AuthenTec (AUTH / $8.20):

I will keep this write up on the shorter side, and use the discussion thread to provide updates. I look forward to a productive discussion on the merits of the deal, risk(s), and the trading dynamics.

Price: ~$8.20

Shares outstanding: ~44m

Shares short: ~3mm

Average Trading Volume pre deal: ~1mm/day

Turnover since announcement: ~23mm

Announced Premium: 57.8%

Buyer: Apple (AAPL)

Transaction will be proxy driven timing – mid/late October. 8k Filing/PR indicates Third Calendar quarter

Pre-deal price: ~$5

Event Type: Risk Arbitrage / Competitive Bidding Situation

Duration: ~100-150 days

Trade Recommendation:

• Focus trade: Buy common stock at 8.20
• Consider September Buy Write: long stock sell September 10 calls for 1/10 payout
• Consider Buy Jan 2012 7.50 puts for 5-10c for cheap insurance

Situation Overview:

In an unorthodox deal announcement, Apple and AuthenTec entered into a definitive merger agreement. Apple is paying AUTH shareholders $8 in cash per share. All that was filed was a definitive merger agreement (link below), a minimal FAQ with very unclear answers (pasted below), and voting agreement for a minimal amount of stock vs the threshold required for the deal to be approved by shareholders (link enclosed) and a technology / IP agreement that is a non-exclusive.

First, let’s take a look at the Q&A below. My comments are in bold.

PROJECT BRYCE INVESTOR Q&A

1.              What was announced today?

Apple and AuthenTec have entered into a definitive merger agreement under which Apple will acquire AuthenTec for $8.00 per share. Certain information regarding the transaction can be found in the Form 8-K filed by AuthenTec with the Securities and Exchange Commission on July 27 and additional details will be provided in the proxy statement AuthenTec will file with the Securities and Exchange Commission. Why wasn’t there a standard issue press release and a conference call? No proxy advisor listed? No outside marketing firm involved? My take: Very secretive 8k filing (I know Apple is normally secretive...).

2.              Why is Apple buying AuthenTec?

AuthenTec cannot comment on Apple’s intentions. Normally in a merger of any size the rationale and merits for the deal are discussed. Various deals were announced in the past two weeks. Here are a few different brief examples:

• RailAmerica / Genesee & Wyoming Transaction: Jack Hellmann, President and CEO of GWI commented, “The acquisition of RailAmerica by GWI is a straightforward combination of two organizations with overlapping holding company structures and complementary railroad geographies. As a result, the synergies between the companies are expected to be significant, and we anticipate unlocking significant shareholder value. “In addition, the transaction is transformational for our North American operations, as GWI will now operate 108 railroads over more than 12,000 track miles [see map]. From a commercial standpoint, we believe that this footprint not only provides us with strong leverage to any eventual recovery of the U.S. economy but also creates a powerful platform for future industrial development along railroads in the 37 U.S. states in which we will do business.
• CNOOK / Nexen: Mr. Wang Yilin, Chairman of CNOOC Limited said, "The acquisition reflects our strong belief in Nexen's rich and diverse portfolio of assets and world-class management and employees. This is an exciting opportunity for us to build on our existing joint venture relationship with Nexen in Canada, and to acquire a leading international platform in the process. We strongly believe that this acquisition will create long-term value for CNOOC Limited's shareholders."
• Why didn’t the PR have a paragraph that reads: The transaction is in-line with Apple's strategy of purchasing technology providers to boost its market and product leadership. The acquisition will allow Apple to offer significantly differentiated touch-based features that will further expand its leadership in the space. In addition to being used in network and device security, AuthenTec's fingerprint technology can be used to offer more consumer-centric innovative features integrated touch-based fingerprint sensing for iPhone, iPad, etc., 2) mobile wallet applications using NFC, 3) VPN functionality for iOS to further increase enterprise penetration and 4) DRM capabilities to protect content being shared and distributed across multiple PCs, TVs and mobile devices. The above commentary are from various sell-side research firms detailing what they believe are the merits of the transaction.
• In summary, biometric fingerprint sensors have the opportunity to become an authentication technique on "digital wallet" smartphones that use near-field communication technology to pay for goods wirelessly.
• Market Opportunity: iSuppli projects 545 mln NFC-enabled handsets will ship in 2015 vs. tens of millions in 2011.

