Are Upcoming IPOs LegalZoom and Intapp Worth a Look?
In this episode of Industry Focus: Wildcard, Motley Fool analyst Asit Sharma joins host Nick Sciple to break down the S-1 filings for LegalZoom and Intapp, two legal tech companies targeting very different segments of the market. Plus, hear some tips on how to approach new IPOs and what to look for in their S-1.
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This video was recorded on June 9, 2021.
Nick Sciple: Welcome to Industry Focus. I’m Nick Sciple. This week we’re taking a look at two upcoming IPOs in the legal tech space, LegalZoom and Intapp. Joining me to break it all down is Motley Fool Analyst, Asit Sharma. Asit, thanks for joining me.
Asit Sharma: Nick, thank you for having me. Always love to join you and talk shop on this podcast.
Sciple: Yeah, it’s great to have you here, Asit. You’re always one of my go-to folks when it’s S-1 time. You’re a big fan of looking at new IPOs. When you see an S-1, what do you look for? What are the first things you go to when you get that document?
Sharma: Nick, one of the very first things that I look at besides the business description, I should say, maybe that’s the first thing I look at. There’s a section required by the SEC called “The Business.” In this section, management gets its one chance to give investors that first impression of their company. I look to see how well they’re doing with that job and if it’s easy to understand, I should say that is the very first thing I do. But right after that, I’m always curious, why has the company come to market? Why not stay private if it’s growing so well? These investor presentations, they’re always touting how well the company is growing. Why would you even bother? There are good reasons to come to the market. Maybe you want to create a new market for your shares to do follow-up offerings, secondary offerings in the coming years, you want to introduce your company to a bigger set of investors versus private investors.Â
There’s so many reasons and you may want to actually raise capital, get money from the public to put it into new ventures. That could be working capital needs, it could be maybe acquiring other companies, and I look for yellow flags here. Maybe a company is coming public to bail some of the borrowings that it’s undertaken. This is another section of S-1 called use of proceeds that I always look at. Other than that, the things that any common sense investor would want to take a look at. Who’s running the show? How long have they been with the company? What’s their ownership stake in that company? What is the technological advantage, if there is one, that the company is bringing to market? So many S-1s that we’re seeing over the past few years have a technology component. It’s rare that you see a company these days, Nick, that doesn’t bring that to the table.
Sciple: Yeah, I think the idea of technology companies and everything else, that dichotomy is very much dropping away. If you’re a company that doesn’t have tech integrated in your system, you’re probably losing ground to the competition. But maybe tease things up when we talked about technology moving into some of these spaces. LegalZoom is a company that’s been part of that. They, just last week, filed their S-1 paperwork to go public on the Nasdaq with the proposed ticker, LZ. Still some blanks on that S-1 to be filled in, but we do have some basics about the company. They describe themselves as a leading online platform for legal and compliance solutions in the United States. I think if you’ve listened to a podcast in the past five years, you probably heard of LegalZoom. Asit, looking at this filing off the tub, what jumped out to you?
Sharma: First of all, I was not surprised that the company was founded in 2000. Investors, including Robert Shapiro, they’ve been around for a while. Robert Shapiro is a pretty well-known attorney. This mission that the company talks about in its mission statement, they want to democratize law, that makes a lot of sense too. If you have listened to one of these commercials, what this company offers is essentially a do-it-yourself type of legal document which state-by-state passes enough muster that they don’t cross the line in giving legal advice to provoke the ire, I think, of governing legal bar associations, and they do it pretty well. They have really evolved into a subscription platform, so they are a Software-as-a-Service company.Â
The first thing that jumped out at me is, even though I understand what this company does, you can go online and create a will for yourself without the help of an attorney as in many states, what I really get out of this is this is not a lot different than SaaS, software as a service business models that we look at every week, that are coming out. I want to read from something that you clipped in our notes to this, Nick. Our platform helps new businesses form. Once a small business is formed, we offer subscription services to protect the business, its ideas and the families that create them. Right here, what you’re seeing in the nugget is the origination of each sector of its eventual markets, protect the business, we all get that, its ideas, that’s intellectual property, the families that create them, so there’s another vertical set of services that are aimed at the people who are creating that business. If you take this concept, you can see how the company has a very tremendous market, which we’ll talk about. Now, how much of this market is really truly accessible? I’m going to lean on your advice, but Nick, as someone with a legal background, what did you think about the way this company is structured and the way it offers its services?
