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Texas Pacific Group's stake in French smart-card maker Gemplus has become a cause célèbre in Paris amid charges of a CIA role. The Americans' only real plot: to make some profits.

Gemplus International, the world's leading producer of smart cards, is recovering, well, smartly. Following eight straight profitless quarters, the French technology

company reported in February that it had achieved an operating profit of E5.2 million ($6.4 million) on sales of E232.6 million in 2003's fourth quarter. That contrasts happily with a loss for the whole of last year of E158 million on E749 million in revenue. "This is the beginning of what we expect will be steadily improving operating profit," Gemplus CEO Alex Mandl, an American, tells Institutional Investor. Gemplus's Euronext- and Nasdaq-listed stock is up 139 percent over the 12 months through March 29.

Could it all be a CIA plot?

That's what a surprising number of French citizens -- including Gemplus founder Marc Lassus and the company's own unions -- seem to believe: that the company is the object of a conspiracy by the U.S. intelligence agency to appropriate Gemplus's ultrasophisticated chip technology for who-knows-what nefarious purposes. Gemplus CEO Mandl and the prominent American investors in the firm dismiss such charges out-of-hand.

Nevertheless, the insinuations and the allegations persist. "Smart cards are veritable minicomputers that can be programmed with complex cryptography -- they are intimately connected with notions of national security," says Nicolas Moinet, a professor of information technology at the University of Poitiers. Smart-card technology, he adds ominously, "is an area where Americans hope to have absolute control."

"Are the American Secret Services Trying to Get Their Hands on the Smart Card?" worried Le Monde in a November 5, 2002, headline. The paper has reported that La Direction de La Surveillance du Territoire, France's version of the Central Intelligence Agency, sent notes to French politicians voicing alarm at the prospect that the Americans would gain control of Gemplus's sensitive smart-card know-how. Gemplus founder Lassus had this to say to business newspaper La Tribune on July 4, 2002: "I am convinced that Texas Pacific Group had some kind of agreement with its government to move the headquarters of Gemplus to California." CEO Mandl denies this allegation as well.

Television newsmagazine Envoyé Speciale implied in a January 16, 2003, program watched by millions of French viewers that Americans with CIA ties were, in effect, ransacking Gemplus. "In a scenario worthy of James Bond, a private French company, Gemplus, could at this very moment be the victim of a takeover by the CIA and the Secret Services of the United States," the documentary breathlessly reported. "The scenario makes some people smile and talk about bad science fiction. But many more talk about an economic war without mercy."

Stale news? Maybe not. French real estate investor Ziad Takieddine, a former Gemplus director who contends that he still owns 1 percent of the company (though Gemplus has no record of his stake), flatly declared to Institutional Investor in October that "Mandl is a CIA agent," a claim Mandl has unequivocally denied. An ally of Lassus, Takieddine resigned from the board under pressure, along with the Gemplus founder, in December 2002.

As recently as February 2, La Tribune observed ruefully that the loss of French control at Gemplus to American interests was the real reason that French President Jacques Chirac gave the Economy Ministry veto power over foreign investments in French companies that are developing cutting-edge technologies. The government "admits today that the growth in power of Americans at Gemplus was not anodyne," noted the paper.

Like most conspiracy theories, this one has at least some basis in circumstantial evidence. In early 2000 powerful U.S. buyout firm Texas Pacific Group became Gemplus's principal owner, acquiring almost 27 percent of the company for E558 million in the largest private equity investment in Europe up to that time.

"What got us excited about Gemplus was that this was a company that had been hugely successful in a market with explosive growth," says Geoffrey Fink, a London-based Texas Pacific partner and Gemplus board member. "A lot of other investors were focused on telecommunications providers and network infrastructure manufacturers. Gemplus's cards seemed a more neglected but very attractive way to invest in that market."