3.              As a shareholder of AuthenTec, what will I receive?

Each shareholder of AuthenTec will receive $8.00 for each share of AuthenTec stock that they own, which represents a 56.9% premium to AuthenTec’s closing share price on the day prior to the announcement of the acquisition.

4.              What will happen to AuthenTec’s existing businesses?

Apple will implement its plans for AuthenTec’s businesses after the transaction closes. Is the business to be integrated or is Apple just keeping the IP?

5.              What will happen to AuthenTec’s employees?

AuthenTec cannot speak to Apple’s intentions. In any event, we do not expect any public comment on future plans with respect to employees. Usually there are comments about integration, planning and timing.

6.              When do you expect the acquisition to close?

The acquisition is subject to customary closing conditions, including regulatory approval and AuthenTec shareholder approval. Subject to satisfaction of those conditions, we expect the merger to close in the third calendar quarter of this year. This language is standard, but Apple is clearly assuming there won’t be a second request because of the non-exclusive IP agreement. I will discuss anti-trust below.

7.              Are there any closing conditions?

The deal includes customary closing conditions, including regulatory approval and AuthenTec shareholder approval. Please refer to the merger agreement attached as an exhibit to the Form 8-K filed by AuthenTec with the Securities and Exchange Commission on July 27.

8.              What regulatory approvals are needed?

The acquisition is subject to review under the Hart-Scott-Rodino Antitrust Improvements Act and certain foreign antitrust laws. Additional details will be provided in the proxy statement AuthenTec will file with the Securities and Exchange Commission. Standard timing is 20 days after the filing of the merger agreement, but they don’t qualify.

9.              What does this acquisition mean for existing AuthenTec customers?

AuthenTec’s current customers are encouraged to reach out to their sales representative at AuthenTec. We cannot comment on Apple’s future plans for AuthenTec’s business. This paragraph is from the RA transaction PR: “For our current customers, the combination will only strengthen our ability to offer what has long been the lifeblood of the short line industry: local, flexible, responsive operations with outstanding customer service. For our Class I partners, our commitment to service excellence, the intensity of our local marketing and commercial development, as well as our industry-leading safety record should be powerful long-term drivers of future rail traffic across all of our Class I connections. For our combined employee workforce, we will bring together the best attributes of GWI and RailAmerica to further sharpen business practices across all of our railroads to create an even stronger company for the long term. From a community standpoint, we will continue to embrace our core belief that railroads are uniquely woven into the fabric of the communities where we do business, and we will maintain an open dialogue with government officials and all stakeholders to foster local economic development.

10.           Did AuthenTec hire an investment banker? If so who?

AuthenTec engaged Piper Jaffray & Company. I am sure Piper Jaffray’s fees are much lower than global investment banks like Goldman Sachs, Morgan Stanley, UBS, but if AuthenTec ran a full auction process across the globe why did they select a Minnesota based bank? I know PJC has offices in Silicon Valley and covers the companies from a research perspective, but looking at the PJC transaction list on their website do they really have the resources to do a thorough market check? Perhaps the low break-up fee is the reason…see PJC transaction list here.

http://www.piperjaffray.com/1col.aspx?id=448&category=4&industry=All&focus=N

I am not going to opine on the list of deals, but there are very few TMT transactions, and minimal global powerhouse buyers.

11.           Will management be hired by Apple?

AuthenTec cannot speak to Apple’s intentions. In any event, we do not expect any public comment on future plans with respect to employees. This must be very comforting for the management team. My guess is the deal terms came together quickly and they are negotiating management agreements and post change of control arrangements (non- competes, trade secrets, non solicitation, investor rights, etc  and future cash payments).

