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Nom de la société - Intitulé de la mission

2 – Smart cards

Chapitre 1 _____________________

Smart cards


4 Chapitre 1 – Smart cards

1. Overview of the sectoral trends

1.1. Smart cards have been, and will probably be a dynamic market in the mid term

Smart cards are used to transfer and store data. They lie at the very heart of the last years’ telecommunications boom, since the telecoms (cell phones) have been the main end market for smart cards. This market was around 2,3Bn€ in 2013.

Financial services (credit cards, which represent a market of 2,1Bn€), public services (ID cards and national health services cards, which represent a market of 2,4Bn€), and transports (contactless transport cards) are also important drivers for the sub-sector.

Please note that there is a distortion between an analysis of end markets by volumes (where telecoms clearly lead the way) and an analysis of end markets by value (where there are three important markets). This is due to the fact that telecom smart cards (SIM cards) are becoming “commodities” and have then a lower price than more value oriented cards such ID cards or bank services.

In 2014, smart cards production has kept growing

More than 8Bn of cards have been delivered in 2014, that is a growth of 10%. The average annual growth between 2009 and 2014 reaches 12, 2% (in volume), the sign of a dynamic market.

Fueled notably by financial services growth, short and mid-term perspectives are good

In 2015, production is expected to reach 8,8Bn of cards, increasing by 9% from 2014. The 2014-2020 CAGR should amount to 7% per year.

Production of microprocessors "smart secure devices" (Millions of units)

2011 2012 2013 2014(f) % of total 2014/2013 CAGR 2014/2009

Telecoms 4 700 5 100 4 850 5 100 63% 5,2% 8,4%

Financial services 1 050 1 200 1 550 1 950 24% 25,8% 21,1%

Public-Health 240 310 350 390 5% 11,4% 19,5%

Others (transport…) 305 480 580 600 7% 3,4% 23,4%

TOTAL 6 295 7 090 7 330 8 040 100% 9,7% 12,2%

Source : Eurosmart


Chapitre 1 – Smart cards 5

However, those high figures have to be handled carefully: they reflect the dynamism of the demand in smart cards. The figures should be lower when focusing on the value of the market (the revenues of the players).

The sector has been through bearish trends regarding prices in the last years:

Competition is increasing, with some major players being very price aggressive, and some new players (mainly from Asia) slowly rising;

Basic SIM cards are in the process of commoditization, though prices are still kept high in some sub-markets (next-generation SIM cards, financial services).

Telecom market should keep growing at a moderate pace, carried by next-gen SIM cards

SIM cards are, and will remain the first end market for smart cards sector. However, the growth should slow down in the mid-term (forecast of 2014-2020 2% CAGR according to Eurosmart). Demand has been fed by increasing equipment of emerging countries as regards to mobile devices, 4G networks roll-outs, and development of machine-to-machine technologies. Asia and America are the most dynamic regions… While Europe is already a mature market, where the main boost for demand should lie in the 4G and 5G network updates.

Financial services opportunities are flourishing, thanks to standards harmonization and emerging countries’ growth

Demand for credit smart cards should be buoyant in the mid-term, with a 10% CAGR between 2014 and 2020. This is explained by :

3.400 5.100 5.250 5.900

750

1.950 2.350

3.500

160

390 440

900

210

600 750

1.700

-

2.000

4.000

6.000

8.000

10.000

12.000

14.000

2009 2014 (f) 2015 (f) 2020

Forecast for production of smart secure devices (millions of units. Source : Eurosmart)

Others (transport…)

Public-Health

Financial services

Telecoms



Fast development of contactless credit cards ;

Transitioning to EMV (international Mastercard Visa standard) of three major

markets: China, India and the US.

Sharpening need for security and extra services.

Demand for electronic ID cards is dynamic, though the volumes are lower

The « public » market (ID, health and social security) should keep growing in the years to come (expected CAGR of 19% between 2014 and 2020). More and more governments and public services are choosing safer, hence, “smart” identity documents. Today, e-ID documents stand for a small third of ID documents; the share should rise to 50% in 2017 (source : ABI Research). It is true both of developing countries and the EU.

1.2. Smart cards employment: Europe still hosts a significant part of jobs

From a statistical viewpoint, smart cards industry is mixed among NACE code 261, along with EMS, microelectronics and connectors. As a result, a statistical approach to assess the number of employees does not seem relevant.

