My job and passion is to seek out companies that can not only beat the market, but CRUSH the market’s returns for years to come, and provide a risk/reward scenario that doesn’t put us at a disadvantage when we finally purchase shares.

I believe that not only have I found that company in AuthenTec, but also that AuthenTec’s shares will CRUSH the market going forward on a consistent basis.

My low-ball estimate is that we’ll see returns in AuthenTec in excess of 50% over the next couple of years, with a real possibility of a double in this stock within 1 year.

What follows is a summary of my full research report on AuthenTec and the reasons why you need to own shares RIGHT NOW!

AuthenTec - The Power of Touch

(Nasdaq: AUTH)
By Chris Fernandez, PeakStocks.com

Table Of Contents:

1. Quick Take
2. About The Company
   1. AuthenTec – The Power of Touch
   2. Business Outlook
      1. Where is AuthenTec Headed
      2. Industry Outlook
3. Financial Performance
   1. Selected Financial Data
   2. Margin Trends
   3. Quick Valuation Metrics
4. Why I invested in the company
5. Potential Risks
6. Bottom Line

I. Quick Take

Variables You Should Know:
Risk Rating:	7.5 (Moderate-High)
Position Size:	1/4 (12-17-07), 1/4 (1-17-08)
Buy Around Price:	$13.50 (12-17-07), $13.25 (1-17-08)

(Note: All information is updated through the Q3/2007 (September 31, 2007) reporting period. To get up-to-the-minute reports on AuthenTec, click here.)

Click here to read my full company research report on AuthenTec.

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II. About The Company

AuthenTec – The Power of Touch

Look at your finger. Yea, that’s right, take a look at all those grooves and patterns on it.

No one on earth has that same pattern. What’s more, beneath the outside layer of skin, to where the “live” layer is, lies a unique pattern that identifies you regardless of whether you actually have any visible fingerprints or not!

This is probably one area of technology that you rarely, if ever, think about, but fingerprint security technology is getting better and better with more uses being found for this growing industry in everything from PC’s and home security systems, to cell phones and GPS devices.

I’ve found an exciting and fast-growing company that is the leader in this industry called AuthenTec (Nasdaq: AUTH).

How do AuthenTec fingerprint sensors work?

AuthenTec sensors use a unique semiconductor-based fingerprint reader that uses small RF (Radio Frequency) signals to detect the fingerprint ridge and valley pattern, thus capturing sharp and clear fingerprint patterns from the live layer of skin just beneath the surface.

The RF electronic imaging mechanism, called TruePrint technology, makes AuthenTec’s sensors less affected by common skin surface conditions — including dry, worn, calloused, dirty or oily skin — that can impair the ability of other sensors to acquire accurate fingerprint images.

This approach, which is in marked contrast with optical, thermal and DC capacitive solutions that read the surface of the skin, gives AuthenTec sensors significant advantages in image quality and in the protective coatings that the sensor can image through.

AuthenTec’s patented TruePrint technology sensors are the ONLY sensors on the market that read this live layer of skin beneath the actual surface!

Oh, and in case you were wondering, because I know some of you are, you CANNOT cut someone’s finger off and swipe it through one of AuthenTec’s sensors like in the movies!

Specifically, TrueFinger — part of the TruePrint technology - ensures that only real, live fingerprints are read by converting the properties of the skin into digital data which are delivered to the host computer for analysis.

Because of this approach, anyone who attempts to swipe the finger of a dead person in order to access their important physical or intellectual data would not succeed in getting past TruePrint.

Now that that’s out of the way…

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The Power of Touch

AuthenTec’s TruePrint technology was first developed in 1998 and has been getting better, cheaper and more reliable ever since.

As you can see from the image above, all of the sensors are about the size of a dime, or much smaller and are found in a range of devices.

The best part is that TruePrint sensors are more accurate than traditional fingerprint sensors because they actually scan beneath the surface of the skin, rather than just looking at the surface.

AuthenTec uses a fabless business model whereby manufacturing requirements are outsourced to third parties. This means that AuthenTec doesn’t actually manufacture their own chips and sensors, but contracts their production out to 3rd parties, which greatly reduces their overhead and increases their margins.

While there are several types of silicon-based fingerprint sensors on the market today, including surface-reading sensors that use either the electrical or thermal properties of the skin surface to detect the fingerprint ridge and valley pattern, AuthenTec sensors are the only silicon sensors that read beneath the skin surface.

Because of this innovative approach, AuthenTec’s TruePrint technology offers many benefits, including the most accurate and reliable imaging available today.

Over 25 million sold

AuthenTec recently announced that they had shipped over 15 million of their fingerprint sensors in the past 16 months, compared to 10 million sensors shipped since the Company’s founding in 1998.

AuthenTec’s growth has been accelerating rapidly in the last 6-12 months, and I believe the market opportunity for their sensors is only just beginning.

By now you’re probably wondering in what sorts of devices you can find AuthenTec’s products right?

While AuthenTec’s applications for their sensors are growing, they come in 3 primary segments as outlined below: PC’s and Peripheral devices, Wireless Devices, and Access Control.