Merger Agreement:

8k:

http://www.sec.gov/Archives/edgar/data/1138830/000119312512318086/d384083d8k.htm

Merger Agreement: http://www.sec.gov/Archives/edgar/data/1138830/000119312512318086/d384083dex21.htm

Voting: Agreement: What’s the purpose in having an agreement with 3.4% of holders (directors and officers)? http://www.sec.gov/Archives/edgar/data/1138830/000119312512318086/d384083dex22.htm

IP Agreement:

http://www.sec.gov/Archives/edgar/data/1138830/000119312512318086/d384083dex101.htm

Risks in the Definitive Merger Agreement:

• Anti-trust: there is no real horizontal overlap, but regulators will key in on Apple’s ability to negatively impact competitors and freeze them out. On July 16^th AuthenTec (AUTH) announced that Samsung (SSNLF) has chosen its QuickSec VPN security for use in new Android smartphone and tablet models. I am guessing this is the reason why AAPL signed a non exclusive IP pact.
• The language in the merger agreement regarding anti-trust is also “cautious:”
  • AAPL not required to divest or litigate
  • Reverse break fee of $20mm for failure to receive regulatory approvals
  • Out date automatically extended for 6 months for regulatory purposes
  • Reasonable chance the deal receives a second request, and it would extend the expected close past September. I expect the transaction to close in mid/late October with a pull/refile of HSR.

DMA Language on the MAC should not be an issue:

• MAC Carveouts
• Announcement of deal, including impact on relationships with customers, suppliers, employees or regulators
• General economic or political conditions (including terrorism or war) (not disproportionate)
• General conditions in the industry in which AUTH operates (not disproportionate)
• Changes in GAAP or Law
• Failure to meet internal or analysts’ estimates or projections, in and of itself
• Actions expressly required by this Agreement or with the express written consent of Parent
• Failure to take action as a result of any restrictions or prohibitions expressly set forth in this Agreement with respect to which Parent has refused to provide a waiver in a timely manner or at all
• Changes in the price or trading volume of AUTH (in and of itself)
• Legal Proceedings arising from deal
• Failure of the Company to timely perform its obligations under, any breach or violation by the Company of, any modification, amendment, reformation or termination for any reason of or any failure of Parent to exercise its rights or options contained in that certain (i) Intellectual Property and Technology Agreement or (ii) Development Agreement, in each case, dated as of the date hereof, by and between Parent and the Company, in and of itself; provided, however, that the foregoing shall not limit Parent’s remedies under such agreements with respect to any such failure.

Event Path:

What Probability is the stock current pricing?

I view the shares as either pricing Apple as a risky buyer or the implied probability of a competitive bidding situation is too low. At 8.20 the probability using a lower break price = less than 10%.

The universe of buyers for AUTH is very broad. I believe buyers include Google, Samsung, IBM, DELL, HP, Visa, Mastercard, NXP, Broadcom could have interest. Others that could express interest would be MSFT and RIMM. As an aside, Samsung and Apple continue to fight in various forums to protect and attempt to grow their respective businesses. 

http://www.reuters.com/article/2012/07/30/apple-samsung-trial-idUSL2E8IRB8H20120730

http://www.reuters.com/article/2012/07/28/us-apple-samsung-trial-idUSBRE86Q16X20120728

http://www.reuters.com/article/2012/07/27/us-samsung-earnings-q-idUSBRE86P1VJ20120727

The rationale for any of the above potential buyers is simple: The wider use of smartphones for everyday transactions and work provide AUTH the market opportunity in providing fingerprint sensor technology and VPN solutions. In a nutshell eWallet.

Summary:

AUTH and Apple have entered into a definitive transaction providing shareholders a nice return at $8 per share in cash with a non-exclusive IP agreement, which either removes the competitive bidding optionality or is an anti-trust remedy... However, there are a lot of unanswered questions on whether there was an auction process. Did AUTH have the right advisors in place to run a real global process? Why are the details about the transaction so limited from a PR perspective? Why didn’t the companies provide a detailed FAQ regarding the merits of the transaction and the impact on shareholders, customers, suppliers, and other related parties? For a market growing so quickly with urgency from various market participants, why is AUTH only being sold for ~$350mm. The opportunity for a competitive bidding situation to develop is higher than the current 10% implied probability, and the downside is very limited and should be defined – ~20 cents. What is the upside? No idea, but we have seen technology driven competitive M&A situations like 3PAR get out of hand. I am not suggesting we see multiple bids/kisses, but it would not be unheard of to see a competing offer followed by a kiss by Apple. I am hopeful this will be a dynamic discussion on the thread with productive commentary.