Since smart cards industry is a concentrated market, with few and well-known actors, it seems appropriate to compute the number of employees through a bottom-up approach, relying on the competitors and adding up the numbers.

According to public sources:

The leader Gemalto is thought to have around 6000 employees in EMEA (EMEA is a

larger region than Europe in itself, but we assume that almost all EMEA employees

are European).

Oberthur headcount is close to 6400 employees all around the world. We assume

that half of them are employed within Europe (France, UK, Spain).

At the end of 2013, G&D employed more than 6000 people in its Mobile security (=

smart cards) division. We assume that half of them are employed within Europe

(mostly Germany), which means about 3000 people in the business in Europe.

We assume Morpho, for its E-documents division, has around 1000 employees in

Europe.

Those estimates lead to a 10K-15K European headcount for smart cards industry. We will consider the mid-point 13K employees as our estimate.

Indeed, smart cards are one of the few, if not the one and only, sectors where Europe is still clearly leading the game:

All top players are European (French of German) ;

Europe is still the region concentrating the biggest share of headcount;



What’s more, Western Europe still has a strong industrial footprint, and not only

R&D.

The figures are then clearly in favor of Europe, but… the trend is plainly less positive. European headcount has been oriented downwards in the last years. However, it is not the case for smart cards players’ global headcount. The bulk of employees and the recruitments are shifting from Western Europe to emerging countries: Eastern Europe, South America, Asia.

The “soft” way is to give minimum work load to western European factories and

staff, rely on retirement and resignation to diminish the number of employees, and

concentrate the work load (both in manufacturing and R&D) in emerging countries.

The “hard” way” is to close plants in Europe and/or initiate programs of collective

redundancies… and, still, concentrate the work load (both in manufacturing and

R&D) in emerging countries.

All players have been using those strategies, in a way or another:

Gemalto headcount has been increasing, but the role of France (and of Western

Europe more generally) has been shrinking. French plants get minimal load, and the

rest goes to low-cost factories. Even though the European R&D employees still play

a key role in the company, there have been numerous recruitments of engineers in

low cost countries too.

In 2014, G&D started a cost-cutting plan, the so-called “P100” program, which aims

at increasing profitability by 100M€. It involves several locations in Europe, and

mainly Germany, causing some protests to rise, all the more important since it was

the first restructuration of that scope in G&D’s history.

The Munich headquarters would be closed and moved to Leipzig;

The Munich plants would also be moved to others German plants;

950 jobs would be cut (around two thirds in Germany), with “re-dimensioning” of administrative and commercial structures;

150 German employees would have to be relocated.

This plan is to be carried out in 2014, 2015, 2016, and has already created restructuring costs of 74M€ in 2014.

Though keeping a significant footprint in France, Oberthur has relied on

outsourcing (for example, in Ukraine and Philippines) in the last few years, both for

manufacturing and R&D. What’s more, they have launched a major restructuring

program in 2014, with several projets :



Closure of two plants in Europe (one in Uk and one in Spain), the remaining

workload being transferred to a French plant (Vitré) or to Asia ;

Closure of two small plants in France ;

Around 400 job cuts in Europe (UK, Spain and France).

Headcount of the only remaining manufacturing location in Europe, Vitré, would

moderately increase (+50 employees).

The number of employees of Morpho is on an upward trend, notably through the

numerous acquisitions realized over the last years. However, Morpho is also

carrying out cost-control strategies. Morpho launched a restructuring program of

its smart cards division, with one site closure in Germany (300 people impacted) :

the R&D and manufacturing activities will be transferred to France and India (R&D)

and Czech Republic and Colombia (manufacturing).

2. Disruptive technologies and strategies of the sector

2.1. Game changer technologies: softwarisation, and the tide of M2M

Smart cards sector is no exception to the general IT trends. More specifically, the movement of softwarisation (with a shift of value added from hardware to software and related services), and the machine-to-machine technology are currently some major stakes the players have to tackle. This also leads to more fragmentation in the market. From an oligopolistic situation, where strength is based on economies of scale for hardware production… new players, IT giants or specific and smaller software companies, are entering the game.

