High-tech

Due Diligence: Inside Contactless

Inside Contactless was started by Jacek Kowalski at the back end of 1994 when Gemplus, the company where he worked as the chip design manager, turned down the opportunity to develop their own contactless chip. Kowalski and three of his colleagues, set up Inside Contactless with a dream, and he recalls now that his passion and belief in contactless technology enthused enough of his friends and family to invest the equivalent of €160K without an adequate business plan or strategy to speak of.

Inside Contactless is now a 10-year old post Chilli R4 fabless chip company located in Aix en Provence, near the heart of the smart payment industry, sometimes referred to as ‘smart valley’. Prior to Gemplus, Kowalski was a design manager at a company that merged with ST Microelectronics. The management team of InsideContactless is complemented by Damien LaRoche, vice president of operations, and Bruno Charrat, CTO. The chairman is Remy de Tonnac from one of the investors Vertex Ventures; he had previously worked with Kowalski at Gemplus.

The motivation for starting Inside Contactless was a belief that one day there will be no need for physical contact between smart cards and their readers, thus providing faster, cheaper throughput as well as provide additional applications and deployments.

Vital statistics
Besides the friends and family round of €160K, Kowalski got a bank loan, 600K FF or €100K based on collateral of his Gemplus shares which he later sold back to Gemplus. As one can imagine, at the time it was a very difficult environment for a startup in France, with pressure coming from his ex employee Gemplus, which was threatening his company with lawsuits, and the lack of venture money for tech startups in general. All the chips were stacked against him and he attempted raising money from US based VCs, who were sympathetic, but required that he move his operation to the US before they would contemplate investing in his company.

Eventually he persuaded Bryan Wood from Alta Berkley to invest $50 K in 1995, as a personal investment and use this as leverage to get others to invest. He rose to this challenge and leveraged 4.3million FF or €700K in September 1995 from a large spread of investors. In Jan 1996, after proper due diligence Alta Berkley chipped in with €1.1 million, making an effective Chilli R1 round of €1.8 million with which they developed their first product using Rohm Semiconductors as a foundry. They later switched to Chartered Semiconductor.

Since then Kowalski has never stopped raising money to feed the ever-increasing appetite for cash to build a substantial product and customer base. He has since raised six different chunks of sizeable investments for his company.

We have recalibrated some of this using The Chilli definitions in order to benchmark them against their peers.

In 1998 the company raised the first part of a Chilli R2 round from 3i and GMIV of 10million FF plus 1 million FF loan notes; the second tranche, in which 3i did not participate, was Ł1.3 million 1999, making a total Chilli R2 of €6.5 million. With this funding the company delivered new products which met the international specifications at that time.

A Chilli R3 round was raised in two chunks: in 2001/2002 from Siparex, NIF, Vertex totalling €10 million, and a further R4 of €4million in 2003. We believe that a last mezzanine round of approximately €5million will be required in mid-2005, when the company is expected to break even, followed by a possible exit via IPO or trade sale, depending on market sentiment, in 2006/2007.

As can be expected, after such large infusion of capital, the company has been able to generate revenues since 1999 and is expected to generate €9 million in 2004 and €15 million in 2005. Revenue split is currently 40 percent USA, 40 percent Asia, 20 percent Europe.

We expect that with the higher average selling price and shipment of its processor based products, gross margin is expected to increase substantially from 20 to 43 percent.

The company currently has 56 employees with 20 in R & D and product development, four in sales and marketing and 15 in operation and logistics.

Inside Contactless value proposition
Inside Contactless was formed to specifically address the market for contactless cards. Contactless cards incorporate a printed antenna on the card and works with a separate embedded chip. The card is activated and draws its power from the card readers, without actual physical contact with the reader, hence it is referred to as contactless. InsideContactless’ value has been its deep knowledge, expertise and volume deployments of its technology in real live end-user environments. In its initial phase, InsideContactless designed a fixed function memory only, proprietary contactless solution for both contactless cards and the readers.

Standards galore, but are they standard?
ISO 14443 allows two different methods for communicating called A and B; most card solutions offer either A or B, but not both as it would too expensive. Card readers do not know which card will be presented to it, so will incorporate both A and B. The ISO 15693 standard allows for longer distance reading, over 1 meter at a lower speed, compared to less than 10 cm with the ISO 14443 standard.

Most vendors are stuck with legacy systems and do not like redesigning their chips to make them compatible with all the new and old standards. InsideContactless has the advantage of being focused and a relatively new vendor. It has a chipset called PicoRead which meets most of the required standards. It is based on its R2R (reader to reader) technology which can act as both a reader chip as well as act as a RF tag. The idea is that the RF tags can be incorporated in mobile phones and consumer products so that they can communicate with each other without the need of separate readers.

Patents
The company has over 50 patents covering a broad range, from near field communications NFC to a coil on film which is only 100-µm thick, for chip on film applications in travel documents. InsideContactless has partnered with a local passport issuing company, Fasver, which will use its patented packaging technology, chip on film, for passport /ID applications.

Customers
InsideContactless has been shipping contactless solutions for over six years in various applications and deployments via its reseller and systems integration partners. Notable customers include Honeywell/Omnitek and HID (Hughes). The company has shipped over 8 million units for ID/access applications. Mexico-based system integrators are using its PicoTag product to tag the cars leaving the country to stop import of stolen cars. Beijing Smart Card Company in China is using InsideContactless products for students’ discount cards. The tags are also used for tagging luxury goods by Avio of Japan.