For Texas Pacific, buying the Gemplus stake was part and parcel of a deal-making foray into Europe that began in the mid-1990s with a brash investment in a struggling Irish discount airline; Ryanair Holdings is today one of Europe's most successful carriers. Another conspicuous European coup: repairing sputtering Italian motorcycle maker Ducati Motor Holding. Both ventures epitomized Texas Pacific's high-return, if high-risk, turnaround tactics. Founder David Bonderman, who rose to prominence in the 1980s as a key deal maker for Texas oil billionaire Robert Bass, can rightfully brag about 12-year-old Texas Pacific's very remunerative rescues back home of Continental Airlines, America West Airlines and Seagate Technology. The firm, which has $13 billion under management, plans to shell out $2.3 billion over the next two to three years for companies in Europe, where its investments now total $2 billion.

Fink's comments on the Gemplus deal are highly unusual, if only because Texas Pacific officials rarely speak to the press -- one more reason, as the French see it, to be on their guard. Bonderman, was so exasperated by the charges of a CIA link that he flew to Paris in December 2002 to denounce the rumors as "ridiculous" in one of his rare press conferences.

But the Texas Pacific holding isn't all that has aroused Gallic suspicion. It turns out that Mandl, a onetime heir apparent at AT&T, was once on the board of the CIA's nonprofit venture capital fund, In-Q-Tel (Institutional Investor, December 2003). It is this connection above all that prompted former Gemplus board member Takieddine to brand Mandl a CIA agent. What's more, U.S.-based recruiting firm Spencer Stuart Management Consultants neglected to mention the tantalizing In-Q-Tel tie when it presented Mandl's curriculum vitae to Gemplus's directors. Spencer Stuart insists that this was a simple oversight and that, in any case, Mandl's role at In-Q-Tel was hardly classified: He served as a quite public adviser alongside Goldman, Sachs & Co. partner Stephen Friedman, now director of President Bush's National Economic Council ("Bien sur!" conspiracy theorists must be muttering), and John Seely Brown, former chief scientist of Xerox Corp.

Last October auditors appointed by the Commercial Court of Marseilles in response to complaints by Gemplus's unions concluded that Mandl and the company's managers were not in fact illegally transferring French technology patents, or jobs, to the U.S. or anywhere else. The unions weren't placated. "We are not at all happy with the conclusions of the audit, and our concerns about the future of jobs and the transfer of technology remain the same," says Stephane Schirar, head of the company's umbrella employee organization, the Comité d'Enterprise, and a telecommunications analyst in Gemplus's research and development department. "We don't believe there is a paper trail that could provide auditors with access to the full facts, so we don't regard their conclusions as convincing. It's plausible that Mandl could be allied with the CIA and that the ultimate aim here could be to eventually control all the input and output of this company from the U.S. Gemplus could be another way for the U.S. to control the world." His Comité represents six unions and virtually all of Gemplus's 1,665 French employees, from assembly line workers to executives.

Dominique Penin, an associate in the Paris office of New York­based law firm Kramer Levin Naftalis & Frankel, which represents the Comité, told II in March that the audit was "superficial and left unanswered many questions about the future of the company that still need to be explored." Accordingly, Penin has asked the Appeals Court of Aix-en-Provence to order a more wide-ranging audit that would take up Gemplus's future plans as well as its past actions. "Getting approval for such an audit won't be easy, because there are virtually no precedents for such an appeal in France," he acknowledges. The court should render its decision on the audit next month.

Top Gemplus officials consider Penin's latest legal initiative a waste of time, since the matter was fully explored the first time around. And, for the record, Mandl adamantly and repeatedly denies that he is now, or ever was, a CIA agent. Nonetheless, the 60-year-old CEO must sometimes feel like a character in a paperback spy novel whose plot contains one improbable twist after another.

In the latest turn of events, Gemplus appears, miraculously, to be on the rebound, along with the devastated telecom market that accounts for most of its sales. With a "clean bill of health" from the Marseilles auditors and the prospect of steady earnings gains, Mandl says, "we've turned the corner both in terms of performance and morale within the company. Many doubts both within Gemplus and outside the company have now been put to rest."