Main drivers for the sector in the years to come should be :

Next-generation SIM cards (4G and 5G) and embedded SIM cards;

Sharpening need for security and safer transactions;

Digital identity;

Financial services on mobile devices;

Machine-to-machine technology.

Strong potential for contactless technologies

In 2014, contactless smart cards amount to 16% of total volumes, but this share has been steadily rising in the last years (as a comparison, the share was only 9,5% in 2012). This is mostly explained by the rise of new types of financial services: electronic wallet, contactless



credit card (or carrying both contact and contactless technologies), Near Field communication (NFC) technologies embedded in smartphones as a payment device…

In Western Europe, contactless credit cards should be the main driver of an already mature market, whereas credit card penetration is still at stake in Eastern Europe.

The growth of mobile payment represents a risk of market fragmentation and could negatively affect the smart cards companies

Payment on mobile phones is obviously one of the top challenges in the sector and object of a fierce struggle between diverse companies. Traditional hardware smart cards companies face the risk of being bypassed by payment companies, such as PayPal or Square, which develop their own payment schemes, or over the top companies (Google).

Today, the secure element of mobile payment is located in the phone SIM card (result of cooperation between smart cards producers and MNOs) but could:

Be directly welded to the phone, or be located in a card dedicated to payment. In

the first case, smart card players could offer related services to payment

identification, without offering the card itself. In the second case, smart card

players could offer the specific card, in addition to the traditional SIM card.

Or the secure element could disappear. This directly to the Google project of ‘”host

card emulation”: payment would be directly handled by Google, without smart card

and without the control of MNOs.

In either situation, revenues of smart card players could be hit, and they will have to prove their ability to offer extra services, even without the hardware part.

Biometric identification is also expected to be a big opportunity in the longer-term, and could allow French players, among them Morpho, to have a say in the race.

Machine-to-machine technology is spreading and could be a game changer for smart cards firms

The expansion of M2M objects (automotive, consumer and industrial electronics…) is a megatrend of the ICT world currently, and smart cards take their share.

Production of contactless smart cards (Millions of units)

2013 2014 2015 2014/2015

Financial services 590 800 1 000 25,0%

Public - Health 200 230 260 13,0%

Others (transport) 250 250 280 12,0%

TOTAL 1 040 1 280 1 540 20,3%

Source : Eurosmart



From traditional SIM cards (allowing secure access to mobile networks) the SIM card is changing and embedded SIM cards with remote management are spreading.

A new specification was adopted in 2014 by GSMA1, and this should boost the development of M2M objects:

SIM card will be embedded in the M2M product during its manufacturing (car,

consumer electronics…) and will be managed (customization, validation…) by

remote control.

This is expected to facilitate:

maintenance (for instance, if a SIM card is located in a sensitive part of a car or a

smart electricity meter, it is easier to control remotely than to change the whole

part);

swap of MNO (instead of changing the SIM card, the MNO will just have to

remotely activate/deactivate the embedded SIM by radio).

Embedded SIM cards are still new, and companies are still working on the construction of hardware/software/services/ offers. Nevertheless, they are bound to be a game changer both for smart cards sectors, and more globally for ICT megatrends.

The rise of related services and software, beyond the hardware, leads to the rise of new software players

Digital identity services (digital signature, online identification for a firm’s employees…) is a promising market, where smart cards actors are struggling to have a role, faced with lack of standards and the arrival of IT security players (from corporate markets or payment processors).

The leaders in this highly fragmented field are RSA, Safenet, Vasco, Entrust, Symantec or Gemalto. Neither Oberthur, G&D or Morpho are thought robust enough in this regard. Other firms also enter the game (Atos, Microsoft, IBM…)

2.2. Strategies of the players

Cost-cutting and outsourcing programs have involved the whole sector, though highly profitable

Indeed, the sector is going through important price pressures on some markets, though the pressure is limited because of the oligopolistic structure of the sector. Those price pressures come from the fierce competition between the top players themselves, and from the local players (most Asian), gaining coverage and shares.

1 GSM Association is a worldwide association representing interests of MNOs.



Those constraints have served as a justification to start cost-cutting programs, and to develop low cost R&D and manufacturing locations (cf.infra with company overview).

This outsourcing trend is a way to reduce costs, but also to get closer to the biggest markets (China, India, South America).

Consolidation over the last years… and more to come?