Some of the other notable projects include Singapore Transport Authority, where the company’s products are qualified to work with Sony, and a passport pilot project in Pakistan which could result in a very large future orders.

The Chilli perspective

Markets
Currently the biggest market for contactless cards is in the transportation/transit sector. Security/personal identity is the second biggest application followed by physical access and payments cards.

Transportation
Commuters at major cities around the world have already experienced the benefit of pre-paid tickets in the form of contactless cards, where a few seconds shaved off the ticket gates can make a difference between catching a train and missing it. Most of these transit cards currently use low cost, dumb memory cards. Cards with microprocessor chips that allow multiple applications like payments and loyalty are technically feasible now. On one hand, standalone transit cards with processors are too costly, unless they carry additional applications. On the other hand, trying to get disparate large bureaucratic organisations like transport authorities and banks involved in the food chain to co-operate and work out a common solution remains a formidable goal.

Micropayments are too expensive for card issuers, unless they are paid and collected in large chunks, a process which may face some consumer resistance unless they are forced to pay a minimum amount each time they load the cards. So far pilot trails that encourage commuters to use the cards for additional purchases at kiosks and cafes have had mixed results.

Payment cards
Adding a payments application to transit cards will have to wait a bit longer until the major EMV Eurocard Mastercard VISA based chip and pin rollouts are complete. Once this has been done fairly successfully, banks may be tempted to offer additional services on their cards, like loyalty and contactless payment. Contactless payment cards are currently being trailed by major card vendors like Mastercard and American Express. McDonalds is doing a pilot at some of its stores, to see how often customers use contactless cards.

Security
The best opportunity for contactless smart cards are in security and personal identity, where there are many new Greenfield projects taking place without the need to work with back end legacy systems.

The biggest growth is forecast to be the personal identity/passport sector, as more countries adopt the International Civil Aviation Organization (ICAO) standard for biometric passport and travel documents. The renewed interest in contactless technology is due to its ability to be easily embedded in existing passport size and ease of use at control posts, as well as incorporating security features and biometrics data.

The ICAO has been charged with setting the standards for chip-based passports and travel documents. Although the specs have been agreed around the ISO 14443 interface, recent plugfest trials have shown up incompatibility between different card readers and chip-based passports. This is due to the different interpretation of the specifications by different vendors. InsideContactless has an excellent opportunity to work with systems integrators and other partners in overcoming these hurdles and create a de facto standard around its ISO 14443 implementations on the card as well as the readers.

BOM All contactless card and reader vendors face the same challenges, namely the additional cost of printing the antenna and the cost of the chips themselves. So a few cents shaved off the cost could make a huge difference to their bottom line. InsideContactless claims that it has developed a processor-based chip solution which is one-third the size of competing solutions. This will give it a major cost advantage if it can garner enough partners and systems integrators to produce all the supporting tools, support and training.

Competitors When InsideContactless started out in 1995, it was an early pioneer in the contactless field. As the market has grown to its current size, estimated to be 200 million units, it has attracted major semiconductor players like Philips, Sony and Infineon. In the early days, like InsideContactless, each player had its own proprietary technology.

Philips’ contactless technology, Mifare, is well established in the marketplace, especially in Korea and China, where it has over 50 pilots in the transportation/transit sector. Philips is also a formidable competitor in the transportation sector.

Infineon is investing heavily in contactless technology as it tries to position itself as a leading player in the high growth chip-based biometric passports sector.

Sony has some large-scale deployments in Japan and Asia, with its Felica branded contactless solutions. Texas Instruments and Atmel are also participating in this market. There are some notable exceptions from this market which could be potential acquirers of InsideContactless.

Summary
There is no doubt that contactless is a large volume market, estimated to be in the 200 million unit range. The challenge is not necessarily in the cost of the components, but the total system integration costs, plus investment and time to deploy large installations. This has a direct bearing on its supply chain, especially card and reader vendors who have to tolerate lumpy revenue streams when key projects involving government departments, systems integrators in the security, transportation materialize and mature. InsideContactless has developed a total card reader solution which reduces the overall cost of the system integration, with lower cost readers and cards.

The other major challenge is the sub-dollar, average selling price, so even with millions of card shipments, the revenue growth may not kick in until major large scale projects materialise. Larger companies can easily compensate for this by relying on revenue streams from other product lines. So product diversification may be worth exploring.

The company is at a critical juncture as it is no longer in a startup phase, and thus need to re-assess whether contactless products and applications will be sufficient to meets its strategic financial goals. Although not losing focus on the existing contactless activity, it may be worth considering leveraging the skills and expertise and looking at a new emerging area of RFID, in order to diversify the product portfolio and market sectors. After all this market also requires readers, tags and partnerships with systems integrators and transport operators, so there could be some synergy.

Having survived for so long and going through so many finance rounds, inevitably means that the share ownership structure is not aligned properly to provide the right level of motivation to the executive team and its staff. So investors may want to dig deep in their pocket and re-assess the size of the option pool.

Overall, the company has the right product portfolio to benefit from a high growth market in security/ID/passport applications. The issue is then how long will it be before some of the mega scale projects materialise in large volumes for the company to meet its financial parameters.

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© Chilli Publishing Ltd 2004

17JAN2005