Kardan Capital Investments Corporation analyst Yair Spalter professes himself baffled by the high valuation the market grants to


(Nasdaq:INDG, INDGW), given its high operating costs.

Spalter has downgraded


(Nasdaq:INDG, INDGW) from Hold to Underperform and slashed its target price from $5.8 to $3.94, 15% below the market.

One main problem is that Indigo failed to grow as fast as expected in the first quarter of 2001. Another us that he believes that value will be slow to materialize from its alliance with

Hewlett Packard


Furthermore, Spalter writes, long development phases are delaying the launch of products that are expected to lead the company to profitability.

Indigo's market cap is $500 million. After deducting its cash reserves of $74 million, the market values the company's business at $426 million.

After factoring in high expenses of $10.3 million for 2000 and expected operating losses of $3.2 million this year, Spalter thinks Indigo's market value is inexplicable.

But he does think that in the long run, the alliance with Hewlett Packard will lift the company to profitability.

In the short term, HP will sell Indigo's machines under an OEM agreement, using the label HP6600. Spalter expects this arrangement to produce moderate sales already in the second quarter of this year, although he sees a risk that the two companies will compete in the target markets. He also notes that sales through Hewlett Packard will be less profitable, because HP's profit margins are narrower.

In the long term, Indigo and HP will probably co-invest in developing new products. This is chancier, as nobody can say whether the new products will succeed. Also, development could take a long time.

Indigo's first-quarter sales increased by 17% against the parallel to $42.6 million. But revenues declined 14% against the same period in 2000. The dip was expected, because Indigo's first quarter is traditionally weak.

Indigo reverted to operating losses of $4.1 million in the first quarter, about the same as the operating losses it posted for the first quarter of 2000.

"After turning to profit at the end of the year, the return to losses is especially jarring," Spalter said.

The albatross around Indigo's neck

One of the main reasons why the firm is losing money is its bloated company structure, which hurts the bottom line despite an annual sales turnover of $165 million.

The company's direct market strategy results in it maintaining 500 sales and marketing employees around the world. Spalter believes that the firm's personnel costs an albatross about its neck.

Concerning rivals, Spalter feels that competition from firms like Heidelberg and


(NYSE:XRX) will make it very tough for the company to return to the kind of results it reported in 2000. Then its gross profit reached 50%, but Spalter suspects that this year, it will slide to 46%.

The analyst says that the firm has undertaken a plan to repurchase up to $5 million of its stock to support its share price.

As for investors, Spalter says that in the short run, investors could take advantage of the fluctuations in the company's share price as it responds to announcements of business developments. But from the larger perspective, he believes that the expected developments are already incorporated in Indigo's share price.

The bottom line is that Spalter believes Indigo is growing at a reasonable pace - but also, that the market is pricing the company above its real value.