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Sensors for PC’s and Peripheral Devices

In the PC market, fingerprint biometrics has emerged as the most popular biometric technology to protect critical computer information, enable convenient security and ensure convenience and personalization.

AuthenTec sensors are used in 200 different models of notebook and tablet PCs, including those made by 10 of the world’s top PC manufacturers.

Their sensors have also been used in a wide range of peripherals devices, including PC keyboards, memory keys, portable hard drives, and password managers.

Some of their customers for the PC’s and Peripherals segment include: Acer, LG, Samsung, Motorola, Lenovo, HP among others.

Sensors for Wireless Devices

In wireless devices, AuthenTec sensors are used in more than 95 percent of all biometric cell phone models to protect the physical device, stored files and secure mobile commerce transactions.

As the demands of the wireless market continue to grow, service providers are introducing new and more powerful wireless devices — making wireless platforms even more valuable – and vulnerable to fraud or theft.

By installing a simple, small and discreet sensor on a phone, AuthenTec can protect the data inside from being pilfered and not detract from the phone’s functionality, usefulness or aesthetics.

In fact, by incorporating this technology on more and more phones, especially those used in business settings or to conduct business (think smart phones, etc.), AuthenTec can tap an ever growing market here and abroad and expand the ubiquity of fingerprint technology where people need it the most.

Some of their customers in the Wireless Devices segment include: Casio, Fujitsu, Hitachi, Samsung among others.

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Sensors for Access Control

In access control, AuthenTec’s sensors are used worldwide to protect homes, corporate buildings, government offices, airports, and other facilities.

Their sensors have been designed into a wide range of access control devices, including multiple biometric door locks, smart cards, remote RF entry keys, time and attendance readers, and other devices.

In addition, their sensors are also used in the U.S. government’s largest biometrics implementation for the U.S. Census Bureau whereby 500,000 fingerprint sensor-equipped PDAs will be used to gather information for the 2010 census.

You can see where this segment can go in terms of growth, as every house in America and around the world can implement these biometric readers for added security, convenience and aesthetics on anything from front doors, to gates, light switches, you-name-it.

Some of their customers for the Access Control segment include: Black and Decker, Biometrx among others.

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Business Outlook

AuthenTec makes money by selling their products to original equipment manufacturers, or OEMs, original design manufacturers, or ODMs, and contract manufacturers.

These manufacturers in turn, implement AuthenTec’s sensors into their products in a wide range of devices and sell them to other manufacturers, or directly to the public as finished products.

Product Lead Time

The products that were described above, such as cell phones, PC’s and peripherals, take a significant amount of time to produce and implement with AuthenTec’s technology.

AuthenTec’s sales cycle begins with their marketing, sales staff and application engineers engaging with customers’ system designers and management, which is typically a multi-month, or even multi-year process. In fact, some of AuthenTec’s customers may need as much as 3 years from initial contact to actually making a purchase of AuthenTec’s sensors.

If they are successful, a customer will decide to incorporate AuthenTec’s solution in its product, but because the sales cycles for their products are long, AuthenTec incurs expenses to develop and sell their products, regardless of whether they achieve a design-win and well in advance of generating revenue, if any, from those expenditures.

AuthenTec does not have long-term purchase commitments from any of their customers, as sales of their products are generally made under individual purchase orders.

However, once one of their products is incorporated into a customer’s design, it is likely to remain in that product for a long time because of that same lead-time.

Consider this process like when a car manufacturer designs a new model car. It takes years of planning, development, testing, etc., before that car ever hits the market. But once it does, you can bet that that model will be around for years to come with only slight changes in its design because of all the up-front expenses.

AuthenTec has experienced revenue growth due to an increase in the number of products offered, an expansion of their customer base, an increase in the number of design-wins within any one customer and an increase in the average revenue per design-win.

Also, as stated before, AuthenTec does not own or operate their own production semiconductor fabrication, wafer bumping, assembly or test facilities and by outsourcing manufacturing, they are able to avoid the cost associated with owning and operating their own manufacturing facility and take advantage of the scale of operations these third parties provide.

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Where is AuthenTec Headed?

AuthenTec operates in a rapidly growing marketplace that is predominately located overseas, and specifically in Asia.

In looking at the AuthenTec story, one must first start with their growing, but highly concentrated customer and regional base.

Outlined below is a table that will help you understand this distribution, and the trends associated with AuthenTec’s sales over the last few years.

Sales To Overseas/Major Customers:

_{*Less than 10%
(1) ODMs which supply Hewlett-Packard Company, among others.
²Through Q3/2007
³Through Q1/2007}

As you can see, AuthenTec’s sales are primarily concentrated overseas, specifically in Japan and Asia. The U.S, Canada, and Europe account for a very small amount of total sales.Of course, early adopters of new technology are always found in Asian markets.

Think about cameras in cell phones about 5 years or so ago. It was unheard of to have a cell phone with a camera in the U.S. at that time, now every cell phone has a camera in it!

