Pegasus' Broken Wings

The stock of Pegasus Wireless (Nasdaq: PGWC  ) , a maker of wireless networking devices, has been on a tear over the last year. The stock is up to over $8.70 from $3.30 in June of 2005 -- a gain of nearly 160%. The market capitalization is up to over $600 million. That's a pretty rich valuation for a company that earned only $200,000 last quarter. Add that to the "me-too" nature of products and the rollercoaster track record of President Jasper Knabb, and this is a stock that Fools definitely don't want to own.

Valuation with wings
The company's price to sales ratio is 12, which is sky-high compared to the communications industry average of 5.8. However, the best way to understand the valuation of Pegasus Wireless is to do a sum-of-the-parts valuation. The company recently acquired three companies: AMAX Information Technology for $8 million, CNET Technology for $1 million, and SKI Technologies for $1.3 million. Before these acquisitions, Pegasus wireless was unprofitable, and for the year ending June 2005, the company had sales of $3.2 million.

Considering that Pegasus was unprofitable before acquisitions, a multiple of four times sales seems generous. That would imply a value of $12.8 million for the legacy business. Summing that with the $10.3 million paid for acquisitions puts the value of the entire business at approximately $23 million. To be generous, you could double or triple that estimate, and the actual value of the business is not in the same order of magnitude as the market capitalization.

To put this in perspective, consider the company's valuation relative to one of its main competitors, Netgear (Nasdaq: NTGR  ) . Over the past 12 months, Netgear booked revenues of $468 million and earnings of $36 million. The market cap of Netgear is $738 million, which isn't much more than Pegasus Wireless' market cap of $664 million. Yet, Pegasus booked revenues of $58 million and earnings of only $623,000. If Pegasus Wireless earned $2.4 million this year, which would require 300% year-over-year growth, its P/E ratio would be over 250. More likely, it'll earn around $1.5 million this year, which would put the P/E at over 400.

This town ain't big enough
Another problem is that Pegasus is operating in a very competitive market, which is already crowded with larger, better-financed players like Linksys (owned by Cisco Systems (Nasdaq: CSCO  ) ), D-Link, Netgear and Belkin. These larger players have recognizable brands, existing sales relationships, and widespread distribution. In this competitive environment, it will be very difficult for Pegasus to generate significant sales growth. The only way for it to overcome disadvantages in brand, sales, and distribution would be to launch a truly innovative product -- something that would break all the rules in the industry.

Unfortunately, the company does not have that kind of blockbuster product. The flagship product, the WiJET, is an add-on device designed to wirelessly connect computers, projectors, and plasma/LCD screens on one network. Businesses can use the device to connect to a large LCD or projector in order to give presentations, and consumers can use the device to wirelessly access multimedia stored on a computer and watch it on a television screen. Overall, this is not a bad idea, but also not a new idea. For instance, D-Link already offers a wireless media player that can connect to data on a computer's hard disk. The D-Link device incorporates a DVD player for movies and a memory card reader for pictures, all for less than a complete WiJET setup. And Epson and InFocus have begun releasing projectors with a wireless card embedded. Pegasus Wireless makes an array of other wireless devices, but nothing that appears to be a category-killer.

Don't eat before going on this ride
Pegasus Wireless President Knabb has been involved with two companies, BIFS Technologies and Wireless Frontier, that have seen huge spikes in share value -- followed by huge losses.

Knabb was an executive at BIFS Technologies. In March of 2000, BIFS Technologies traded at $0.03 per share. Six months later in August, BIFS Technologies was trading at $2.26 per share -- that is a 7433% gain. By December of 2000, the stock had fallen back to 0.13 per share -- a 94% loss from August.

Four years later, in 2004, Knabb was the CEO of Wireless Frontier. Between January and March of 2004, Wireless Frontier shares increased from $0.15 to $0.90 -- a 500% gain. By June, the stock had plunged back to $0.13 -- an 86% loss from March. While there is no evidence of wrongdoing by Knabb at BIFS Technologies or Wireless Frontier, the pattern is disturbing.

It also should be pointed out that Knabb has never received a salary from Pegasus Wireless, and he has made significant purchases of company stock. On June 7th, he purchased 40,000 shares at $8.81. That brings his total ownership to 2,657,221 shares worth over $25 million. In most cases, I would applaud management for jumping in with shareholders, but in this case, I think his stock purchases may give false signals to the market.

No pros is a con
Another concern here is the lack of institutional ownership. After a search of Capital IQ, Yahoo! Finance, MSN Money, and Reuters, I wasn't able to find any indication of institutions that own this stock. I don't always agree with strategies employed by the professionals who invest institutional money, but the pros are usually more diligent in researching companies and monitoring their accounting than amateur investors. Not having any pros on board could be the sign of a problem.

In the most recent 10-K filed by Pegasus Wireless, the most significant owners are management and directors. The only other owner listed is Vision 2000 Ventures, which owns 12.7% of the stock as of the last filing. I wasn't able to find any information on Vision 2000 Ventures, and it's probably not an outside investor (considering that its address is the same as the Pegasus Wireless headquarters).

Back to square one
The bottom line is that Pegasus has been able to post enormous gains in its market capitalization, but upon closer examination, the operations of the business can't support the valuation implied by the current share price. In addition, Mr. Knabb has headed up a couple of companies whose stock rocketed up and crashed down in short periods of time. Most importantly, the company can't compete in a market consisting of larger, established players that have more capital and greater brand recognition. I believe it's only a matter of time until this company returns to penny stock status.

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Where are the unfairly punished stocks, the undervalued enterprises? Philip Durell and his merry band of Fools at theMotley Fool Inside Valuenewsletter service are standing by, ready to lend a hand with the valuation scenarios. Try out a free 30-day trial subscriptionto see whether bargain-hunting is right for you.

Brendan Mathews is a consultant and financial writer living in Washington, D.C.He welcomes your feedback. He does not have a position in any of the stocks mentioned in this article. The Motley Fool has a strict disclosure policy.


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