Description

ActivCard (ACTI) develops and sells software and hardware products for digital identity and electronic certification technology. It products are used by businesses and governments for authentication and managing the digital identity of employees, suppliers, partners and customers accessing e-business resources online. Its technologies support digital identity technologies such as smart cards and tokens. Established in France in
1987, ACTI started to trade in Easdaq in 1996 and completed a public offering in the US on the NASDAQ in March 2000 and started to trade as ADR. It recently hired an American CEO and is increasing its HQ presence in Fremont, CA.

The France (or Europe for that matter) has been a technology leader in smart card since the early 1980s. In fact, outside of the US, smart card technology for digital identity and commerce (such as banking) is growing rapidly. With the rapid growth of the Internet for e-commerce and mobile network access, Dataquest (a market research firm) estimated that unit shipment of smart cards designed for network access will grow in excess of
250% compound rate through 2003. Pundits forecast that smart card edential
verification software market will exceed $5B by 2003. While e-commerce and mobile network access are clearly killer applications for the Internet, the actual penetration rate has not lived up to the hypes mentioned above. Nonetheless, I believe its not a matter of if, but rather a matter of how quickly this market will grow.

While the e-commerce and smart-card based network access markets are developing, a market for using smart card as digital identity is growing, especially within government entities. The impetus for the smart-card based ID card market is expected to grow rapidly as a result of the tragic events of September 11. Since ACTI is a leader in this market, it
is expected that it will benefit from it. ACTI reported that since September 11, it has a “dozen government projects in the pipeline from Europe, Asia and the Middle East, a dozen more from U. S. federal agencies and state departments and a handful of projects from European and Asian militaries”. ACTI is currently working on a DoD project to provide smart card infrastructure.

ACTI has been migrating from a product mix of mostly hardware and software to one of mostly software. In addition, ACTI is migrating away from older token-based technology to focus on smart-card-based technology. As a result, it expects the gross margin will increase. In fact, its gross margin grew from 59% in 3Q 2000, ending September, to 75% in 3Q 2001. ACTI distributes its products mostly through systems integrators such as
Check Point, Citigroup, Datacard, Hewlett-Packard, Sun Microsystems, etc. ACTI has won notable projects with smart-card-based ID for the Department of Defense, Hewlett-Packard, Sun Microsystems, and Lloyds TSB Bank.

As of 3Q 2001, revenue for the nine months was $21 million (I netted out $3.2 million of revenue in 3Q as it was from a non-monetary transaction with VeriSign), compared to $12 millions in the comparable 9-month periods in 2000. ACTI has been investing heavily on marketing and R&D, resulting in an operating loss of $16.8 million (excluding $4.9 million of non-recurring charges) in the same nine month period. Net loss was reduced to $6.9 million due to interest income and currency gain.

ACTI’s balance sheet is solid. It has $274 million in cash at the end of 9/01, and practically has no debt. On a 40 million diluted share basis, this translates to $6.85 per ADR in net cash. With the ADR is trading at $8.15, this means that the market is valuing the on-going business at approximately 1.6 time annual sales. With sales expected to grow at anywhere between 50% to 80% a year in the foreseeable future, this price to sale ratio is cheap. Typically, high growth high-tech companies trade at price-to-sales ratio between 4 to 6 times.

Why is ACTI selling at a discount? There are several reasons: (1) IT budget is tight in Europe and North America, resulting in concern of slowing sales; (2) ACTI has not been consistent in execution, resulting in delays in project completion and revenue recognition; and (3) it has not been profitable.

What will be the catalyst to drive ADR price expansion? The new CEO has a proven track record in managing technology-based company and has grown his former company from a size similar to ACTI’s current revenue level to well over $100 million. He is focusing on execution and committed to turn a profit soon. Post 9/11, demand for smart-card based ID system will surge. Longer term, network and e-commerce security will cause the
demand to explode. With a cash cushion, the down side risk is limited at this level. The upside potential can be at $15 - $16 per ADR in 12 to 18 months, assuming sales doubles in that time frame, and price-to-sales ration expands to 5x.

For the purpose of full disclosure, I own ACTI’s ADR.

Catalyst

The new CEO has a proven track record in managing technology-based company and has grown his former company from a size similar to ACTI’s current revenue level to well over $100 million. He is focusing on execution and committed to turn a profit soon. Post 9/11, demand for smart-card based ID system will surge. Longer term, network and e-commerce security will cause the demand to explode.