That assessment may be premature, given Gemplus's recent history and Penin's last-ditch appeal for a full-blown audit. Mandl himself has already seen plenty of upheaval at the company. For starters, he endured a long-running boardroom battle between Gemplus founder Lassus and Texas Pacific's Bonderman. It ended with Lassus resigning in December 2002 when it became apparent that the other board members had the votes to oust him.

Mandl's own actions have caused an uproar with Gemplus's unions. By the end of this year, he expects to have slashed the company's operating costs by E100 million over three years, to E194 million, largely by laying off 941 of the company's 5,680 employees worldwide. High-cost French operations, which will employ just under one third of all Gemplus workers after the cutbacks, have been the hardest hit -- helping to trigger resentment and, ultimately, the Comité's demand for an audit. And even though Mandl signed an agreement last May guaranteeing that Gemplus would maintain its French production quo-tas, though not necessarily staffing levels, through June 2006, that action has done little to quell French suspicions that his real aim is to move Gemplus's operations offshore, namely to the U.S. "Right now France is still the big engine for this company," says the Comité's Schirar. "But we still don't know if that will be the case beyond the medium term."

Amid the bickering, Mandl -- aided considerably by the recovery of telecoms, source of 70 percent of Gemplus's revenues -- is restoring much of the company's luster. He cut losses by roughly half last year from 2002's E321 million. Gemplus has "laid the foundation for long-term growth and profitability," he contends. He projects a 10 percent rise in sales this year, after three years of unrelenting declines, and predicts a full year of operating profits. The company's client list continues to boast such gilt-edged names as IBM Corp., MasterCard, Microsoft Corp., Nextel Communications and Vodafone Group. Gemplus, which for years traded at a sizable discount to its book value, was selling at a 15 percent premium at the end of March, giving it a market cap of E1.11 billion. That's a fivefold increase from what the market judged it to be worth in September 2001 -- when Mandl took over -- but less than one third of its E3.62 billion market value at the stock's peak in December 2000.

Plainly, vast challenges remain. Gemplus's industry -- smart cards -- has undergone a radical shift that has intensified competition and drastically reduced card prices. "Four years ago there was less than a handful of companies you could go to for this kind of technology," says David Cerdan, an information technology analyst at HSBC CCF in Paris. "Today a bank or a mobile phone manufacturer can usually get the high-tech software that drives most smart cards from a designer that doesn't have the added expense of an assembly line, while the cards can be manufactured by an Asian operation with a lower salary base than Gemplus's."

Gemplus may yet be forced to cede its independence. Even after cutbacks, the company spends more on R&D than any of its rivals do -- roughly E70 million a year -- but it may still have to merge to beat back competition, gain exposure to new markets and add to its research firepower, especially if IBM or Hewlett-Packard Co. or Microsoft, or all three, decide to get into smart cards to tap into the huge post-9/11 security market. Texas Pacific bought its stake in Gemplus for E3.50 a share and in late March, with the stock trading at E1.84, it was sitting on a paper loss of about E262 million. It might look favorably on a takeover bid that would relieve it of its French headache. None of the Fort Worth, Texas­based firm's officials would comment.

Irony of ironies, then, putative CIA operative Mandl may actually be prepping Gemplus for sale to a French acquirer. One strong candidate: Sagem, a Paris-based defense and electronics company that is a world leader in biometric identification technology and, what's more, is indirectly controlled by the French government. Sagem may already be stalking Gemplus. In December 2002 it bought 10 percent of the company, and although Sagem later sold its holding, a senior French Treasury official told II that the government encouraged the company to acquire the Gemplus shares.

Sagem's chief financial officer, Hervé Philippe, insists that the Gemplus investment was motivated strictly by business. "The principal goal was to secure a joint agreement to supply the United Arab Emirates with a smart-card identification system, using technology that can record impressions of both fingerprints and irises," Philippe explains. "Secondly, this was a good investment, since we paid an average price of E0.85 a share, versus a book value of about E1.60." Sagem sold its stake, which it purchased for E55 million, in late September for a E20 million profit.

