e-discovery 2.0

Yesterday, I explained what I think Iron Mountain’s acquisition of Mimosa says about valuations in the archiving / e-discovery industry. Today, I will address the other questions that people commonly ask about the deal – why did Iron Mountain (Stratify) do it, and what does it mean for the electronic discovery industry?

In their letter to customers announcing the deal, Ramana Venkata (President of Iron Mountain Digital) and TM Ravi (CEO of Mimosa) point to two main benefits from combining the companies. On the archiving side, Iron Mountain can now offer Mimosa as an on-premise solution in addition to its existing hosted service. If it can integrate the two, then it can offer “location-independent” archiving which “will help you transparently and seamlessly move data between the on-premises data center and the cloud.” One additional benefit to Iron Mountain, which is not mentioned in the letter, is that it could even leverage Mimosa’s technology for its hosted offering, and replace Mimecast who it currently pays to provide this service.

On the e-discovery front, Iron Mountain now has a suite of 2 products and 1 service: Mimosa NearPoint for collection and preservation; the Stratify eVantage appliance for ECA (Early Case Assessment); and, Stratify Legal Discovery Services for review and production. This makes Iron Mountain a competitor to Autonomy, Clearwell, EMC/Kazeon, and everyone else listed in Gartner’s recent MarketScope covering e-discovery software companies. I’m sure the hope is that there’s synergy between the different products so that, for example, Mimosa’s experience in on-premise software will help Iron Mountain drive adoption of its new Stratify eVantage appliance behind the firewall.

Will the combination work? As Barry Murphy (a former Mimosa employee) points out in his excellent post on this topic, a lot depends on execution. But there are at least 2 reasons to be doubtful. First, the competition is far ahead, and will be hard to catch. As Barry, points out: “Iron Mountain will have a tough road ahead to compete with the likes of Autonomy, which bought successful archiving company Zantaz and has now had almost two years of development time for its hybrid on-premise/SaaS archiving offering.” The same is true on the e-discovery side, where companies like Clearwell have hundreds of corporate customers for on-premise ECA and review.

The second reason to doubt why the combined company will be any more successful than either were before the acquisition is that Mimosa and Iron Mountain Digital serve very different markets. Most of Mimosa’s customers are small to medium sized companies; most of Iron Mountain Digital (ie., Stratify)’s revenue comes from law firms. So it’s not obvious that by combining them you create a company well-suited to serving large corporations, which is the sweet spot for e-discovery and archiving.

It will be interesting to watch events unfold.

Learn More On Litigation Support Software & Electronic Discovery Litigation

On February 21, Iron Mountain Digital (formerly Stratify) announced it had acquired Mimosa Systems for $112 million. The deal was widely rumored at LegalTech New York last month, so it came as no surprise. I know several people closely connected with Mimosa and I’m happy for them that the company has found a good home.

From an industry perspective, there are two interesting questions about this deal, and I’ll cover the first of them in this post: what does the price suggest about the valuation of archiving/e-discovery companies?

To answer that question, you have to consider Mimosa’s history and financial performance. The company was founded in December 2003, and proceeded to raise $51.5 million in venture funding over 5 years from Clearstone Venture Partners, August Capital, JAFCO, Mayfield, and few others. Initially, it had great traction in the market and, at various industry events around Silicon Valley, I would often hear about how well it was doing. But then, as often happens with startup companies, Mimosa lost its way, and the growth slowed. I don’t know exactly why that happened; it could have been the recession, competition from Microsoft Exchange 2010’s new archiving features, or something completely different. But the signs were unmistakable: there were layoffs, pay cuts for the remaining staff, and (according to Venture Source) a series of 4 small debt financings totaling $10.4 million between May 2009 and January 2010.

The deal documents, which were sent out to all shareholders to approve the acquisition, reveal the financials. In 2009, Mimosa generated $20.6 million in revenue and $32.7 million in expenses, meaning it was burning about $1 million dollars every month.

So, to answer the question that many in the archiving / e-discovery community are asking, that means Iron Mountain Digital paid 6 times trailing revenue to acquire Mimosa. That’s about the same multiple it paid for Stratify in October 2007, about the same multiple Dell paid for MessageOne, and a lower multiple than EMC recently paid for Kazeon. It is reasonable to expect that the revenue multiple would have been much higher if Mimosa had been profitable, or growing more quickly.

Overall, I think this is a great outcome for Mimosa’s shareholders who must be delighted. My congratulations to them, and to the entire Mimosa team.

In the past couple of weeks, I have spoken to several people close to the Iron Mountain-Stratify deal, and it has been interesting to hear their different perspectives.

