On Track Innovations Getting On Track

Aug. 9.06 | About: On Track (OTIV)

Let’s look at OTI - On Track Innovations Ltd. (Nasdaq: OTIV) of Rosh Pina in northern Israel, as a company that is on the right track. Such a company needs help from an investment bank, one that knows the smart card market well and, obviously, all the related markets. However, management must choose an investment bank that understands the task, to help companies like OTI continue growing, rather than one which thinks its primary purpose is find a deal and make a bargain.

Frost & Sullivan, a global leader in business research and consulting, and the leading company in consulting and strategic planning for smart card companies, has chosen OTI as company of the year for the second year in a row. Frost & Sullivan notes the Israeli company’s progress in fields such as wireless-based payment systems, web-based passport issuance and security identification. It defines these as growth areas and OTI as the company leading the growth in them. The company was founded by chairman, president and CEO Oded Bashan in 1990 to provide solutions for smart card applications, a field which everyone agrees is one of the hottest around, even more so in the current era of terrorism and potential theft of classified material.

Despite winning this award, OTI suddenly fell last week, after it was revealed that it failed to win an US government tender for electronic passport production. Apparently the company had already been disqualified once from the tender but managed to convince the US Court of Federal Claims in Washington, D.C. that it had not been disqualified on financial or technological grounds, following which the court duly ordered it to be reinstated in the tender by the US Government Printing Office [GPO]. On Track now says it will take its case back to court since its technology is far superior, so it claims, to that of its competitors. It will seek an order forcing the GPO to reinstate it once more.

Of course, I don’t know whether or not OTI’s technology is better than that of its competitors, but it no doubt has the required technology, since to be selected by Frost & Sullivan as company of the year is no trivial matter. What’s more, most of the companies that bid in the GPO tender and made it to the next stage were also covered by Frost & Sullivan’s research and consulting specialists.

OTI is a relatively small company in a field that is showing an impressively fast rate of growth. In the three years from 2003-2005 it increased its sales from $19 million to more than $35 million, while posting losses of more than $9 million for the second consecutive year. The company’s stock has fallen from $11 in February to less than $9, and has now rallied to $9.50.

Meanwhile, everyone is absorbed with speculation about which company will be next in line to be acquired by one foreign giant or another. Given the potential growth in smart card technologies, OTI is definitely an interesting acquisition target. Of course such a deal would not be on the scale of that of Mercury Interactive Corp. (MERQ), or a possible sale of Comverse Technology Ltd. (Nasdaq: CMVT), for which many learned commentators have already closed a deal unbeknownst to the company’s management.

The battle between leading smart card makers, most of which are European or Asian companies, is fought over the same market segments that OTI is active in. The company apparently has the last word in smart-card technologies, and the only reason that I think it hasn’t been acquired yet is that it’s too small to attract their attention, or maybe because it’s an Israeli company.

Why is OTI’s share falling? There are several reasons. One is related to the smart-card industry as a whole, which has not had a good time on the world’s bourses lately. Dutch-Luxembourg company Gemalto NV, which makes smart-cards and markets them worldwide, for example, has fallen 23% since June. Another reason for OTI’s decline could be its ongoing losses, including in the previous quarter. Although the company’s sales are growing rapidly, its losses are not shrinking; they’re actually increasing. I believe that this is a transition period for the company, and we’ll soon see both sales growth and a switch to profits.

Gamalto, by the way, is the company that beat OTI in the GPO tender. It was created through the merger of Luxembourg Gemplus International SA (Pending:GEMP), founded in 1988, and Dutch Axalto NV, founded in 1979.

It is interesting that smart cards first caught on in Europe, rather than the US. According to Frost & Sullivan, the smart card market will grow 22% a year in the financial sector (mostly credit cards), and 40% in the security and identity authentication sector, mostly because of demand by national security agencies. Frost & Sullivan is a strategic consultant for both companies. The fact that it twice picked OTI as the Company of the Year raises a number of possibilities about it. If the company’s technology is really of such great quality, its large competitors obviously know this, and we’ll see how this story turns out.

Citigroup analyst Lyonel Francoy, who covers the smart-card industry, believes that Gemalto will grow 11% this in the financial sector and 31% in the security sector. He does not think that the market properly understood the Gemplus-Axalto merger or the value of Gemalto’s share. The analysts’ consensus is that the company will post earnings per share of $1.72 in 2007, and is traded at a p/e ratio of 14 for 2007.

The second largest company in the smart card industry is Oberthur Card System of France, which had $600 million in sales in 2005, compared with Gemalto’s $2.2 billion. The analyst claims that the European merger will initiate a campaign of mergers and acquisitions in the smart-card industry similar to the trend in many technology sectors. The leading companies in the smart card sector after Gemalto and Oberthur are Japan’s Hitachi (NYSE: HIT), Germany’s Infineon Technologies (NYSE: IFX), Dutch Royal Philips Electronics (NYSE: PHG), Japan’s NEC Corporation (Nasdaq: NIPNY) and NTT DoCoMo (NYSE: DCM), Swiss STMicroelectronics (NYSE:STM), and France’s Thales. Gemalto and Oberthur’s comes entirely from smart cards, but smart cards comprise only a small part of the other companies’ operations.

Another interesting point about this industry is that, in the US, the smart card companies are IBM Corp. (NYSE: IBM) and Texas Instruments (NYSE: TXN), and the industry’s latest worry is that Chinese manufacturers are starting to try to take it over.

OTI was founded by Bashan and VP products Ronnie Gilboa who came from Electro Galil. 16 years later, on the basis of Frost & Sullivan’s analysis, OTI is definitely on track.

OTIV 1-yr Chart

Published originally by Globes [online], Israel business news - www.globes.co.il
© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.