Take a Pass on Applied Digital

But we believe other factors need to be considered besides the technology when putting money at risk. The chip's practical usefulness, for one, along with Applied Digital's poor operating performance record and the societal impediments in its path, do little to instill confidence and makes us want to stay clear of this story for now.

After months of languishing near the $2 level thanks to a reverse split, Applied Digital's shares have received a big bump from VeriChip's recent approval by the FDA. The company's shares, which barely traded prior to the announcement, have gained some 160% in less than three months, with millions of shares changing hands daily. Applied Digital is being valued at $303 million by the market, a number that implies lofty expectations.

The trouble is that Applied Digital generates most of its revenue from the sale of voice, video and data networks, not RFID tags, and the human-implantable chip market is unquantifiable at this time and may never have a meaningful impact on the top line. Of Applied Digital's $92 million in revenue in 2003, less than half can be attributed to its tagging business, and that was from its role in tagging animals to monitor things like food safety and the environment for customers like the U.S. Army.

Applied Digital didn't become an RFID play overnight. The company was founded in 1993 and has grown through more than 50 acquisitions. This "roll-up" strategy catapulted the company's sales, which reached their peak in the white- hot e-business market in the late 1990s. Back then, Applied Digital was providing network technology for the government and generating $300 million in sales a year. Like most tech companies, though, Applied Digital saw its sales fizzle, to under $100 million in 2003. To make up for the sales shortfall, Applied Digital racked up debt in the form of a loan from IBM (IBM Quote). In June of that year, a new management team took the company through a painful restructuring to help it avoid Chapter 11 bankruptcy, and found the company a new hot market to exploit thanks to its acquisitions with its RFID business.