New Stock Pìck: ActivIdentity (ACTI)

Investment Summary:
We believe that ActivIdentity (Nasdaq: ACTI), at its current price of about $4.37, represents a low-risk investment, with substantial upside price potential in the next two to three years, as the company capitalizes on new growth opportunities in the digital identity assurance market, under the guidance of the new CEO, Jason Hart.

Background:

The current stats on ActivIdentity (Nasdaq: ACTI) are as follows:
Current Share Price:  4.37
Shares Outstanding: 45 million fully diluted
Market Cap:  197 million
Net Cash: 145 million
EV (Enterprise Value or Market Value of company minus cash + debt):
$52 million
Last Year Sales: $42 million
Last Year Free Cash-Flow: Negative $32 million
Last Year Cap-Ex: $1 million
EV/Sales: 1.25
EV/FCF: N/M

Description of Business
ActivIdentity is a global leader in digital identity assurance solutions that allow customers to issue, use and manage trusted digital identities to enable secure transactions, communication and access to information. Our solutions include secure remote access, enterprise single sign-on, enterprise access cards, and multi-channel identification and verification. We provide software and hardware products that authenticate the user to a network, a system, applications or a facility. Our products provide authentication through different security devices, such as smart cards, tokens, biometric devices, mobile phones, and personal digital assistants. This enables organizations to confirm identities before granting access to computer networks, applications, and physical locations. Globally, over ten million users at corporations, government agencies, and financial institutions use our solutions to safely and efficiently interact electronically.

The company´s website at: http://www.actividentity.com/ provides a good summary of all the company´s products. However, we think it is most important to understand that the company is targeting the online identity assurance market, which is clearly a huge growth market given the tremendous security threats of identity theft both within businesses and in sales directly to consumers. We think that this quote from the company pretty much sums up the value proposition of the business:
"ActivIdentity will provide individuals with the same level of confidence in electronic interactions as in face to face transactions by integrating identity assurance services into the infrastructure,” said Yves Audebert, President and Chief Strategy Officer. “The solutions will provide our customers with irrefutable proof of a business interaction providing a basis for the digitally binding ‘I Agree’.”

Why is the downside risk in the stock low?

As can been seen from ActivIdentity (Nasdaq: ACTI)’s stats, the stock has low downside risk at the current price because:

    * Horrendous Stock Performance

ActivIdentity´s (Nasdaq: ACTI) stock has fallen by over 50% in the last two years and is down nearly 80% from five years ago. The bottom line is that this stock has been a complete dog. That means that there are not too many fans of ACTI and that therefore the potential supply of sellers in this stock is very low (Note: Remember that stocks are somewhat like commodities in that they are influenced by the supply and demand for shares. As such it is important to buy stocks that have a low supply of sellers and the potential for demand from a new crop of buyers). We would also note, somewhat comically, that ACTI has restructured its operations every year since 2002. It´s difficult to find such a  clear example of a horrendous business and stock with few Wall Street cheerleaders.

    * A Strong Balance Sheet

Over 70% of ActivIdentity´s (Nasdaq: ACTI) stock market cap is in cash, providing good downside protection and the financial flexibility to grow the company. It should be noted that the company´s cash position continues to shrink due to massive losses, but we believe these losses will be contained in the coming year under the guidance of new management. We believe the company could be cash-flow positive relatively quickly with some more corporate downsizing.

    * Low Valuation

As can been seen above, ActivIdentity´s (Nasdaq: ACTI)  is trading at about 1.25 EV/Sales. This is far below the valuation given to the company´s main competitors (Note: We are not doing a complete relative valuation here, since we are confident that ACTI has been poorly managed and as such its costs are likely way out of line with current revenues). The largest competitor for the company is RSA Security (Nasdaq: RSAS). RSA Security ( Nasdaq: RSAS) has about a $1.1 billion enterprise value, did about $310 million in revenue last year, for an EV/Sales ratio of about 3. Another competitor is Secure Computing (Nasdaq: SCUR).  Secure Computing (Nasdaq: SCUR) has about a $355 million enterprise value, and did about $110 million in sales last year for an EV/Sales ratio of 3.2. A third competitor is Vasco Data Secutry (Nasdaq: VDSI). Vasco Data Secutry (Nasdaq: VDSI) has an enterprise value of about $340 million and did about $55 million in sales last year for EV/Sales ratio of 6. As can been seen from the above,  ActivIdentity´s (Nasdaq: ACTI) stock is trading at a significant discount to the average valuation of its competitors. Now of course, this discount is warranted based on past performance. But, therein lies the upside for ACTI´s stock. 

So why should you invest in ACTI now and what is the potential upside?