I believe that same market dynamic is at play, and the growth potential for AuthenTec’s products in other markets is extremely large and growing rapidly.

Also, as illustrated in the table, AuthenTec has a very concentrated customer base. This is not something you like to see, but is inevitable with a small rapidly growing company like AuthenTec that produces a niche product.

The good news is that AuthenTec has been diversifying their revenue stream over the last several years to more and more customers, and as they grow, this trend will continue, which will give them more of a buffer if they lose a large customer.

Just think of the possibilities for fingerprint sensors:

• GPS devices: of which AuthenTec’s sensor was just installed in the first commercially available model in Europe.
• Automotive applications: Things like entry systems on doors or key fobs, ignition systems, etc.
• Other access control devices: Any door, gate, lighting system, etc., can install AuthenTec’s sensors.
• Personal Devices: Sensitive data like hard drives, flash memory cards, etc., can all contain AuthenTec’s sensors, and in fact some already do.
• Payment Gateways: Already in Japan there is a fast growing market for payment called M-Commerce, or Mobile Commerce. See “Market Trends” below for more information on this.
• Any other of a myriad of applications. Things that I can’t even think about yet that are practical and feasible. Use your imagination and the possibilities are endless.

As a result of AuthenTec’s current products as well as yet-unknown products, I believe we are on the cusp of a growing, and just-turned-profitable business that can be a core holding for years to come based on not just what they are currently doing, but more for what they can and will do.

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Industry Outlook

The market for biometric sensors is growing rapidly.

As more and more people put sensitive data onto laptops, cell phones, PDA’s and other personal devises, the need for a better and more efficient means to protect that data is growing and in high demand. Forget about simple stuff like passwords, consumers are looking for a more robust and high-tech way to protect their data, their homes and to make life easier.

This doesn’t even include markets that already rely heavily on authentication devices such as banks, government buildings and facilities, the military and private sector businesses looking to protect their data and the integrity of their businesses.

In 2006, businesses and consumers lost approximately $49.3 billion to identity theft, according to Javelin Strategy and Research.

In addition, the Ponemon Institute found that nearly 81% of 500 companies surveyed in August 2006 reported losing one or more laptops with sensitive information.

As the need for password systems in businesses increases, the management of such systems becomes continuously more expensive in terms of real costs and lost productivity.

Above and beyond this data, AuthenTec is poised to take advantage of a growing trend in Japan and elsewhere called M-commerce, or mobile commerce, where customers can pay for transactions using their cell phones. AuthenTec estimated that over 15% of M-Commerce enabled cell phones shipped in Japan in 2006 included a fingerprint sensor.

Specifically, AuthenTec is targeting the following markets:

• PC’s: The PC market, particularly laptops, currently represents the largest market segment using fingerprint sensors. According to IDC, a leading market research and analysis firm, approximately 82 million laptops were shipped worldwide in 2006. Of this amount, AuthenTec believes approximately 10% of laptops shipped in 2006 had an integrated sensor.

Laptop shipments are expected to grow at a compounded annual growth rate, or CAGR, of approximately 17.2% from 2006 to 2010.

In addition, the desktop and PC peripheral markets also represent significant market opportunities for AuthenTec’s products.

AuthenTec estimates these two markets represent over 500 million units shipped in 2006.

• Wireless Devices: AuthenTec believes the integration of fingerprint sensors into wireless devices is in its early stages and will accelerate consistent with the adoption rates of other wireless device features that first found acceptance in the Japanese market such as camera functionality, internet access and mobile television.

According to IDC, over 1.0 billion wireless devices were shipped worldwide in 2006, and this market is expected to grow at a CAGR of approximately 6.9% from 2006 to 2010.

AuthenTec believes the demand for their products will grow as M-commerce expands globally with the use of wireless devices as a means of commerce. M-commerce is a well-established means of executing financial transactions in certain countries such as Japan.

Consumers embrace M-commerce because of its convenience and security advantages while service providers and credit card companies value the revenue opportunities it creates.

According to ABI Research, nearly 30% of the phones shipped worldwide by 2011 are expected to be M-commerce enabled.

• Access Control: While physical access control presently represents the smallest of AuthenTec’s three markets, the adoption of fingerprint sensors in this market is being driven by the desire to replace or complement traditional access methods including keys and keycards.

According to Frost & Sullivan, a leading business research and consulting firm, the electronic access control market generated estimated revenue of approximately $4.3 billion in 2006 and is expected to reach $6.0 billion in 2010, a CAGR of 8.7%.

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Fingerprint Biometrics Market

According to AuthenTec’s Prospectus:

“The silicon fingerprint sensor market is a sub-segment of the global biometrics market and includes sensors based on various technologies of varying capabilities, size and cost. Although still in its early stages, the market is growing rapidly. According to Frost and Sullivan, the overall silicon fingerprint sensor market is expected to grow from 2006 at a CAGR of 50.6% to $2.0 billion by 2013. Growth in the fingerprint sensor market is being driven by a variety of factors including:

• heightened awareness of the need for security;
• demand for enhanced security as PCs and wireless devices continue to store additional sensitive data;
• proliferation of portable electronics;
• inadequacies and/or expense associated with various security solutions;
• growth in E- and M-commerce;
• need for small and cost-effective solutions catering to high volume end markets; and
• desire for additional functionality such as navigation and personalization features.