The one thing they all agree on is that, as a business, Stratify was doing well. From a combination of news reports, Iron Mountain’s statements, and my various sources, I learned that Stratify’s revenue grew from $24M in 2006 to $30M this year. That is below the $40M+ it forecast earlier in the year, but healthy growth all the same. Gross margins are an impressive 60-70%, which is great for a services business, and profit margins are 20-30%. The vast majority of its 110 customers are law firms but – I know from personal experience – it has had some success in the enterprise. Net net: Stratify was in pretty good shape.

But at that point, opinions begin to differ. I heard 2 competing interpretations of the acquisition:

1. It’s a good deal for all sides

This was my initial reaction and the topic of a blog post written on the day the deal was announced. It has since been echoed in the press and by the analyst community. The story goes something like this:

Everyone wins from this deal. Once you factor in assumed stock options and retention packages along with the $158M that goes to existing shareholders, Stratify gets a multiple of 5.5X current year revenue, which is high for a services business. It also gets to operate autonomously under the Iron Mountain umbrella, with (supposedly) minimal interference from back East. For its part, Iron Mountain gets a growing, profitable business which it can grow more quickly, by selling into its installed base, and more profitably, by leveraging its existing sales force.

2. Stratify sold too cheap, too early

Why sell a profitable, growing business, especially one in a rapidly growing market like e-discovery? Given its growth trajectory, won’t an independent Stratify be much more valuable in 2-4 years time than it is today? Why repeat the mistake made by shareholders of VMWare and MySpace, who sold billions in value for a few hundred million?

The answer, say people who hold this view, has nothing to do with Stratify’s business and everything to do with its shareholders. On the one side, Mobius, the venture capital firm which owned 70% of the company, wanted out – the firm is winding down, some of its partners are raising a new fund and wanted an outcome to boost their VC track records. On the other side, the founder was tired after 8 years slugging it out and wanted a payoff. The business is not suitable for a financial buyer (sales are too lumpy and unpredictable, making it hard to take on large amounts of debt), so an acquisition was the only option.

With the benefit of more time to digest the deal, I have come to feel that both views are in fact correct. It’s a good deal for all sides, even though there’s a strong case that Stratify sold too early. Regardless, there’s still a lot for the Stratify team to feel good about – and, following the MySpace example, they can always go back and ask for a pay rise.

After months of rumors that Iron Mountain was going to do “something”, the grandfather of records management announced today that it is acquiring Stratify for $158 million in cash. My best guess is that Stratify will do about $30 million in bookings this year, making the purchase price about 5X revenue – a pretty good multiple for a services business with gross margins of 50-60%.

Iron Mountain’s motivations are not hard to guess. It stores oodles of electronic data for large corporate clients. Whenever those clients have a case, they retrieve a subset of that data and send it off to a service provider like Stratify for processing. Through this acquisition, Iron Mountain now has a chance to up-sell its customers on Stratify and capture that service provider revenue for itself. This will be compelling to customers if (and this is a big “if”) Iron Mountain is able to integrate Stratify with its archive, making it easy to pass data from one to the other. As one Iron Mountain customer at a major Wall Street bank told me, “Iron Mountain is great about getting data in; it’s awful when you want to get data out.” If Stratify can help solve that problem, even if it’s only in the case of litigation, then every Iron Mountain customer will cheer.

Given the obvious potential of this deal to Iron Mountain, the question is less about why they would want to acquire a service provider in general, and more about why Stratify in particular. E-discovery services is a large, fragmented market, and there is no shortage of players to choose from. That said, I think they found Stratify a compelling target for 3 reasons:

• Good Technology: Unlike many service providers, Stratify (or Purple Yogi, as it was originally called) started life as a product company. It went through several incarnations: starting out in 2000 to “personalize the internet” for consumers, it soon moved on to knowledge management for corporations, before finally settling on e-discovery services for law firms. To fund all this, it raised over $30 million in venture capital and invested a good chunk of that in product development. The result is a sophisticated product that goes far beyond the review platforms that most other service providers have built.
• Right Size: Many acquirers like companies in that $20-30 million in revenue range. On the one hand, they are big enough to provide a solid platform for growth; on the other, they are small enough to be affordable. When Iron Mountain analyzed the market, it will have found the vast majority of targets either too big or too small, leaving it with only a handful of players to consider, like Stratify, Cataphora and H5.
• Willing Seller: It is no secret that Stratify’s largest shareholder, the venture capital firm Softbank, is winding down and was looking to sell its stake in the company. That, together with the inevitable fatigue that sets in after 7 years of slugging it out, most likely made Stratify a willing seller.

So, on paper, this is a good deal for both sides. Stratify gets a decent return for many years of work; Iron Mountain gets the chance to capture more revenue from its customer base. My congratulations to the Stratify team – I have huge respect for entrepreneurs who weather the dark days, re-invent their company, and lead it to a successful outcome. I wish them well on their new adventure.