e-discovery 2.0

Assuming that you can buy each company for the same price, which would you acquire?

Company A has been in business 3 years, has 25 customers, no brand to speak of, and did about $5 million in revenue in the prior year; or,

Company B has been in business 7 years, has over 100 customers, a strong brand in its market, and is doing $25 million in annual revenue?

“No brainer,” you say, “obviously, Company B.” So it is that FTI looks to have got a great deal buying Attenex (Company B) today for $88 million, whereas Seagate looks like it grossly overpaid for Metalincs (Company A) which it bought for $82 million in December 2007. But things are not always as they appear, and there are good reasons why Attenex has sold for a paltry 3.5x revenue, a multiple well below the 16x commanded by Metalincs or even the 5x revenue that Iron Mountain paid for Stratify.

Three forces reduced Attenex’s acquisition price. The first is that FTI accounted for a large proportion of Attenex’s revenue. That gave FTI leverage over Attenex since it could say, “sell to us for $88 million, or we will take our business elsewhere, your revenue will plummet, and the value of your business will be greatly reduced.” This power that FTI had over Attenex made it the only logical acquirer, so there could be no pressure from other bidders to raise the purchase price.

The second force depressing Attenex’s valuation is that its revenue will likely decline post acquisition as Attenex’s partners (who compete with FTI) switch from Attenex to other solutions. Software investors value growth above all else – and are willing to pay up for it. For example, Bladelogic, an unprofitable software company, went public last year at a $500 million valuation with less trailing revenue than Attenex. But it did $62 million in revenue the following year (Bladelogic sold to BMC Software for $800 million in April 2008). Attenex, by contrast, will see declining revenue in the next 12 months.

Finally, acquirers worried that, since Attenex’s revenue comes almost entirely from its hosted offering via service providers, its revenue was more volatile than enterprise-oriented e-discovery software companies. This is due to the fact that customers (typically, law firms) purchase Attenex-powered services on a case-by-case basis and can switch away at any time. Enterprises, in contrast, purchase long-term software contracts that will not vary based on short-term changes in case volume.

Once these factors are taken into account, the price and the multiple start to look a lot better. Attenex’s founders, who are some of the pioneers of the e-discovery industry, get some well-earned liquidity; the venture investors make a decent return; and, employees get to join a professionally-run company that compensates its people well. My congratulations to the Attenex team, and to FTI which has negotiated a great deal.

Of course, all this says nothing about the deal’s impact on the broader e-discovery market. That will be the subject of my next post.

Earlier this month, I attended the 4th annual EDRM kickoff meeting in Saint Paul. For those unfamiliar with it, the E-Discovery Reference Model (EDRM) project is one of the foundational organizations in electronic discovery, started in 2005 by George Socha and Tom Gelbmann. It has grown rapidly over the past 3 years and now boasts a roster of 80+ companies that represent the best and brightest in the e-discovery world, both vendors and (increasingly) practitioners.

What I love about EDRM, and what differentiates it so much from other (equally worthy) groups that focus on issues around electronic discovery, is its relentless focus on solving practical problems, usually in a very concrete and actionable way. There’s clearly a place for deep thinking about e-discovery case law and strategizing about best practices for e-discovery policies and practice, but Tom and George saw a growing need for a complementary group that focused on e-discovery nuts-and-bolts, with a particular emphasis on technology-based solutions. If nothing else, EDRM’s rapid growth has certainly proven the merit of their idea.

So, like the mighty Mississippi River that flows by a few hundred yards from the doors of the St. Paul Hotel, when you dive into EDRM, you know it’s going to take you somewhere. There is exciting follow-on work that is happening across a range of current projects, most notably Evergreen, XML, Metrics, and Code of Conduct. But what I found most exciting this year is a completely new project that will be tackling one of the most important and challenging aspects of e-discovery: search.

Launched by a grassroots group of conference participants, the Search Project seeks to tackle critical problems around e-discovery search from a practical, actionable perspective. Given the criticality of search in e-discovery, it is something that many participants felt was sorely needed.

For example, the project is discussing how to develop a common language for talking about search across various vendor implementations. It’s also tackling the problem of ensuring consistency across searches in different steps of the EDRM process. This whole area is ripe for innovation, and I am delighted to see the e-discovery community collaborating to make more progress than any one participant could alone.

There is no bigger idea in enterprise technology than the idea of “cloud computing“. What does it mean? Simply put, the idea is that enterprises will cease to buy hardware, software, and all the headaches that come with them. Instead, companies will rent whatever applications they need and access them over the internet. Software vendors will keep their applications on a pool of shared infrastructure (the “cloud”), which will automatically allocate resources between applications according to demand. Using a common analogy, we will move from today’s world where companies are buying and building their own electricity generators, to a world where there are power companies distributing electricity over a grid.