The smart cards players have tried to adjust to the “softwarisation” of the sector, and to try to answer to the new and buoyant technologies (NFC…). One of the answers has been a strong movement of concentration: the 4 majors have bought a lot of smaller software companies to extend their technological offer.

After this movement of external growth, the sector could step up to the next phase of concentration… with M&As involving the 4 major players. What is at stake:

the ability to compete against IT giants, while the borders between smart cards, IT

services, financial services, telcos are being blurred;

For the numbers 2, 3, 4, the ability to catch up with the fast pace of Gemalto.

In the wake of its restructuration, G&D could split up its activities2 (bank notes production, smart cards for telcos and banking, ID smart cards, digital ID…).

This sector, already highly concentrated (with top 4 gathering 80% to 90% of the revenues) could then concentrate even more. This would be a response to technological and strategic issues… but also a step towards increased profitability, even though the players already enjoy good performance.

3. Main players and employment in Europe

3.1. Overview of the main competitors

The leader Gemalto is in good shape

Gemalto is a smart card « pure player », and the leader with a market share of 40%, benefiting from a complete portfolio, both in terms of end markets (telecoms, finance…) and in terms of value chain position (from hardware – card- to software and extra services). It holds a strong footprint on the e-identification sub-segment.

This French-Dutch group is publicly listed in Paris, and relies heavily on financial communication to the stock exchange markets. It keeps releasing top results, and achieves the targets.

In 2014 too, results have turned out to be good: the revenues are up, notably thanks to the Payment and identity Business division (EMV transition). Even though the operational and

2 Source : media.



net profits are slightly lower than previous years, this is mostly explained by heavy restructuring charges (30M€), because of reorganizations and lay-offs (both in manufacturing and R&D). The structure is still solid.

In 2015, Gemalto bought two companies:

Safenet, a company specialized on data and software security ;

The Secure documents Division of Trüb AG.

With weakening results, Giesecke & Devrient has launched restructuring and outsourcing programs in the last two years

Giesecke & Devrient (G&D) is a German family group, and one of the sector top 3 players. It is mainly committed into “reliable transactions” business (bank notes printing is the first business line of the company), with a smart card division.

In 2014, sales amounted to 1,8Bn€ (5% growth), among which 778M€ for Mobile security, the smart cards division (6% growth). G&D has generated positive results over the last years, though lower than those of the leader Gemalto. However, it was not the case in 2014, because of heavy restructuring expenses (74M€ in 2014). From 3,4% of sales before restructuring, the OP sank to 0,6% of sales after that.

G&D has indeed launched major restructuring programs in Europe, including cost-control policies, plant closures and lay-offs. Some manufacturing activities were outsourced to Asia, and especially China.

There were rumors about splitting up the firm into several pieces (banknotes, mobile security…). There have been tensions among the management, and some key managers left the group over the last year.

Oberthur must meet with LBO ambitious financial targets, and find new sources of financing

After being bought by an investment fund (Advent), Oberthur is now a French pure player, but used to be a competitor in money printing business. It is one the top 3 players, with revenues of 1,3Bn€. Oberthur is strong in financial services sub-sector, but weaker in Identity division.

M€ 2009 2010 2011 2012 2013 2014

Revenues 1 602 1 906 2 015 2 246 2 384 2 465

Operational profit 134 163 183 239 283 270

% of revenues 8,4% 8,6% 9,1% 10,6% 11,9% 11,0%

Net profit 118 167 161 201 258 221

% of revenues 7,4% 8,8% 8,0% 8,9% 10,8% 9,0%

Net cash 381 236 309 348 449 493

Main results of Gemalto



Oberthur is a profitable company, but must comply with very aggressive financial targets since it was bought, under Leveraged-Buy-Out scheme, by the Advent investment fund… leading to short-term, aggressive and “cash-oriented” management. Oberthur has to pay back the LBO, which means increasing levels of operational profit and cash flows. Oberthur has also chosen an aggressive commercial strategy, whose goal is probably to gain market shares.

Oberthur has recently chosen to start a IPO process, and should complete the procedure at the end of 2015. Advent would stay the majority shareholder. The firm is looking for new financing in a very competitive and capital-intensive business.

Nb : Oberthur does not release any of its financial result.