The silicon fingerprint sensor market, the market in which we operate, comprises two different types of products: touch and swipe sensors. Touch, or area, sensors are generally larger and more costly than swipe sensors. Users of touch sensors place their finger on the sensor. Swipe sensors are generally smaller and less costly and involve the user swiping their finger across the sensor. Swipe sensors have become the more dominant form factor over the past few years and now represent a significant majority of sensors shipped.”

As you can see, the potential market for AuthenTec is very large.

I did some number crunching and came up with the following for their growth potential:

25.3% of the overall biometric sensor market is fingerprint sensors. This year that’s expected to reach about $3 billion dollars, so that equates to about $759 million in gross sales for the fingerprint market.

By 2012, this market will grow to about $1.85 billion.

Right now AuthenTec has about 6.8% of the market share if you go by total sales figures alone.

If we take that out for the next 5 years, AuthenTec will get about $125 million in sales from this segment alone, assuming no gain in market share, representing a 20% CAGR. Not bad for a small company.

However, I believe as AuthenTec enters new markets and expands their business and takes more market share, this figure will be at least double, representing a huge upside potential for AuthenTec’s shares at their current price.

This is the next great market in terms of adoption for value-added convenience to personal electronic devices such as cell phones, laptops and other devices where a quick swipe of a finger would add an extra layer of protection to your device and data, without increasing the overall cost by much.

In addition, these devices are becoming cheaper and more mainstream and it won’t be long before we see AuthenTec’s fingerprint technology in every walk of life, from not only PC’s and cell phones, but also in things that perhaps are in the works or we might look to in the future such as unlocking car doors (or even starting the engine), various remote control devices like TV remotes, garage door openers and the like, and a multitude of other applications that I haven’t even thought of or are underway as we speak.

In fact, AuthenTec is the recognized volume supplier leader of biometric fingerprint sensors worldwide — shipping nearly two thirds of all sensors sold in the PC, wireless and access control markets during the past five years.

The company continues to win new designs with the world’s Top 10 PC manufacturers as its fingerprint sensors have now been integrated into more than 200 PC models.

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III. Financial Performance

Selected Financial Data

AuthenTec is a rapidly growing business that has never been profitable for an entire fiscal year, although they just had their first profitable quarter in their latest reporting period of Q3, 2007.

Let’s take a look at the growth trends and overall financial performance within AuthenTec‘s business over the last 3 years, with 2008 estimates where applicable.

Sales/Income/EPS/Growth Table: 3-Year Comparison, 1-Year Estimate: (In Millions, except EPS):

_{*Analysts Estimates
¹Through Q3/2007}

Sales growth has been robust, with a strong acceleration from 2005 – 2006. I think that the estimates for next year are overly conservative, but we’ll go with them for now.

Either way you slice it, AuthenTec is kicking some butt in terms of top line growth, and finally, bottom line growth in terms of profits as evidenced by their expected almost break-even year this year, and $.19 profit next year.

Also, note that diluted shares increased exponentially because of their IPO.

Here are the highlights from their latest earnings announcement on October 29th, 2007:

Year-Over-Year Quarterly Sales/Income/EPS/Growth Comparison Table (In Millions, except EPS):

_{(Note: All figures are in millions, except for EPS)}

Revenue for the third quarter of 2007 was a record $15.1 million, representing an increase of 84 percent when compared to $8.2 million in the third quarter of 2006 and an increase of 23 percent as compared with revenue of $12.3 million in the second quarter of 2007, which was amazing sequential growth from quarter to quarter.

AuthenTec also had their first profitable quarter ever, earning Under Generally Accepted Accounting Principles (GAAP), $517,000, or $0.02 per diluted share.

Since they weren’t public for the comparison quarters, obviously there is a large discrepancy in the earnings per share. From here on out though, the comparisons will be using roughly the same number of diluted shares.

Operating cash flow during the quarter was $2.0 million and cash, cash equivalents and investments totaled $67.0 million as of September 28, 2007. The company has NO debt, and in fact added $2 million to their coffers in this latest earnings period, again, wonderful stuff.

Furthermore, AuthenTec raised their guidance for the 4th quarter this year (which I think they will handily beat).

So what else can I say? Nothing.

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Margin Trends

Looking at a company’s margins is critical to understanding their past performance and future prospects. Usually, businesses start out with smaller margins and they expand over time as the business becomes more efficient, and scales.

3-Year Margin Trends and Outlook Table:

_{*Through first 3 Quarters of 2007}

As you can easily tell from this table, AuthenTec has been scaling their business, and getting closer and closer to turning a profit. In their latest quarter they finally were able to turn a profit, much sooner than anyone thought, and it’s just going to get better and better from here.

Now let’s take a look at AuthenTec’s last 6 quarter margin trends.

