Nearly five years after the September 11, 2001, terrorist attacks leveled New York’s World Trade Center, the security industry continues to consolidate, and smart cards have become one of the most active sectors within the business for M&A deals. Security-oriented smart cards and related applications, while still fragmented, are undergoing an M&A wave as public and private security initiatives offer a rich lode of contracts for suppliers whose products control facilities access and determine identity. A recent marquee deal was the $326 million acquisition of Eden Prairie, Minn.-based Fargo Electronics Inc. by HID Global Corp., a subsidiary of Swedish lock maker Assa Abloy AB. The transaction, announced in May, is the latest indication that the credentialing sector of the security industry is drawing heavy attention from dealmakers. A more complete security package “This is a great marriage of companies providing different products in the security industry,” says Jack Mallon, a Principal at New York-based investment bank Mallon Associates. He says the acquisition of Fargo’s I.D. printers will complement HID’s already extensive menu of offerings in access control. Another deal driver, according to Randy Vanderhoof, Executive Director of the Smart Card Alliance, is companies’ desire to broaden their product offerings. For HID, the deal means it will be able to not only offer security readers and card stock but also the systems to issue and personalize these products. “Companies are looking to integrate multiple services to get a bigger percentage of sales,” he notes. A recent study by Vanderhoof’s group estimated that the North American microcontroller smart card market will consist of 132.2 million smart cards this year, with a compound annual growth rate above 27% projected through 2010. The lofty premium paid for Fargo, about 50% over the stock price, is an indication both of how hot the sector is and the value of Fargo’s intellectual property. Fargo makes identity card systems, printers, I.D. card materials, and software that complements HID’s line of access-control cards. High profits justify the price While the price might have seemed high, Mallon says it was justified by the impressive profit margins at Fargo, which he calculated at about 12%. Mallon isn’t alone in viewing the pricey premium was appropriate. “Fargo makes the best stand-alone printers bar none for smart card credentials,” says Jay Meier, a senior analyst at Miller Johnson Steichen Kinnard, a Minneapolis-based investment firm. Despite the generous take-out premium, Meier says he was disappointed by the deal because he believes that Fargo’s long-term opportunities are impressive and could have been developed as an independent. He points to the high barriers to entry and the slight competition that the company faces because of its dominant position in the technology known as reverse lamination. This process enables issuers to embed computer chips in cards without damaging the chips as the cards are printed. While there are many manufacturers of I.D. cards, there only three worldwide, including Fargo, that qualify to bid on government contracts for federal workers and contract workers. Very lucrative government contracts Government programs like the Department of Defense’s common access card, which is expected to create more than one million electronic-based identity cards, are likely to be lucrative markets for security-oriented smart card manufacturers. Another government program, mandated by the Real ID Act, requires that future state drivers’ licenses be technologically enhanced by 2008. “For starters, you’re talking about the federal government alone buying 2,500 to 3,000 smart card printers at $10,000 each,” Meier states. He adds that in addition to gaining control of the smart card printer market, HID will now be able to offer a range of services including biometric markers that link the holder to the card and the encryption that validates the card. In the bidding process for government and other contracts to provide secure identification and access control to facilities, it will be important for bidders to provide a variety of services, he says. Bright prospects for smart cards Industry players are making deals to prepare for a new era of heightened identification and access control that will be fostered by government projects and corporate security programs. These will include electronic passports, “smart” drivers’ licenses, and other forms of electronic I.D. cards. Private-sector applications of these technologies also are expected to expand as attempts to foil identity theft and control access to facilities become more refined at private businesses. The smart card industry itself is broader than security applications. It also includes commercial uses such as consumer identification for credit and debit transactions. The Fargo acquisition is only one of a number of recent deals that are reshaping security-oriented smart cards and adjacent parts of the security industry. In fact, Mallon says that “the 800-pound gorilla” in the industry was created in January by the $770 million acquisition of Viisage Inc. by Identix Inc. The combined company will offer multi-biometric search technology and document authentication services. Another large contender in the smart card arena was formed last year in Europe with the merger of Amsterdam-based Axalto NV and Paris-based Gemplus International SA which created Gemalto. The newly formed company bills itself as a leader in digital security with opportunities in corporate security, electronic passports, health care, and information technology. Vanderhoof says that as the smart card industry matures he expects to see more deals. “We’re on the verge of major investments in homeland security and companies will try to be in the best position to take advantage of these opportunities,” he says. (c) 2006 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com

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