Sciple: One of the things that really jumped out to me is just how meaningful their brand is and how strong a brand they have in the space. Some of the figures that they cite in the S-1, 10% of new LLC filings in the U.S. in 2020, handled by LegalZoom, 5% of new corporate formations, super meaningful. Two thirds of the small businesses that are formed through LegalZoom in 2020 had not begun operations when they did business with them. Also, 60% of customers who form a business with LegalZoom also attach some of these other subscription models, whether it’s for trademark issues or stay plans or taxes or anything like that. Their approach makes sense to me in the sense that, when you’re starting a business, you want to protect liability, set up your LLC, wall off your business assets from your personal assets because businesses are risky things. Attaching with customers at that point makes some sense and also offers an opportunity to attach some of these other revenue models on whether that’s trademark filings or the like.Â
One thing that I do think is challenging for LegalZoom or makes the environment something complicated to navigate is, as you mentioned earlier, the practice of law across the U.S. is regulated state-by-state by bar associations. There’s a couple of limitations there. One is, if you’re not a licensed attorney, you can’t practice law. What that really means is you can provide forms, you can provide basic educational information around, these are the considerations you should think about when forming your business or taking on trademark protection, or what have you, but you can’t offer personalized advice. Just like we can offer personalized financial advice, we can offer personalized legal advice, say, hey, for your particular businesses, this is what you need to do for your trademarks, so it really limits the services that LegalZoom is able to offer and exposes them to some risks.
Throughout its history, there have been various times where folks from bar associations have gone after LegalZoom accusing them of authorized practice of law, offering too much custom advice, and they say in their filings that, “We anticipate that we will continue to be a target for such lawsuits in the future.” There’s a tension here, where I think on the customer side, there’s a lot of attraction to a flat fee model for forming your business, a lot of attraction to something that I can access simply through the Internet. But on the side of the legal field, there’s a lot of resistance to LegalZoom building out its offerings. They have built out a network of independent attorneys across the country and tax advisors they can refer folks out to, but again, you’re in this gray area when it comes to what you’re allowed to do practicing law. Because of those regulations, it actually illustrates why there’s so little online services. From the S-1 it says, according to the ABA, American Bar Association survey, 8% of legal services in the United States conducted online in 2020, this is when everything is locked down, compared to 70% in the financial services industry, 30%-45% in healthcare services. Another survey from the American Bar Association, 40% of solo attorneys don’t even have a website. There’s just not a lot of tech in the legal industry, partially because of the restrictions on folks practicing law.Â
One other thing to mention is the ethical restrictions prohibit non-attorneys from owning stakes in law firms. That’s another complication. The fact that LegalZoom is coming public and it’s going to be owned by public shareholders, by definition runs at a foul of the idea that non-lawyers can’t own law firms. All that to say, I think the brand that LegalZoom has is incredibly strong in this space and I think to the extent regulations relax in the future, which I think they are likely to, given the pressure from customers, LegalZoom is in a really strong position to take advantage of the move of legal services to more online. The example that comes to mind for me is, if you remember DraftKings a few years ago, when they were on a little bit of a legal edge when it comes to DFS, actually their merger with FanDuel got scuttled because of some legal issues. But then whenever the Supreme Court removed restrictions on sports betting, they had such a powerful brand and the market opened up so much that they really thrived in a really significant way. I think when I look at LegalZoom, that’s where I really see lots of potential is to the extent that restrictions are lifted on practice of law and they can really go after more of the providing direct legal services to folks. That’s where things get really interesting and this company becomes a rule breaker. For right now, I think they’re a super strong brand in the space, offering what they’re doing, but it’s hard for me to see where they’re going to launch after hypergrowth.
