the stock, beaten down to a recent $15 by the Nasdaq sell-off, looks to him like a bargain.

While ViaSat’s star is rising in wireless, Tekelec is prospering in land lines. The Calabasas-based telecom equipment provider has been on a tear since late 1996. With the company reporting profit for the March quarter that was almost double Wall Street forecasts on a 70% surge in revenue, the stock is still moving up fast.

The key to Tekelec’s growth is its Eagle switch, a software-laden device that makes telecom networks more “intelligent.” The Eagle’s competitive edge, says Eric Zimits, a communications technology analyst with Hambrecht & Quist, is a feature that enables phone companies to enter a competitor’s territory and sign up new customers without requiring them to change phone numbers.

This “local number portability,” as it’s called, fits into the federal deregulation mandate, and it’s what Zimits expects to continue to push the stock ahead.

Though Southern California is rife with high-potential stocks, as even this less-than-comprehensive survey shows, no one is suggesting that geography should dictate investment strategy. Big winners come from all corners of the nation. In the long run, it’s likely that knowledge of an industry will pay off more than knowledge of a region. But there are many ways to be successful in the market, notes John Bollinger, who writes the Capital Growth Letter in Manhattan Beach.

“One way is to invest in companies you do business with directly, or those whose offices you drive by on the way to work,” he said. “For many people, this is an important factor in what investing is all about. If the companies you know and see in your area are what you are comfortable with, it allows you to sleep better at night.”

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SoCal Picks

A look at one-year and six-month percentage price changes in a selection of stocks favored by analysts in the accompanying story.

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Stock % price % price price on chg. over chg. over Name Ticker 4/17/98 6 months one year Amylin Pharmaceuticals AMLN $3.56 --60% --68% Applied Micro Circuits AMCC 25.56 NA NA Aurora Biosciences ABSC 11.13 --25 NA Cymer CYMI 25.13 -14 21 Daou Systems DAOU 20.88 --26 255 First American Financial FAF 67.13 55 196 PairGain Technologies PAIR 20.25 --27 --19 Rainbow Technologies RNBO 26.75 --2 63 Safeskin SFSK 36.63 64 251 Santa Barbara Bancorp SABB 28.94 22 78 Signature Eyewear SEYE $8.50 15 NA Tekelec TKLC 45.75 13 341 Univision Communications UVN 37.00 17 118 ViaSat VSAT 15.00 --31 43 Vitesse Semiconductor VTSS 54.69 20 76 Xylan XYLN 29.31 30 115

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Source: Market Guide