"Remember," says the Sagem CFO, Texas Pacific "has a large part of the capital of Gemplus, and there is no indication that they intend to sell at current prices." He adds, though, with a Gallic shrug, "You should never say never."

The two other most likely acquirers are Oberthur Card Systems and defense electronics company Thales -- both French and therefore politically palatable.

THE PROTOTYPE FOR SMART CARDS WAS INVENTED in 1974 by French engineer Roland Moreno and quickly came to epitomize France's effort to upgrade its technology sector. The extrasturdy microchips embedded in the cards are far superior to the magnetic strips on the back of many credit and debit cards at securely storing cardholder and transaction data. Semiconductor manufacturers began to refine techniques for making chips small and durable enough to be implanted by machine into plastic cards in the late 1970s. One of the pioneers was Gemplus founder Lassus. The son of elementary school teachers in the Pyrenees, he earned a Ph.D. in solid-state physics from Lyon University and then worked as a researcher at the National Institute of Applied Sciences in Lyon. Joining Motorola in 1967, he oversaw the assembly line that manufactured the world's first smart card, in 1979.

Starting in the early 1980s, as part of Paris's industrial policy, France Télécom rolled out a modernized public telephone system that required users to buy smart cards and insert them into phones in lieu of coins. Bull, the French computer giant, and Schlumberger, the New York­ and Paris-headquartered offshore oil services and technology company, became leading suppliers of the cards. Soon banks as well as health care and social welfare agencies throughout Europe had embraced the cards, because of their ability to carry vast amounts of medical and billing data.

In 1984, Lassus moved to Thomson Semiconducteurs (now Geneva's STMicroelectronics) in Toulouse, France, to be head of integrated circuits. After failing to persuade Thomson to get into the manufacturing of chips and cards for the burgeoning telephone, mobile phone and banking markets, he and five other Thomson engineers left in 1988 to form Gemplus. Thomson did, however, provide seed money. The fledgling enterprise became the first to specialize in smart cards; Lassus saw that as an advantage over more diversified manufacturers. Starting out mass-producing prepaid phone cards for France Télécom, Gemplus expanded rapidly into bank cards (though it later lost its momentum in this lucrative field) and into so-called subscriber identity modules, or SIMs, the removable plastic cards installed in GSM (global system for mobile communications) wireless phones to identify callers.

Gemplus was hailed as "la plus belle start-up Française," and Lassus was celebrated as the kind of visionary who would allow France to keep pace with the U.S. in technology. He located Gemplus in Gémenos in southern France rather than in stuffy, comme-il-faut Paris, and he insisted that the company's employees, from janitors on up, learn to speak English. (The company is officially incorporated, however, in Luxembourg.)

Gemplus soon shot ahead of its rivals in smart-card production. Bull exited the business in the late 1990s; Schlumberger is planning to sell its smart-card division, Axalto, in keeping with a broader divestiture of its non-oil-related tech businesses. Gemplus, which now produces more than 600 million chip cards annually, holds a slight lead in volume over Axalto, according to The Nilson Report, a U.S. card industry newsletter.

Investors and analysts naturally speculate about a linkup between Gemplus and Axalto, although it would be bound to encounter union resistance. "We would welcome many combinations, but a deal with Axalto would be disturbing," confides the Comité's Schirar. He worries that it could lead to "a lot of layoffs" because of overlap between the businesses. A much bigger problem could be that between them the two companies control 60 percent of the global telecom card market, posing antitrust issues.

As smaller and less successful companies than Gemplus rushed to do IPOs in the mid- to late-1990s, Lassus clung to private ownership. In 1997, however, the then-59-year-old chairman and CEO, saying that he wanted to concentrate on long-term strategy, stepped aside as CEO, though not as chairman; he took up residence in London, where income taxes aren't as steep as they are in Paris. Daniel Le Gal, a veteran Gemplus engineer, was named the new CEO, but Lassus continued to call the shots.

