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.

First ZANTAZ, then Stratify, and now MetaLINCS – all within 5 months. The e-discovery space is consolidating fast!

On December 6, Seagate announced its acquisition of MetaLINCS. Financial terms were not disclosed, but my sources tell me that the price is $80 million. Given that MetaLINCS is a 50 person company with fewer than 25 customers , this is a fantastic outcome and I congratulate the MetaLINCS team. My educated guess is that in 2007 MetaLINCS will earn $5 million to $10 million in bookings, making this a healthy multiple of 8-16X. Contrast that to the 5X revenue paid by Iron Mountain for Stratify, and MetaLINCS shareholders clearly got a great deal.

That still leaves the question of why Seagate, a non-entity in e-discovery, would want to pay such a rich price. The answer, according to Seagate, is its desire to grow beyond manufacturing hard drives by having its services group provide a broad range of “solutions”, including archiving, back-up, recovery, and e-discovery. EVault, acquired last year for $185 million, is the backup and recovery part of that equation; MetaLINCS is the e-discovery component; and, say the analysts, don’t be surprised if an archiving acquisition is next.

Does Seagate’s entry into the e-discovery market make any sense? I don’t think so, and here’s why: there is a mismatch between Seagate/MetaLINCS and its target market. Seagate’s services offering will appeal most to mid-market companies which often outsource archiving, backup, and recovery. Seagate admitted as much when it announced the EVault deal. But the mid-market will be the last place to adopt e-discovery software like MetaLINCS; it is the Global 2000 who will move first, as they are the most sophisticated and in the greatest pain. For the limited amount of mid-market e-discovery business that is out there, Seagate/MetaLINCS will compete with every other service provider, from Kroll to Stratify to the hundreds of mom-and-pop shops across the country.

Net net: this acquisition is great for MetaLINCS, is small enough to be immaterial for Seagate, and will likely have no impact on the e-discovery market which will be won and lost in Global 2000 companies that are not interested in a Seagate/MetaLINCS service offering.

First ZANTAZ, then Stratify, and now MetaLINCS. It makes you wonder who will be next.

Thursday, December 6 was a big day for several e-discovery companies. Starting on the home front, it was Clearwell’s 3^rd birthday and we celebrated by announcing our deployment at Bear Stearns. Looking at where we are now, it’s hard to believe that 3 years ago the company consisted of a few guys with an idea. Today, we have over 100 customers who rely on Clearwell for e-discovery, and we are thrilled to count Ruben, Christoph and the team at Bear Stearns among them.

That same day, MetaLINCS announced its acquisition by Seagate (more on that to follow shortly), and Guidance announced the appointment of a new CEO. Victor Limongelli was promoted from President to the top job after what sounds like a comprehensive evaluation of both internal and external candidates by Guidance’s board. I always enjoy my conversations with Victor and applaud Guidance’s decision.

All in all, an eventful day.

To the long list of reasons why e-discovery companies should be good to their customers, we can now add one more: because if you don’t, they might blog about you and say nasty things. That’s what has happened to Metalincs on this blog Which carries the intriguing description of “legal software whistle-blower” in its web page address.

I have no idea who this person is, but their comments about Clearwell’s e-discovery solution are well-informed and accurate.