To get a sense for how this might happen, just take a look at the CRM market. Ten years ago, Siebel and other packaged software vendors were among the fastest growing companies in America. Today, they are shrinking as customers migrate en masse to, for example, salesforce.com’s cloud-based approach. One Wall Street analyst I spoke to last week forecast that hosted (i.e., cloud-based) applications will grow their market share from 12% to 21% by 2011, and account for all growth in the market.

E-discovery is no exception to this mega-trend, and I expect a portion of the e-discovery software business to move to the cloud. How quickly this happens depends on how easy it is for companies to adopt cloud-based e-discovery solutions, which is why Google’s recent moves into e-discovery are so significant.

Google is by far the largest cloud computing company in the world. Its cloud-based Google Apps suite of applications was only launched in 2007, but is already being used by several hundred thousand businesses and, Google tells me, 2,000 new businesses sign up every day. Today, the customers are mainly small to medium sized businesses (500-5,000 employees). But as its functionality improves, larger companies will increasingly start asking why they should pay for Microsoft Office when cheaper alternatives exist.

Talking to Bill Kee, a product marketing manager at Google, it’s clear the biggest gap in Google Apps’ functionality was the lack of enterprise features around security, compliance, and e-discovery. That’s why Google acquired Postini, a leader in messaging security. It’s why Google recently launched Message Discovery, a hosted archive that comes bundled into Google Apps Premier Edition. And it’s why Google is collaborating with Clearwell to educate the market on cloud-based e-discovery solutions.

If you are interested in learning more about “e-discovery in the cloud”, register for a free webinar which we are hosting with Google on June 3.

Two days, 4 customers, 7 journalists, 4 bloggers, 3 analysts, 5 partners, 3 breakfasts, no lunches, 4 dinners, 2 parties, many drinks, countless hallway conversations…and 2 aching feet. That’s what LegalTech 08, held in New York earlier this week, was like for me ⁽¹⁾. If traffic at our booth is any guide, then attendance was up significantly from last year. Despite having 3 demo stations, we frequently had people lining up to see the product. And the wait time for an elevator must have broken the 10 minute mark!

Fun as it was, LegalTech is anything but inexpensive. Even a medium-sized booth in an undesirable location costs over $11,000. Add to that the cost of travel, booth rental, and accommodation in one the world’s most expensive cities, and you can easily end up spending three times that amount. Hence the obvious question: is it worth it?

The answer largely depends on what you expect from the show. If lead generation is your exclusive focus, then most tradeshows are a poor investment. No matter how many contacts you zap with the scanner, the cost per lead is probably far higher than other methods of demand creation.

To my mind, the true value of an event like LegalTech is that it gathers everyone together, tears them away from their laptops (if not their Blackberries), and puts them in a frame of mind to think about new things. By simply putting yourself in the flow of ideas, you can identify new trends, explore new partnerships, learn what the competition is saying about you, and generally gather information that will help you make better decisions.

What price can you put on that?

⁽¹⁾ I’m sorry to say that the one item conspicuously missing from my LegalTech list is the conference sessions themselves, only because there was not time. I was particularly sorry to miss the keynotes given by our customers, Pallab Chakraborty from Cisco and Jay Brutz from GE, two of the most insightful opinions you can hear about e-discovery in the enterprise.

Yesterday’s post about the top e-discovery software vendors prompted a couple of interesting comments. George Socha posted a response here, disagreeing with my conclusions; and someone else (“top8”, whoever that is) asked whether one should “always listen to the top 5-10 songs on the list…[or] use the top 5 software products, regardless of one’s situation.”

To clarify, I whole-heartedly agree with George that there is no such thing as a “best” e-discovery service provider – as George says, it really does depend on your situation and I can think of many cases where a smaller, less well-known firm is a better choice than a national brand.

But e-discovery software is different for 2 reasons. First, and most importantly, in software there are increasing returns to scale which do not exist for service providers. The more companies that use a particular software product, the better that product becomes. Speaking from personal experience, when you have a large number of demanding customers, they force you to make your product better – and give you the money to do it. That’s why most technology markets are incredibly concentrated: everything from databases (Oracle) to search engines (Google) have a single dominant player. We are still in the early days of the e-discovery software market, but ultimately I expect it will follow suit and consolidate around a very small number of players.

The second difference between e-discovery software and service providers is that enterprises cannot change their software vendors as easily as they can change their service providers. Once software is deployed behind the firewall, it is fiendishly difficult to get it out, requiring enterprises to pick a single product for all cases. By contrast, it is easy to change service providers, so enterprises can pick the most relevant expertise on a case-by-case basis.

To answer the question posed by “top8”, I am not suggesting that everyone should only read Harry Potter, watch American Idol, and (Heaven forbid!) listen to Britney Spears. Those are matters of personal taste where diversity is what makes for a rich, vibrant society. But there are very good reasons why so many corporations rely on Veritas for backup software, Oracle for databases, Symantec/McAfee for anti-virus, IBM for developer tools, and so on. In software, the best products only get better. That’s why, 5 years from now, the list of top e-discovery software vendors will be even shorter.