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Inside Seeks to Broaden Customer Base with Acquisition of AuthenTec Security Unit

France-based chip supplier Inside Secure has agreed to acquire the Embedded Security Solutions unit of U.S.-based AuthenTec, which designs software and hardware products used for digital rights management, virtual private networks and other network security.

Inside hopes the acquisition–for a cash price of up to US$48 million—will help it broaden its customer base and provide a steady stream of licensing and royalty revenue, while also making Inside's new secure element chips for NFC devices more attractive to customers.

Apple is acquiring AuthenTec for a reported $356 million, and the Inside acquisition makes it clear that Apple is not buying AuthenTec for its embedded security products but for its fingerprint sensor products, which are part of AuthenTec’s Smart Sensor Solutions segment. A filing by AuthenTec with the U.S. Securities and Exchange Commission in August confirmed the planned July 26 acquisition by Apple, which would close before the end of the year.

Apple could use the high-end semiconductor-based fingerprint sensors to accurately authenticate users to its devices and perhaps to services, though there is no real evidence yet that Apple wants to combine the technology with NFC to secure mobile payment, as has been previously reported.

Inside’s CEO, Rémy de Tonnac, when asked today by a financial analyst in a conference call why the owner of the Embedded Security Solutions unit would want to sell off a profitable business, declined to comment or even to name the owner. But Inside is likely buying the unit from AuthenTec.

Inside will pay for the acquisition out of its cash on hand, which stood at $103 million at the end of October, according to the company. But de Tonnac insisted the move is not a risky one for Inside, which has struggled with falling revenue and losses, though has enjoyed a stable or growing cash position.

“It is about half of the cash we have, but it is not everyday you get to find this opportunity,” de Tonnac told analysts.

The AuthenTec unit brought in revenue of $25.3 million in 2011 and had operating income of $6.3 million. For the first nine months of 2012, the unit had $21.4 million in revenue and operating income of $6.2 million. According to the company, sales in the unit increased by 55% during the first half of 2012, largely due to an increase in licensing revenue from IP and digital rights management, or DRM, products, royalties for security toolkits, as well as revenue from nonrecurring engineering projects.

De Tonnac noted that about 80% of revenue for Embedded Security Solutions, or ESS, comes from licensing and recurring royalties and maintenance fees.

“(For example), AT&T and Verizon are offering a few million Galaxy S IIIs, and they recommend to Samsung to embed in those units the secure (ESS) toolkit,” said de Tonnac. “Each time Samsung is shipping (a) Galaxy S III to AT&T and Verizon, ESS is getting a few (tens of) cents of royalties.”

AuthenTec supplies DRM software to content providers or networks, such as music or movie distributors, and to device makers or mobile operators or mobile platform providers.

For example, consumers could download an app for their iPhone or Android smartphone from a content provider through an app store, and the app would come with a software-based encryption key secured by AuthenTec technology. The key enables the user to view the content.

AuthenTec also earns revenue from virtual private network, or VPN, software and other network security software used by device makers and network equipment makers. And AuthenTec also licenses security IP to chip makers. The company's customer list for its embedded security unit includes Alcatel-Lucent, Cisco, HBO, LG, Motorola, Nokia, Samsung, Sky and Texas Instruments.

In addition, de Tonnac said the unit’s DRM, VPN and other software could be combined with Inside’s secure elements for NFC phones to offer higher-grade security.

Inside recently introduced its first embedded NFC secure element, which is a smart card chip, offering a tamper-resistant area for storing encryption keys. This would make it more secure than storing the key in software, even with AuthenTec's secure software key storage. Government agencies would demand this higher-level security, de Tonnac said.

“It is clear a government-level of application, a higher level of application, would be willing to implement this solution,” he said. “It is something we could implement and introduce in 2013 and bring to market in 2014,” he told analysts.

Under the terms of the deal, Inside will pay $38 million at closing and up to another $10 million “subject to completion of certain post-closing transactions.” The unit employs 79 people.

Despite the “opportunity” for expanding Inside’s market and offering more recurring revenue, Inside’s shares closed down by a little more than 2% today to €2.39 (US$3.06) on trading in Paris.

While Inside’s shares had been rising this month, following a low of €1.92 the stock price hit last month, the NFC and smart card chip maker’s shares are still sharply down from their post-IPO high early this year of nearly €10.

Inside reported revenue for the first nine months of 2012 came in at $90.8 million, down 15% from a year earlier. NFC chip revenue in the three months ending Sept. 30 reached only a little more than $9 million, down by 41% from a year earlier, though about 8% higher than Q2 2012 NFC revenue. The vendor lost $21.1 million during the first half of the year.

Inside has been trying to break out of its dependence on NFC revenue from BlackBerry-maker Research in Motion. De Tonnac told analysts he hopes to announce a design win or contract before the end of the year for supply of Inside NFC chips to an Android phone maker–a first for the vendor cracking the Android market. It might be a second-source supply, however, with a Chinese phone maker. 

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