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Capstone a Bargain?

An unusual cash situation creates opportunity for buyers


There may be a lot of bargains on Wall Street these days but perhaps none like Capstone Turbine Corp., the Chatsworth-based maker of high-tech power generators.

The stock market has so soured on Capstone that a clever suitor might be able to acquire the company for free.

That's because the amount of cash Capstone has on its books--$164.4 million--is significantly more than its $123-million stock market value as of Monday and its $12 million in liabilities.

Once one of hottest stocks to emerge from the state's energy crisis, Capstone shares traded close to $100 each less than two years ago, but since have fallen to single digits, closing Monday at $1.59 a share, up 7 cents, on Nasdaq.

This has created an unusual situation in which an opportunistic buyer could offer shareholders a premium over the share price, acquire Capstone and then use the company's cash to fund the transaction, according to several analysts and investment fund portfolio managers.

"It's not common for the net cash holdings of a company to exceed the market value of its common stock," said Marty Whitman, manager of Third Avenue Value Fund. "But this looks like a heck of a speculative play."

Whitman said Capstone's management would have the best shot at pulling off such a transaction, because "insiders always have the advantage." In Capstone's case, company management controls 8% of the stock.

But outsiders might be able to work "a tremendous deal" because of the unique cash position, Whitman said.

Capstone officials declined to talk about whether they have been approached by a potential buyer or would consider using the company's money to take it private.

"This is a very peculiar situation, and it certainly has come to the attention of our board of directors," said Ake Almgren, Capstone's chief executive. "Our focus is to develop the company, not to sell it."

Two giant industrial companies are interested in microturbine technology similar to what is used in Capstone's generators. Ingersoll-Rand Co. has launched its own line of generators, and General Electric Co. purchased microturbine patents and equipment from Honeywell International Inc. in December.

Capstone makes fuel-efficient, low-emission microturbine power generators that sell for $25,000 to $55,000, depending on their size and configuration.

Using technology similar to what is in a jet aircraft engine, Capstone's refrigerator-size machines run on natural gas and other fuels. The smallest generator produces about 30 kilowatts, enough to power a fast-food restaurant.

The stock market became enamored of Capstone practically from the day it went public at $16 a share in June 2000, which happened to coincide with escalation of the state's burgeoning energy crisis.

Investors rushed in, believing that high electricity prices and blackouts in California would create demand for machines that provided a backup or alternate power source. Shares closed at an all-time high of $94.38 on Sept. 1, 2000.

But interest in Capstone's machines has remained scant. Though its technology is well regarded, the company sells about 1,000 generators annually, too few to be able to produce machines at a profit.

"It is almost painful [for Capstone] to sell one of these things these days," said Cyrus Lowe, an analyst at J.P. Morgan in San Francisco.

Capstone's cash holding position is the remainder of $426 million raised in various public and private stock offerings over the last decade. The company has never turned a profit since going public, and lost $12 million on revenue of only $4.6 million in the first quarter of 2002. At that pace, it will burn through its remaining cash in three to four years.

Capstone executives acknowledge that the stock's sizzling run-up in 2000 was due to eager investors who underestimated how long the company would take to break into the power generator market. But the executives say the current share price does not reflect the value of the company.

Karen Clark, Capstone's chief financial officer, said she hopes a prospective buyer does not emerge now but waits for Capstone to better develop the microturbine market and then make a bid when the stock price has rebounded.

Companies are cautious about adopting new technology, especially in a slow economy when capital spending is down. Capstone is finding that the generators make the most economic sense in situations in which the heat from their exhaust can be used for heating and air-conditioning systems.

Cal State Northridge, for example, uses a bank of six Capstone generators to provide the electricity for its central heating and cooling plant, recycling the machines' heat back into its system.

But like many of Capstone's customers, CSUN's use is experimental. And in this instance, it's supported by government grants.

And companies that do use traditional generators, typically those with reciprocating engines, are less willing to adopt replacement technology, particularly when capital- spending projects are being scrutinized.

"It can take a decade to bring a new piece of power generation equipment onto the market," said Eric Prouty, an analyst at Adams, Harkness & Hill in Boston.

Capstone's stock turned down as the California energy crisis abated. Investors sold out when they realized that the expected electricity blackouts were not developing, and that businesses would not be making big investments in backup power systems.

Then the economy slumped, further dampening capital spending and investment.

At the same time, Capstone developed a reputation for missing Wall Street's earnings and revenue targets.

That created skepticism about the management, especially Jeffrey Watts, the previous chief financial officer, who was responsible for explaining Capstone's financial status to the investment community, Lowe said.

The company's low share price now "means that investors are apathetic about the growth opportunities for this stock," he said.

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