Gemplus's revenues grew a steady 30 percent annually well into 2000. Lassus, nevertheless, made some key strategic blunders. Anticipating ever-growing demand for smart cards, he almost doubled Gemplus's workforce, to nearly 8,000, between 1997 and 2000. Then in early 2000, at the height of the tech boom, Lassus responded to a global chip shortage that was driving up prices by signing take-or-pay-contracts with chip manufacturers. Had the high prices and shortages persisted, this would have been a coup. Instead, fallout from the tech and telecom crash stuck Gemplus with fixed chip costs and supplies at a time when chip prices were tumbling. Thus the company's costs stayed stubbornly high even as its sales plummeted.

In late 1999, before the problems surfaced, Lassus decided to seek capital for acquisitions and growth. So Gemplus sold the 26.4 percent stake to Texas Pacific, diluting the founder's holding from 8 percent to 6.25 percent, although later in the year Lassus exercised options and pushed his stake up to 16.3 percent. Gemplus's other major, and continuing, shareholders are Germany's Quandt family, which controls BMW (19 percent of Gemplus); Thierry Dassault, scion of the Groupe Dassault aerospace family, through venture capital fund Dassault Multimedia (5.4 percent); General Electric Capital Corp. (4 percent); the Brunei Investment Agency (3.7 percent); and the Singapore government through venture capital fund Vertex Investments (1.7 percent). With the exception of Dassault, a Lassus ally during the days of boardroom struggles who purchased his stake in early 2002, all of these investors bought into Gemplus as private equity investors in the 1990s. The company's IPO took place on December 11, 2000.

Gemplus proved more resistant initially to Texas Pacific's tough love than have other investments. Personality conflicts complicated Gemplus's hard job of responding to the telecom crash and a 40 percent decline in smart-card prices. At first, Bonderman, now 61, and Lassus seemed to get along well. When they had finished negotiating Texas Pacific's investment in Gemplus, Bonderman invited Lassus to his sprawling Wildcat Ranch outside Aspen, Colorado. There, with the snow-capped Rocky Mountains as a backdrop, the customarily blunt-spoken former trial attorney and Washington law partner reportedly charmed the Frenchman over cold cuts and cheese by telling Lassus how much he admired him as an entrepreneur.

Once the deal was concluded, Bonderman and Lassus agreed that Gemplus needed a CEO with more international experience than Le Gal, who exited to found a venture capital fund in Aix. The pair's search led them to Antonio Perez, who had spent 25 years with Hewlett-Packard, most recently as president of the consumer products division. "Everyone believed Perez was the right man to lead Gemplus," says Texas Pacific partner Fink. Lassus purportedly dubbed Perez "Gemplus's Zinedine Zidane," referring to the star playmaker of the French national soccer team. Perez took the post.

In December 2000, six months into his tenure, Texas Pacific and Lassus arranged to float 11.7 percent of Gemplus on Euronext, raising E430 million for the company's expansion strategy. The month of the IPO saw the high-water mark for Texas Pacific's Gemplus holding: The share price hit a peak of E9.90 on December 29, 2002, giving the firm's stake a paper value of E1.6 billion. It is currently worth about E295 million.

At Lassus' direction, Gemplus made three modest purchases in 2000; then the telecom market collapsed out from under Gemplus, and its sales tumbled. Relations between Bonderman and Lassus grew progressively worse as they disagreed over how to pull the company out of its nosedive.

Perez became a flash point. Lassus wanted to develop Gemplus's relatively weak bank-card business, while Perez preferred to concentrate on the more established GSM-chip business. In addition, Perez sought to make cost-cutting a priority, while Lassus favored expansion. "Perez came in with the attitude that we had to face tough market conditions sooner rather than later, and we supported him on that," says Fink. When Lassus sought veto power over the CEO, Bonderman blocked him through his effective control of five of eight board seats.

In hindsight Gemplus probably erred in not paying more attention to nontelecom opportunities. "In the smart-card business, it's best to spread your bets, which is what Lassus wanted to do," says Charles Copin, CEO and founder of Analyses et Syntheses, a Paris-based smart-card-industry consulting firm and newsletter publisher. Counters Fink, "If revenues are falling, you don't gamble the future of the company on calls that are highly uncertain."

