e-discovery 2.0

I knew the rumors about FTI’s acquisition of Attenex were true when we received a call in early May. It was from a large Attenex partner, who said: “We need to switch out Attenex no later than the end of June.” There have been many similar calls since then; as one service provider told us the other day, “I cannot imagine any Attenex partner not looking for other alternatives.”

The reason is obvious: Attenex Advantage partners – such as BDO Seidman, Deloitte & Touche, DiscoverReady, DTI Global Document Technologies, Forensic Consulting Solutions, Navigant Consulting, SPI Litigation Direct, VMAX Consulting and 10-15 others – compete directly with FTI. If they must now rely on FTI for their Attenex technology, it puts them at a massive disadvantage when competing for business. FTI could easily undercut them on price, since it no longer pays usage fees to Attenex; or, FTI could promise additional features in the Attenex product that its competition cannot match. It could certainly claim to be the world’s greatest Attenex experts (after all, who knows Attenex better than Attenex itself?). Perhaps worst of all, every time an Attenex Advantage partner works on a client using the Attenex product, it has to inform FTI at the end of the month so that it may be invoiced for usage, thus enabling FTI to track its client engagements.

Yes, FTI will likely make all sorts of promises about “Chinese Walls” and continuing to support other Attenex Advantage partners. But those promises are impossible to enforce (ask the editor of the Wall Street Journal!), and FTI could change its mind at any time, leaving service providers which depend on Attenex in the lurch. I don’t know anyone who would take that risk.

So the single greatest impact of the FTI-Attenex deal is that every other “Attenex Dis-Advantaged” partner needs to find an alternative e-discovery solution – and fast!

A second impact can be surmised from the market’s reaction to the deal. As the chart shows, FTI’s stock immediately popped 10%, adding about $300 million to its market capitalization. Partly, that’s because FTI negotiated such a great deal. It purchased Attenex for only 3.5x revenue, in a transaction that is neutral/accretive to earnings. Partly, it’s because FTI has a great track record with software acquisitions. For example, it acquired RingTail (a hosted review platform) in 2005 for $34 million, and today RingTail generates over 3 times that amount in revenue. Personally speaking, I have always been impressed by FTI’s team which is without doubt among the best in the business.

The interesting thing in this acquisition, unlike many others, is that the value will not come from selling the acquired product, since FTI is doing that already. In fact, FTI has been selling Attenex for years, and has even integrated it with RingTail. Rather, my guess is that FTI will use Attenex to grow its consulting business in several ways, such as:

1. By convincing clients to switch consulting firms, not technology. Let’s take a hypothetical example and say Ford is presently using Attenex through LECG. If LECG now uses a different electronic data discovery solution, then Ford is left with a choice: keep LECG and lose Attenex, or change from LECG to FTI and keep Attenex. Ford’s decision will, of course, be driven by many factors, and it will be interesting to see what happens in scenarios like this.
2. By winning a greater share of e-discovery dollars. Today, companies primarily engage FTI on life-threatening issues: stock option investigations, merger 2nd requests from the DoJ/FTC, and so on. By leveraging Attenex’s brand, FTI might extend that to also cover everyday e-discovery issues like run-of-the-mill litigation and regulatory inquiries.
3. By building an e-discovery footprint behind the enterprise firewall. Attenex has struggled to sell its product for on-premise deployment at enterprise customers in the past. Its website has no customer logos and I’m only aware of a couple of installations, neither of which is publicly reference-able. FTI’s strong consulting business might help change that and make it easier for enterprises to adopt Attenex.

I am sure there are other ways for FTI to get value from the deal that I am not smart enough to think of. My point is that, given FTI’s leadership talent and the scope of its consulting engagements, there are lots of things FTI could do with Attenex to create shareholder value far in excess of the acquisition price. That’s why I believe the second impact of the deal is that it will have a positive impact on FTI’s core business.

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 litigation support software company 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.

Learn More On Ediscovery Litigation.

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, e discovery 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 litigation 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.

Know more about Electronic Data Discovery & Electronic Discovery Litigation

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 keynote given by our customer, Jay Brutz from GE, one 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.

There are two independent analyst reports identifying the top ediscovery software vendors.

The first, published in June 2007, is the Socha-Gelbmann Annual Electronic Discovery Survey. The authors, George Socha and Tom Gelbmann, probably know more about e-discovery than anyone else you are likely to meet. As someone who has filled out their 178-page survey, I can tell you it is excruciating in its detail and incredibly rigorous. According to the report, George and Tom contacted nearly 1,000 individuals and collected detailed data from 115 organizations.

The second analyst report is Gartner’s MarketScope, which is published today (December 2007). Its author, Debra Logan, is fast emerging as one of the leading lights of e-discovery and has great instincts about the market. For her report, Debra tells me that surveyed 30 vendors and checked over 90 customer references.

The results from the two reports are as follows:

(1) Companies listed as “Top Electronic Discovery Software Providers Based on 7 Criteria” (Table 19 and 20), listed in alphabetical order. (2) Companies awarded ratings of “Positive” or “Strong Positive” (Figure 1), listed in alphabetical order.

Why are the lists so different? Primarily because of two main factors:

1. Gartner’s list mixes service providers and software companies whereas Socha breaks them out separately. The Socha report has an entirely separate list for service providers.
2. Socha’s report was completed 6 months earlier than Gartner’s. In that intervening period, several new players entered the e-discovery market. For example, Kazeon was ranked by Gartner earlier this year a “niche player” (lower left quadrant) in the enterprise search market, and has not been in e-discovery long enough to participate in the Socha study (or, if they did participate, they did not have enough e-discovery customers to gain a high ranking).

Conclusions

The first conclusion to draw from these lists is that any vendor not in them is probably not worth considering for e-discovery. If neither Socha nor Gartner ranked them highly, then the vendor either could not provide compelling customer references or has lost competitive bake-offs to someone who is on the list. Either way, they are best avoided.

The second thing that stands out is how different these lists are. Of the 21 vendors identified by Socha and Gartner, only 5 are ranked as top e-discovery software vendors by both of them. Those 5 are Attenex, Clearwell, FTI, Guidance, and LexisNexis. So, if you are an enterprise looking for an e-discovery solution, it is clear who you should call first.

Finally, it is worth noting that both these analyst reports are relatively new. This is the third annual survey for Socha, and the first MarketScope for Gartner. That speaks to the fact that e-discovery software is a new, fast-growing product area. More and more enterprises are adopting e-discovery software solutions, and asking analysts about them, because they offer such a compelling ROI.