Last 6-Quarter Margin Trends:

Look at the steady ramp up of all three margins: Gross, Operating, and Net. Also note that their last quarter led to the first positive net margin in their operating history.These trends show a strengthening business that is poised for further growth and margin improvement. Any addition to their top line, will start dropping a bigger and bigger chunk to their profit.

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Quick Valuation Metrics

(Note: Valuation metrics calculated using $14.00 share price. Please adjust accordingly. See the “More Detailed Business Trends and Outlook” section in the AuthenTec research report for a more detailed valuation breakdown.)

Because we are at a disadvantage (or extreme advantage depending on how you want to look at it!) when trying to pin down a valuation for AuthenTec, using traditional valuation techniques is difficult and an exercise in art more than science.

Let’s start with the Discounted Cash Flow Analysis (DCF):

DCF is often called the king of all valuation metrics because it measures a company’s actual ability to generate cash from operations, and in the end, that’s all that really matters.

When using this modeling, I typically account for 3 scenarios:

1. The best-case scenario: This scenario typically assumes the highest growth rates, margins and cash flow, and also assumes the lowest volatility, tax rate, debt levels, etc. for the company you are analyzing.
2. A middle scenario which is the most likely, with moderate assumptions on growth rates, margins, cash-flow, volatility, tax rates, debt levels, etc.
3. The worst-case scenario: This scenario typically assumes the lowest growth rates and margins, and also assumes the highest volatility, tax rate, etc. for the company you are analyzing.

Using a modified DCF analysis, here’s what I get under these 3 different scenarios:

• Best Case Scenario: AuthenTec’s shares are valued at anywhere from $22.50 - $45.00 per share ($33.75 average)
• Middle Scenario: AuthenTec’s shares are valued at anywhere from $15.00 - $30.00 per share. ($22.50 average)
• Worst-Case Scenario: AuthenTec’s shares are valued at anywhere from $10.00 - $18.50 per share ($14.25 average)

So using this measure of valuing a company, I get an average share price range from: $14.25 - $33.75, taking the midline of each scenario.

With AuthenTec’s shares trading at about $14.00 as of this writing, even under the worst-case scenario (and with some horrible growth numbers in there that are below what AuthenTec is tracking for next year) shares are way undervalued.

More to the point, I believe the midline model is most accurate because it is conservative, while being realistic with growth rates and assumptions made about acquisitions and organic growth.

Using this metric, AuthenTec’s share value is trading way below its intrinsic value of about $24.00 per share.

Now, of course, DCF can’t be used on it’s own, especially in light of the fact that AuthenTec has no track record for profitability, and needs to be used along with other measures of value, so to that end, I have detailed some more valuation metrics below that are more traditional.

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Price to Sales Ratio (P/S):

AuthenTec’s market cap (total shares outstanding times the share price) is about $380 million dollars. At this level the valuation of the company represents a price-to-sales ratio (their market cap divided by their total sales) of about 8.27, based on trailing sales.

The FORWARD (P/S) ratio for the next 4 quarters stands at about:

$380 million market cap / $66.2 million in sales (according to analysts estimates) = 5.74

The average price to sales ratio in their industry is about 4, so they are trading at about a 43% premium to the average company in their industry.

Considering they are expecting growth of about 50% or more for the next year or so, while the average company in their industry is growing at about 15%, and their closest rival Atmel Corp (Nasdaq: ATML) is expected to grow about 7% next year, AuthenTec is trading at a nice discount to their peers, because AuthenTec is growing over 3 times faster than their industry, and over 7 times faster than their closest rival, Atmel!

Also, consider that AuthenTec beat sales estimates for this past quarter by about 12%, so if we say that analysts are wrong and underestimating the future sales potential over the next 4 quarters by about 10% (they also raised estimates), then that would make the total sales be closer to $72.82 million, which would yield a P/S ratio of:

$380 million/$72.82 million in sales = 5.21

This is getting even better, at about a 30% premium to their peers.

AuthenTec deserves a much higher premium than that, closer to 60% or more above their closest rivals.

Bottom Line: Fast growing companies always deserve a higher multiple than slower growing companies. I believe that AuthenTec’s shares are trading at a discount to this growth using the P/S metric by about 60-80%.

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Price to Earnings ratio (P/E)

Analysts are pegging AuthenTec’s earnings to be about $.19 per share in 2008 and $.41 per share in 2009, which I feel are both extremely conservative numbers.

Remember, you pay for the future of a company, not the past, so let’s look at those numbers:

At $.19 per share in earnings next year (2008) using $14.00 per share, their P/E ratio (The Price of the shares divided by the expected Earnings per share) would be about 73.68.

At $.41 per share in earnings in 2009, their forward P/E ratio would be about 34.16.

The industry average is 23.58, while their closest rival Atmel’s P/E ratio on a trailing basis was negative, and is expected to be about 35.5 for this year.

Using this metric, AuthenTec looks overvalued and rich, but again, a fast growing company (the average growth in their industry is about 15%) deserves to be valued higher, and remember that AuthenTec just became profitable, so a basic P/E ratio is almost useless until a few years down the line.