The number 4 Morpho is trying to catch up with the front pack in main end markets

Morpho is a subsidiary of French MNC Safran, and number 4 of the sector. The company progressively tried to broaden its portfolio towards telecoms and banking, from a solid position in identification and security. Morpho relied on external growth (acquisitions) to do that, and strengthen its technological position. Among others, Morpho bought Dictao, focused on digital identity, in 2014.

The mother company Safran has been supportive of this strategy over the last years, but the “pay back issue” is still in the picture: when will the cash invested (in R&D and acquisitions to extend the portfolio) generate higher sales, higher market shares and positive cash flows ?

Morpho sales amounted to 1,5Bn€ in 2013, steady in comparison to 2012, and positive OP. But the company nevertheless embraced the cost reduction strategy of its fellow players. It is especially the case in Germany.

More globally, the strategy of the company, and the behavior of Safran towards its subsidiary, is still uncertain. The nomination of a new CEO, with “a telco and digital profile” is clearly a step in the right direction.

3.2. Trends for the employment in Europe

As a reminder (cf. 1.2), we consider the mid-point 13K employees as our estimate for the smart cards industry in Europe.

M€ 2012 2013 2014

Revenues 1 789 1 754 1 833

Operational profit 97 61 11 -

% of revenues 5,4% 3,5% -0,6%

Net profit 39 3 73 -

% of revenues 2,2% 0,1% -4,0%

Net cash 156 - 250 - 235 -

Main results of Giesecke & Devrient



Main trends underlying our scenarii

Smart cards industry, as a global market, is dynamic and presents good

opportunities in the future, both in terms of end-users (emerging countries’ growth,

e-payment, security…) and of products (hardware and growing needs for software

and services).

However, the major markets are shifting to Asia or Latin America, while Europe

is mature.

Smart card players have generally presented positive results, and the industry is thought to be profitable. However, the industry is capital-intensive, with lots of investments required to keep up the pace, especially the pace of Gemalto. Moreover, the competition is increasing (local players, in Asia for instance) and the rise of software component is reshuffling the game.

In terms of skills, European employees are still considered as top-level regarding R&D (especially as far as patents issuing or quality go), but the differences with other countries, mostly Asia, are gradually disappearing. Regarding manufacturing, there is no major difference.

As a result, over the last years, the smart cards players’ strategies have not been keen on European jobs. All firms have carried out cost-cutting policies, with European plant/site closures, outsourcing to low-cost locations, massive job cuts in Europe. The low-cost outsourcing is also said to be a response to the shift in the biggest end-markets (getting closer to the clients, hence India, China, Latin America…).

Most manufacturing locations still remaining in Western Europe are closing down

(Oberthur) or used at minimum level.

Finally, a major event could disrupt the smart cards field in the next years: further consolidation with two players merging (within the top 4) could arise as a response to enhanced competition and ever-greater financial needs. Such an event, which appears if not certain, as least likely. It would induce “synergies”, and, thus, restructuring and job cuts (at least at the corporate functions level, which are mostly located in Europe).

Hypotheses and conclusions of the two scenarii

Business as usual scenario

In this scenario, we suppose:



“Natural” diminution of jobs in European manufacturing, the bulk of production being gradually transferred to low-cost locations.

R&D functions are maintained in Europe for all major players, but are not significantly increased as R&D is developing in Asia and Latin America.

On-going restructuration programs are completed.

Most importantly, a merger occurs between two key players in the industry, which leads to :

restructuration of corporate functions (HR, finance, supply, IT…), and to job cuts

in Europe (which still hosts a good part of those functions) ;

rationalization of R&D activities, and maybe plant closures.

Given those hypotheses, our “business as usual” scenario forecasts a 10% reduction of the number of European employees up to 2020.

Desired state scenario

In this scenario, we suppose:

Jobs in European manufacturing are not increased but at least maintained.

R&D functions are maintained in Europe for all major players, and even slightly developed in Europe, as new issues and activities arise (NFC, M2M, software component…)

On-going restructuration programs are completed.

A merger occurs between two key players in the industry, which leads to :

restructuration of corporate functions (HR, finance, supply, IT…), and to job cuts

in Europe (which still hosts a good part of those functions) ;

R&D and manufacturing are not heavily impacted by rationalization.

Given those hypotheses, our “desired state” scenario forecasts that the number of jobs in the sector would stay more or less the same up to 2020.

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