* New Chief Executive Officer

In August of 2005, ActivIdentity (Nasdaq: ACTI) acquired an Australian software company, Protocom, for $21 million and 1.7 million shares of ACTI. The founder and CEO of Protocom was Jason Hart. Mr. Hart is not well-known outside of Australia, but this guy is a superstar entrepreneur. A quick search Google can reveal that Mr. Hart started Protocom out of his garage in 1989, when he was all of 18 years old. By 2005 the company had over 95 employees and did nearly $20 million in sales (Note: We estimated this from ACTI´s 8-K filing upon the acquisition of Protocom, wherein Protocom can get additional shares of ACTI should revenue at Protocom exceed $18.7 million by July 2006).

Last month (February 2006), ActivIdentity (Nasdaq: ACTI) named Jason Hart as the new CEO of the company. Mr. Hart is currently the largest individual shareholder of ACTI, owning about 1.4 million shares (a fund by the name of OZ Management LLC owns about 3 million shares) and Mr. Hart has been buying shares on the open market in March (75,000 shares for about $4).

If there is one recipe for the success of a company it is this:
Proven Entrepreneurial Talent + Capital = Significant Stock Price Appreciation. In the case of ActivIdentity (Nasdaq: ACTI), the company now has a proven leader as the CEO and with $145 million in cash, Mr. Hart now has more money to work with to grow the company than we´re sure he could ever have wished for. As the largest single shareholder, Mr. Hart also has an incentive to use the cash wisely to increase shareholder value.

We should also note that the in addition to a new CEO, ActivIdentity (Nasdaq: ACTI), also has a relatively new Chairman and a new CFO.

* Potential Dividend/BuyBacks/Acquisition Target
With $145 million in cash, it is anybody´s guess as to what can happen with ActivIdentity (Nasdaq: ACTI). The company is clearly overcapitalized and is therefore an easy acquisition target. At the same time, it can use its cash to acquire other companies in the digital assurance industry. Better yet, the company can even pay a  large one-time dividend.  Our feeling is that company can easily shell out $100 million in cash to investors or about a $2 per share one-time dividend. That would still leave the  company with over $40 million in cash, which is plenty of capital to grow the business. Mr. Hart would be smart to pay out such a dividend as he owns 1.4 million shares. We expect that Mr. Hart may consider such a dividend after he accumulates more shares via his earn-out clause from the Protocom acquisition. If the company pays out a one-time dividend, the stock can easily double or triple from teh current level.

On the upside, should Mr. Hart steer ActivIdentity (Nasdaq: ACTI) towards profitable growth, it seems clear that the stock could trade at 3X EV/Sales or about $6 per share. That represents about a 40% gain from current price levels based on last years sales. What is more likely, however, is that Mr. Hart will re-energize the company in the next year or two, and grow sales significantly above current levels. At that point Wall Street will assign a 5X multiple to the company with ACTI trading above $10.
 

What are the risks here?

Continues to Burn Cash
We consider the biggest risk to  ActivIdentity (Nasdaq: ACTI) to be the company´s inability to control cash losses. Over the last few years, ActivIdentity (Nasdaq: ACTI) has burned cash faster than most companies earn cash. It´s as if the company´s goal was to burn as much cash as possible. Despite past management´s promises, there is currently no indication that ActivIdentity (Nasdaq: ACTI) is firmly committed, as a company, to profitable growth. It is still somewhat conceivable that management will continue to pay themselves and their cronies exorbitant salaries and drain the cash from the company. We have seen this in the past at companies with large cash balances. Should this cash burn continue, we expect that ActivIdentity´s (Nasdaq: ACTI) stock will most probably decline back to the $3-$3.50 per share level. However, we consider the risk of continued cash losses to be low, because of the new management team just put in place at the company. In addition, the market will find out the intentions of new management quite soon, leaving us plenty of time to exit this position at a small loss, if need be. 

The bottom-line:

We believe that ActivIdentity (Nasdaq: ACTI)’s current stock price already adequately reflects all the risks that the company can face (including competition, product risk etc.). At the same time, should the company begin to show top-line growth and bottom-line profits, above current expectations, the stock has at least 100% upside from current levels based upon the relative valuations of competitors.

Comments

[DAN]

INCREDIBLE THESIS! solid work......I'll take a look at this and possibly buy 1,000 shares later today........thank you

[Bob Courtney]

Do you think this is the break-out price period? Is Mr. Hart cutting the fat? How has he increased his marketing? Is the last $7.5 mil europe order the tip of iceberg?

I did a number of turn-arounds and if he is cutting costs (dead wood) and hitting the road and increasing sales. This could be a real winner? Feedback please.

Bob Courtney