In addition, these numbers can change because AuthenTec has BEATEN analysts estimates their first 2 quarters as a public company, by $.03 each time.

If they beat estimates by $.02 per quarter (taking a more conservative estimate) over the next 8 quarters on average, then the forward P/E ratios change to 51.85 (assuming $.27 per share in ‘08), and 24.56 (assuming $.57 per share in ‘09).

This makes their shares look much more reasonable, but that far out there is way more risk of them missing earnings (which will hammer the stock price) or some other business event happening (not to mention a slow-down in the business itself), that would bring these estimates into question.

Bottom Line: Using traditional P/E ratio metrics, while useful for more mature businesses, are not as beneficial to us in measuring AuthenTec’s true scale and eventual profitability at this time.

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Price to Earnings Divided by Growth (PEG):

The last number that I would like to use is what’s called the PEG multiple.

This takes into account the Price to Earnings (P/E), divided by the growth in percentage terms. So if a company has a forward P/E of 60, and they are growing their earnings by 60% per year, then their PEG ratio is 1.

A good measuring stick to use for risk/reward ramifications, is to look for a forward PEG with some downside protection, so anything around 1 or less is usually considered less risky (although there already is plenty of risk involved when looking that far out ahead, which is why you want a lower PEG multiple and not a higher one).

In 2008 analysts expect AuthenTec’s earnings to grow to $.19 per share over a loss this year (2007) of about -$.03.

Assuming AuthenTec earns -$.03 this year and grow to $.19 next year, this would yield a growth rate of over 700%. Taking the forward P/E ratios from above, we get:

PEG (2008) = (73.68/700) = .105

Obviously this number is ridiculous and is not justifiable because since AuthenTec just started earning a profit, these sorts of metrics are way out of whack. This is why these kinds of companies are extremely hard to value in their early stages (and why we can profit from this discrepancy).

So, for the sake of argument, let’s then take the more sane measurement of the ‘08 vs. the ‘09 numbers.

In this case we get the predicted earnings growth from fiscal year 2008 to fiscal 2009 as:

Expected earnings in 2008 = $.19

Expected earnings in 2009 = $.41

———————————————

Difference in earnings = ($.41 - $.19) = $.22

Earnings growth = (Difference in earnings) $.22/(Previous year’s earnings) $.19 = 115% growth

So, the forward PEG for 2009 is: (P/E for 2009, calculated earlier) 34.16/ 115% growth = .297 PEG

This again, is extremely low.

Like I said, anything around 1 (sometimes for really fast growing companies, ahem, like this one, you might pay up to 1.5 PEG), and certainly anything UNDER 1 is a steal.

However, here’s the catch: when using the PEG ratio, the calculation is usually taken out for 3-5 years. In other words, sure AuthenTec’s growth is absolutely stunning when looked at what COULD happen over the next 2 years or so, but what happens after that when year over year comparisons are harder to make?

Well, if we look at the analyst’s expectations for this company (and to be honest I think they are conservative), they are giving AuthenTec a forward growth estimate of 35%.

That changes things. Now the calculation above looks like this:

Forward PEG for 2009 is: (P/E for 2009, calculated earlier) 34.16/ 35% growth (according to analysts 3-5 year growth estimates) = .976 PEG

This gives us more information to look at to better understand valuation, and when to pull the trigger on a trade to minimize downside risk and maximize upside potential, otherwise known as the RISK/REWARD, and something I look at very carefully and take very seriously here at PeakStocks.com.

But even with this multiple, AuthenTec still looks way undervalued.

Bottom Line: Using the PEG multiple valuation metric, while flawed, gives us a better indication of AuthenTec’s potential, and its valuation. I believe that using this metric, AuthenTec is undervalued by at least 50% or more, which could prove conservative if they beat estimates again, and raise future guidance.

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IV. Why I Invested In the Company

• Amazing Technology: We already talked about what makes AuthenTec an amazing company and the technology that they are bringing to market, but it bears repeating that all great investments start, at their core, with a fundamental understanding and belief that that core technology can penetrate on a mass-market scale, and yea, even potentially change the way we do things.

As far as AuthenTec is concerned, that technology deals with improving security, safety and privacy. Who wouldn’t want to improve those areas of their lives with little additional cost and with the added convenience that a simple fingerprint sensor can add?

I believe this trend will accelerate going forward, and we’ll see more and more of AuthenTec’s proprietary, patent-protected fingerprint sensors in more and more devices and eventually, these sensors will receive mainstream adoption and AuthenTec will be the beneficiary.

• Huge Growth In an Expanding and Rapidly Developing Market: As the data above shows, the market for authentication services, and specifically for biometric sensors is growing rapidly. With over 20%+ CAGR for biometric sensors, and specifically, over 50% CAGR for fingerprint sensors, we are at the beginning of this technological advancement.

On top of this, most of AuthenTec’s sales are to overseas and specifically, Asian markets.