Compounding their business disputes, Bonderman and Lassus clashed personally. The Gemplus founder, who is fond of describing himself as a peasant, is partial to polyester suits and economy-class travel. The dapper Bonderman, by contrast, threw a 60th birthday bash for himself and 300 friends in Las Vegas that featured Robin Williams telling jokes during dinner and the Rolling Stones playing songs afterward. Newspapers reported that the shindig cost $10 million, although Texas Pacific sources say it was nowhere near that expensive.

The growing acrimony between Bonderman and Lassus -- who was demanding an independent audit of Gemplus to uncover alleged mismanagement and also openly supporting employee groups calling for Perez's ouster -- alarmed investors. "We were not on the board for the first year and a half after the Texas Pacific investment, but we felt they were too involved in the day-to-day management of Gemplus," says Jörg Appelhans, a spokesman for the Quandt family office, Gemplus's second-biggest holder, with a roughly one-fifth stake.

Something had to give. "Everyone recognized that the company had come to gridlock," acknowledges Fink. In December 2001, Texas Pacific reached an understanding with the Quandts: Both Perez and Lassus would have to go. Perez resigned, resurfacing last year as chief operating officer of Eastman Kodak Co. (he declined to discuss Gemplus). Lassus, meanwhile, was paid $2 million and allowed to keep his board seat in exchange for a promise "to refrain from communication with management, employees and representatives of the company."

Taking Perez's place as CEO on an interim basis was Gemplus director Ronald Mackintosh, 55, chairman of Differentis, a British technology consulting firm that is 45 percent owned by Texas Pacific. Predictably, the "silencing" of Lassus and the naming of someone so closely tied to Texas Pacific as acting Gemplus boss fed French anxieties about the Yanks' intentions. Mackintosh proceeded to rile Gemplus's rank and file by axing 1,050 jobs -- 416 of them in France. The unions clamored for his head. The Scotsman was quite happy, even eager, to relinquish the interim CEO title when the Gemplus board awarded the top job to Mandl in August. (Two other candidates, both French, had purportedly dropped out of the running after circumstances changed at their companies.)

An Austrian-born naturalized American who has an MBA from the Haas School of Business at the University of California at Berkeley, Mandl had risen through the finance ranks at American forestry company Boise Cascade Corp. and transport giant CSX Corp. before becoming CFO of AT&T in 1991 and then president and COO in January 1996. He had a reputation as a cost-cutter. Although his promotion at AT&T nominally put him in line to succeed Robert Allen as CEO, Mandl quit in August that year to take an eye-popping $15 million signing bonus to become CEO and shareholder of Teligent, a U.S. builder of rooftop antennae for delivering telecom services to companies. Backed by such formidable names as buyout firm Hicks, Muse, Tate & Furst; Liberty Media Corp.; and Microsoft, the Vienna, Virginia­based Teligent spent lots of money building out its network for a customer base that was slow to materialize -- an all-too-familiar pattern for tech start-ups. Mandl left after the owners rejected his plan to raise more money, and Teligent went bankrupt soon afterward.

"I finally took the Gemplus job because it was one of the best opportunities around," says Mandl. "It's the clear leader in its technology, it has a significant global revenue base, and it has a better cash position [E390 million as of January] than any other company in this space." He sees bright prospects for Gemplus in manufacturing the sophisticated GSM chips required by third-generation wireless services, but he is also enthusiastic about smart-card uses in banking and security.

The persistent French suspicions about American intentions for Gemplus clearly frustrate Mandl. "We have said publicly, in an agreement with the unions, that the level of manufacturing here in the south of France will remain as is for the next three years," he says with a sigh. "We've further stated that our research and development capability, which is an important part of the future of the business, will largely remain here." As for the possibility of selling Gemplus -- most likely to a French company -- Mandl observes cryptically, "As a general statement, everything has a price."

A spy couldn't have said it any more circumspectly.