Sharma: Yeah. I can see this company being a strong grower for years to come, maybe not hypergrowth. One of the things that’s interesting is that this economy over the last, I would say 40-50 years has turned from a manufacturing based economy to a consumption based economy. Then in the last five years, of course, we’ve become more of I think a technology based consumption economy. Over the last year, we have seen an acceleration in the potential for the gig economy portion of total gross domestic product. All of the people who were uprooted during the pandemic in terms of losing jobs or maybe searching out different careers, and the people who maintain their jobs remotely, but now don’t want to go back to a physical environment and are thinking of maybe expanding a side hustle they picked up during the pandemic. These are all trends that are accelerating the entrepreneurial aspect of our current economy, the state of our current economy.Â
What this means for LegalZoom is that if they never get that opening up of regulation, they still have a market that’s going to grow at a decent rate, compounded annual growth rate for the foreseeable future. We should talk about the market opportunity that management sees. I love Nick’s opinion picking this apart a little bit. They say that their total addressable market and this is serviceable addressable market, or SAM, you’re used to hearing total addressable market or TAM for non-service businesses. It’s basically the same thing. It’s about $48 billion. Out of that, they see that $18.3 billion exists in services that small businesses use at the time of business formation. This is important when I look at this company because I do see a trend of people deciding they don’t want to work in the office anymore. We’ve already seen corporations, especially middle-market corporations and large corporations, become more and more comfortable with having fewer employees and more contractors. Well, if you are a contractor of a big company, let me take IBM just off the top of my head, versus being an employee, you’re running your own business. At some point in time, if you’re making enough or if you add on another company, let’s say, your work with IBM decreases, then you are really in a position of what’s called a different tax situation versus being an employee. What that means is that you need to think through perhaps incorporating as a single member LLC, maybe remaining as a sole proprietor and having a scheduled SE on your tax return.Â
But what does this also imply? It implies that you’re going to become more knowledgeable and start thinking about what you do with those returns each year, and how that affects your legal implications, how it affects any trust implications once you start thinking as a business owner and then thinking about preserving your assets. I see this trend going on for a long time. Now, to continue on this market opportunity, they also see $21.5 billion in services that small businesses use later in their lifetime. As you grow, you begin to need additional legal services just as you need additional tax services. I should say, Nick, this reminds me of a company that is really good at providing a similar level of service in the small business world, not the legal portion of it, but bookkeeping, payroll taxes, etc. That’s Intuit, the owner of TurboTax and a lot of personal finance, smaller companies under their umbrella. They’re very good at pulling people in. Let’s say you are a sole proprietor or you’ve incorporated as a business, they help you do your tax return. If you have a more complex need, they have a network of CPAs and other other types of accountants and bookkeepers that can help you so that they don’t lose you as a customer. That’s what LegalZoom also has a talent for.Â
They have, as you mentioned, Nick, a network of attorneys, so when you cross that line between just filling out a legal form and needing true legal advice, they can provide that and keep you within that umbrella. Lastly, they see $8.8 billion in consumer state planning services and this is what I was referring to earlier. As you build wealth as an entrepreneur, you start thinking ahead, how am I going to pass this money on to my heirs? When you start seeing the end of that cycle of opportunity and maybe you decide to retire and move on. This is a natural evolution from a person who sees themselves as a small business owner or an entrepreneur. They follow you through the whole growth cycle and they have a service point at each part of that cycle. They may not ever reach hypergrowth if the regulations don’t change, but I could see them being a steady company that let’s say has double-digit revenue growth over the next several years and could be a persuasive buy if you like the software-as-a-service business models, which I’m a fan of that capital-light type of business model.
Sciple: Yeah. I will say I’m a little skeptical on the size of that serviceable addressable market, particularly on the consumer estate planning services. Just because I think most of the value of that estate planning, it’s going to be biased toward the folks with very complex estates that need meaningful legal services. By definition, LegalZoom is not going to be satisfying those types of super complex estates on account of they’re complicated enough that you need to get a lawyer looped in there and there’s a lot more complex things going on. I think they’re probably a little bit generous on the serviceable addressable markets. It’s going to be folks who have very, very basic needs, that once you get past a very low level of complexity, I think you’re going to want to move to a more high touch legal advice. I talked to some of our in-house attorneys here at The Motley Fool and they basically said the same thing is that if I got past a minimum level of complexity, it would probably be looking out for a full service attorney, which is why I think to the extent we can remove that barrier to offering full services when things get really interesting. But when we look at the business, today Asit, and we look at the financials, why they’re raising the money as you mentioned off the top of the show, what jumped out at you in the financial numbers reported by LegalZoom.
Sharma: There’s one thing that is so big that you almost have to focus on it first. That is that the company has a lot of long-term debt for the size of their balance sheet. If you look at total assets on the books, that’s about $200 million, they have total liabilities of almost $700 million. The difference is in $515 million of long term debt. This is one of the things that I’ve learned over time, Nick, not to be too scared off from if a company has a plan to reduce the debt through their public offering. Once in a while, you see companies that are controlled by venture capitalists and private equity firms that are basically just shoving off a bad business model onto shareholders and those investors are getting out, you’re saddled with the debt as an owner of the business if you buy into the IPO or post-IPO. This doesn’t seem to be quite that case. What it looks like to me is that LegalZoom has some very strict covenants on its debt. It’s high-interest debt and they’re saddled by this. They have to allocate a certain portion of their cash flow to stay within leverage ratios that are stipulated by their debt covenants. If they can raise some capital to refinance a little bit of that, this should help appreciably with their bottom line. In fact, it’s the debt service or the interest component of that debt service, which is keeping this company really from being profitable because on an operating basis, they’re pretty decent.Â
In 2019, the company had revenue of about $408 million and they had operating income of $46 million. In 2020, the company generated $470 million in revenue and had about $49 million in operating income. But in both years, you had interest expense in 2019 of about $39 million and you had interest expense of $36 million odd in 2020, which really reduced the net income. After you figure in tax effects and other income, they had net income of just $7 million in 2019, about $10 million in 2020. Now, what we have in exchange for that is a company that is growing at a fairly decent growth rate and they are getting to the point where they’re really starting to generate scale on their operating cash flows. Operating cash flows for all of 2020 were $93 million. That’s a really nice jump from $53 million in the prior year. If they can raise enough capital to pay down what is really a term loan from 2018, that’s the specific piece of debt that bothers me, they could start to reinvest in the company a little bit more significantly than they have. I think this may have been a limiting factor on your growth. When you’ve got a large piece of debt service, Nick, that can hold you back because you just don’t have the cash to plow into areas where the growth is. But that’s what leaped out at me on these financials. What caught your eye when you were skimming through these?
