The Internet Incubator You Haven't Heard of

LAGUNA NIGUEL, Calif. -- Incubators are the rage among fledgling Internet investors, and why not? Newbie investors don't know how to pick stocks and they can't get access to the coveted initial public offerings. So shares of incubators -- companies that sift through the start-ups and spit out the worthy ones as IPOs -- offer a tempting promise. Consequently, the ranks of companies known as incubators (some new, some recently repositioned this way) have been multiplying faster than "Millionaire" game shows.

Shares of CMGI (CMGI), Internet Capital Group (ICGE), Point West Capital (PWCC), Rare Medium Group (RRRR), Safeguard Scientific (SFE) and Winfield Capital Group (WCAP) have all blossomed as investors have discovered the companies' charms.

But another incubator -- one with a longer track record but not on Wall Street's radar -- is about to join the Internet fold. Anaheim, Calif.-based Odetics (ODETA) is quietly building a small portfolio of technology companies. And by almost any standard, Odetics, with a $172 million market cap, is undervalued. After an impressive disk-drive spinoff in 1997, Odetics is about to spin off its high-tech automobile software company Iteris, set to be valued at roughly $200 million.

After that, an Internet subsidiary is waiting in the wings. The company is expected to outline the progress of Mariner Networks -- a subsidiary that brings low-cost Internet networking devices to small business and branch offices -- at the Cruttenden Roth Growth Stock Conference at the Ritz-Carlton in Laguna Niguel this week.

Odetics is an ancient company by Net standards. It launched in 1969 as a supplier of various components to the space program and had a robust business until spending slowdowns forced a re-evaluation of its business. The company is an odd one: Employees were known to be as happy as the workers at Disneyland (located just across the parking lot) pretended to be. Long before it was management fashion, the company called employees "associates." Then there is the company gym, swimming pool and volleyball and basketball courts. Companywide excursions are planned by an official "fun committee."

CEO and founder Joel Slutzky treasures this corporate culture and, in 1989, created two classes of Odetics stock to ensure that the company would hold onto control. Odetics A shares are for the public; insiders' B (ODETB) shares are identical but have 10 times the voting rights. Employees have rewarded the company with a host of smart technologies, and now Odetics is taking these technologies, one by one, and nurturing them into self-supporting subsidiaries ready for new lives as IPOs.

The first of those was ATL Products. On Halloween 1997, the company spun off its 82.9% interest in ATL, a disk-drive maker. Odetics shareholders received 1.1 tax-free, pre-IPO ATL shares for each Odetics share. The new stock shot out of the gate at $11. A few months later, competitor Quantum (QNTM) thought the company was still a bargain and took it over, buying all the outstanding shares for $29. Odetics shareholders were able to take a 163% gain with their ATL shares -- and they never had to sell any Odetics.

This spinoff became a new model for Odetics. Ever since, the company has embraced the role of technology incubator. "These guys just spit off IPOs, but they've completely flown below the radar of Wall Street," says Howard Love Jr., hedge fund manager of California-based Love Capital Management. "It's not the easiest thing in the world to value. Most people aren't willing to do the work."

The next endeavor is right around the corner. Odetics subsidiary Iteris filed its S-1 with the Securities and Exchange Commission on Dec. 17, with Bear Stearns as its lead underwriter. (Cruttenden Roth is also a part of the deal.)

Iteris makes vehicle sensors that keep cars and trucks from running off the road. A few years ago, Daimler-Benz tested the products on a few truck lines. It was so impressed that it decided to buy a piece of the company. Two weeks ago, DaimlerChrysler (DCX) made a mezzanine-level investment in Iteris, acquiring a convertible note for 2.5% of the company at $3.75 million. Odetics still owns 93% of Iteris, and upon the IPO, will be distributing approximately 1.15 shares of Iteris for every share of Odetics.

"Iteris' market capitalization at IPO will be valued at about $200 million," says Jeffrey Van Sinderen, an analyst with B. Riley & Co. (His firm does not do any underwriting.) "That alone is worth about $15 per Odetics share. You get the remainder of the Odetics, including Mariner, for about $2 a share." Consequently, Van Sinderen has a buy on the stock.

And the rest of Odetics? Well, that's another story.

LATER TODAY: I'll look at the rest of Odetics -- an Internet networker, Mickey Mouse and more.

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