I believe as their fingerprint sensors become more accepted in the U.S. and Europe, AuthenTec will greatly expand their potential market and penetration and along with AuthenTec’s products and proven track record, should ensure them increasing market penetration, market share gains and protracted dominance for years to come.

• New Company on the Precipice of Fundamental Breakout: If you paid attention to the valuation metrics, margin trends and other financial data provided above, it doesn’t take long to see that not only is AuthenTec trending higher in every major fundamental and valuation-wise way, but they are also gaining steam in ways that will lead to undervaluation by analysts. That includes increasing profit margins, net income, cash flow, etc.

I believe that analyst’s estimates are incorrect for the next 2 years, and as these expectations get shattered, AuthenTec’s shares will trade much higher than they are today.

Let me put it this way: Even if analysts are dead on in their predictions for AuthenTec for the next few years, shares are STILL undervalued at today’s levels!

Now how often do you get to say that about any company, let alone a company that just came public, has a large market opportunity with amazing growth prospects, and is in the early innings of that cycle?

Don’t say I didn’t warn you!

• High Margin Business: Because AuthenTec uses a fabless production model, their costs are contained and their visibility and margins are more stable and higher than other semiconductor companies.

Although margins might fluctuate slightly from quarter to quarter because of various start-up costs associated with a new line of chips, a new manufacturing process, etc., once those lines are up to speed, AuthenTec and their 3rd party manufacturers can begin to really ramp up production, squeeze more and more profit out of each chip, and really begin to expand their margin prospects.

Going fabless was a great move for AuthenTec.

• Multiple revenue streams: This is lower on the list for the mere fact that AuthenTec produces essentially one product: fingerprint sensors.

However, it should be noted, that these sensors can be installed into any number of devices.

Right now their primary market is PC’s and cell phones, but as this technology trickles down to other potential applications, it won’t be long before AuthenTec’s fingerprint sensors are being installed in more and more consumer products, and therefore, AuthenTec’s revenue stream will become more diversified, less cyclical and seasonal, and protect them from any potential customer losses in any one sector or market.

• Co-Founder CEO With Large Stake: Scott Moody is the co-founder and CEO of AuthenTec and has been at the helm since 1998. He owns over 5% of the company, which is a very large stake for this type of business because of the venture capital needed to start operations and bring the company to profitability.

In addition, shortly after AuthenTec came public, when shares were trading around $10-11, Mr. Moody bought even more shares on the open market!

I like to see that sort of confidence in your business, and the visibility that it shows for improving market trends and business fundamentals.

• Insider lock-up period has expired: The insider lock-up expiration has come and gone, and so far, no one is selling!

There have been a few minor sales, but those have come from original investment firms, such as Harris Corp., which is a public company, with personal ties to Mr. Moody and AuthenTec.

Other than that, there hasn’t been a peep from anyone else - no insiders, directors, management, etc.

Ask yourself this: Why haven’t they sold their shares yet? Especially if they’ve held shares for years waiting for the IPO so that they could make a little money for the time and efforts they put into creating and running the business all these years?

Quite simply, it’s because they see much better times ahead, and are holding their shares because they know AuthenTec is going higher.

I agree with them.

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V. Potential Risks

• Impending Litigation with Atmel Corp: On March 22, 2006, Atmel Corporation filed a complaint against AuthenTec alleging that their fingerprint sensors infringe an Atmel patent.

The complaint was amended on November 1, 2006 to add certain Atmel affiliates as plaintiffs, as well as an allegation that AuthenTec is infringing a second patent.

The second complaint alleges that AuthenTec’s fingerprint image software infringes Atmel’s patent. Atmel is seeking a preliminary and permanent injunction as well as damages in the case.

AuthenTec has in turn filed a counterclaim challenging the validity of the patents and seeking a judgment of non-infringement. The case is in the discovery phase with patent claim construction hearings likely to be held in the second quarter of 2008.

At December 29, 2006, AuthenTec accrued the future estimated costs associated with defending this lawsuit in the amount of approximately $2,781,000.

I don’t have to tell you what would happen if AuthenTec either loses this case, or gets some type of injunction thrown at them as a result of it, or has to settle in an unsatisfactory manner. AuthenTec states that they believe they have done nothing wrong and aren’t infringing on anything, but what else are they going to say? We’ll have to hang tight and see how this plays out.

From what I read and understand, these types of legal proceedings are not uncommon in the semiconductor industry, but nevertheless, this is a potentially large case since AuthenTec’s entire business rests on one product that is now being challenged.

• AuthenTec’s Reliance on Only One Product: I’ve said it once and I’ll say it again: AuthenTec only sells one product, fingerprint sensors.

This is a huge risk if this market doesn’t grow as expected, they lose key customers, or more competitors enter the market unexpectedly.

Although AuthenTec is well protected because of their patents and current market penetration and dominance, any company that relies on one product is a very risky proposition until they have demonstrated consistent dominance in that one market or a more consistent track record.

• AuthenTec’s Reliance on a Few Customers for over 80% of their Revenue: As previously discussed, AuthenTec relies on only a few customers for a large portion of their overall revenue.

Now, while this has been trending better lately, and should get better as AuthenTec grows larger and expands their business, for right now and for the foreseeable future, if AuthenTec loses any of these significant customers, their revenue will be impacted in a negative way on a large scale.

• AuthenTec’s Reliance on Customers Outside of the U.S. for Over 96.5% of Their Business: As previously discussed, AuthenTec gets that majority of their sales from customers in the Asian and Japanese markets.

This isn’t a big risk factor to me, as those markets are typically first adopters, and it means that there is a huge market opportunity in both the U.S. and Europe for AuthenTec going forward, but it is something that you should be aware of.

• Potential Security Breaches: Because AuthenTec’s sensors are used to protect sensitive data in cell phones, PC’s and access markets like garage door openers and security gates, I don’t have to tell you how important it is that AuthenTec’s sensors actually WORK and not allow an intruder to falsely get access to an area or to data that was protected by an AuthenTec sensor.

If they do, the potential negative publicity or backlash and potential manufacturer distrust in AuthenTec’s products can be a huge problem going forward.

• Potential Lumpiness from Quarter to Quarter: As AuthenTec’s sales grow, there may be more lumpiness in their results from quarter to quarter because of various factors that are out of their control such as: new customer and product wins, timing of orders from customers, variability in margins because of product mix, variability of expenses, seasonality and general economic conditions.

Now, while we don’t care a whole lot about fluctuations in a business from quarter to quarter so long as the long-term story remains on track, the market certainly will. As a result, expect potentially large fluctuations in AuthenTec’s share price if they ever “disappoint” the Street in any one-quarter’s earnings release as a result of one-time fluctuations because of some of the factors mentioned above.

• Insider Lock-Up Period Expired: The insider lock-up period for selling shares of stock in AuthenTec expired December 23rd 2007. While this could be a contributor to the stock’s recent decline (good for us!), it hasn’t seemed to be a major factor up to this point.

In fact, as recently as a few months ago, the CEO was BUYING more shares in the company. I feel that insiders are keeping their shares knowing that better days are ahead, but bear in mind this might put downward pressure on the stock in the coming weeks/months.

• Competition: Believe it or not, there is a lot of competition in this market, even though AuthenTec is the leader right now. There are several public companies, such as Atmel Corp., Lite-on Technology Group and Mitsumi Electronic Co., as well as several private companies, that compete directly with AuthenTec.

Rest assured that as a result of this competition, AuthenTec will need to stay on their toes, continue innovating, and keep their prices cost-competitive or risk losing market share.

• Reliance on 3rd Party Subcontractors: AuthenTec relies on 3rd party subcontractors to manufacture their fingerprint sensors. There may be a time when reliance on these contractors creates problems for AuthenTec’s business, such as: unexpected price increases, delays in manufacturing or capacity and quality control issues.

• Future Funding and Share Dilution: AuthenTec just had their IPO in June of 2007. According to their latest filing, they have over $65 million in cash on hand (about $2.43 per share).

What worries me is that in that same filing, they also state that the cash on hand and cash from continuing operations should be enough to last them 1 year or so.

In addition, they also state that they could elect to seek additional funding through public or private equity or debt financing.

Now I think that this is just 10-Q, cover-your-butt, mumbo-jumbo, but it bears watching, especially in light of the fact that AuthenTec just turned cash flow positive in their latest quarter and are expected to further ramp up their profitability in coming quarters.

• Other risk factors. Things like options scandals, margin deterioration, losing business, losing customers, increased costs, overall market volatility, etc. Pretty much anything that can go wrong within a business is a risk factor, but the ones listed previously are the main risks to the business, with these being secondary, and possibly primary, risk factors going forward that all businesses need to worry about.

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VI. Bottom Line

Buy some shares!

I have brought you a cutting edge technology company that is growing like wildfire, is profitable, has no debt, has expanding margins, a defensible moat around it’s business and is a small enough company that we can still get in now, and reap very nice rewards in the next few years that is trading at a significant discount to where it should be.

What else is there?

Are there some risks? Sure, that’s the reason a lot of people won’t touch companies like this, but that’s not the way we play things around here.

My job and passion is to seek out companies that can not just beat the market, but CRUSH the market’s returns for years to come, and provide a risk/reward scenario that doesn’t put us at a disadvantage when we finally purchase shares.

I believe that not only have I found that company in AuthenTec, but also that AuthenTec’s shares will CRUSH the market going forward on a consistent basis.

My low-ball estimate is that we’ll see returns in AuthenTec in excess of 50% over the next couple of years, with a real possibility of a double in this stock within 1 year.

Optimistic? Outlandish? Maybe. But based on my thorough and detailed analysis of the company, its fundamentals and finally, the risk/reward proposition where AuthenTec sits now, I believe that these risks are the kinds we need to be taking.

Do yourself a favor today and buy at least a small position (one that will let you sleep at night), and see how things play out.

At the very least you’ll have some skin in the game and won’t let the current valuation pass you by and potentially miss out on one of the next great companies that is poised to dominate its market and niche for years to come.

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