Sciple: Yeah. I think those are some main things also. The executive comp is pretty high, so the CEO, CTO, and CFO each received an excess of four million dollars in compensation last year, which is a lot. There were a handful of material weaknesses in accounting about not maintaining effective controls. That’s always something you want to control F-4 in these documents to see what’s going on. Sometimes you’ll see these pop-up and companies coming from private to public, but always something to watch, and to your point, Asit, to the extent that interest expense is detracting from marketing they can put forward, it really seems to me to be a lifetime value to customer acquisition business. You want to acquire customers as long as you can and then keep them around and attach these other services, and so the main driver for a business like this, and as we mentioned at the top, you probably heard about them on a podcast is things like advertising. So to the extent, interest expense is taking away from the ability to push more on advertising to grow the business, that’s not good. For me, what I’m really looking for is, how can I get that debt situation under control? Do they get the material weaknesses corrected?Â
Then, also there’s significant private equity ownership here with this company that’ll be an overhang when the company comes public. All that to say, I mean, for almost any IPO that I look at, I want to watch it for a few quarters, but I think in particular here for LegalZoom, I would want to sit back and watch. See how they handle becoming a public company, see how they get the balance sheet issues under control, see what happens when it comes to some of these potential regulatory/legal issues that are going to pop up from time-to-time for the company. I think to the extent those things happen and the shares rerate, that might be an interesting buying opportunity for me. But I think this is one where I really like the brand. I think there is a strong trend toward folks wanting to do more of their legal work themselves, particularly on the low-end and the attractiveness of a flat fee, but execution is no easy task, I think in this space.
Sharma: I agree, and I think we should mention this before we move on to our next ticker. I think we both forgot to just give the numbers here. The revenue growth rate is solid, double-digit. In the last year, revenue increased about 15% over 2019. In the first quarter or actually this most recent quarter, I’m not sure if this is the fiscal first quarter, they had revenue growth of 27% year-over-year. Now, we need to understand that LegalZoom, like a lot of other companies, got a COVID boost, and a lot of businesses that were formed as people were stuck at home. You’re going to see that growth rate normalize, but here what we’ve got is a company that maybe is growing normalized in the mid-teens, and it has a lot to like, but as Nick mentioned at the beginning of the podcast, we’re at the fill-in-the-blank stage on the S-1 statements, so we’re going to see exactly what the ownership percentages are for management. We’re going to see how much these private investors own of the company. Lots of other details to come. Even not having seen those, Nick, I’m landing where you are, that this isn’t one that I am itching to buy, right after it goes public, but I will certainly keep it on the watch list. It’s a good market, and if we see some regulatory movement that allows them to play a little bit more of a hands-on role with what they offer to their customer base, sure. It could be, as you say, a company that moves from solid mid-teens growth to hyper-growth, and that would make it a lot more interesting.
Sciple: Yeah. Lastly, I always like using David Gardner’s Rule Breaker framework. It’s a big part of The Motley Fool approach. I think, pretty healthily, it checks off the top dog and first mover, No. 1, and I think you could argue, it has a strong spot and strong consumer appeal. No. 5, I think I do have some questions about how sustainable the advantage is as more and more tech moves into the space. The management, I want to see them show me a little bit when it comes to that. But moving on from LegalZoom, which is one sector of this legal tech market, let’s move on to Intapp, which also dropped its S-1 filing last week, proposing to go public on the Nasdaq with ticker I-N-T-A. This company has also been in business for 20 years, similar to LegalZoom but playing in a different space than LegalZoom.
Sharma: Their mission is to, and I’m quoting, “Enable professional and financial services firms to better connect their people, processes, and data through AI-powered software solutions.” Think about big law firms, big accounting firms, big consulting firms. How do you manage relationships with your customers? How do you protect very confidential information? Things like this are enhanced by artificial intelligence. How do you work with documents interchange between yourself and your clients? We’ll talk about how this works in a legal setting and also in professional services and consulting as we go along. Think about the machinery required for a big firm to operate well and operate efficiently. This is what Intapp does also on a subscription basis. But Nick, you pointed out something very interesting in the page where they were trying to explain their business. I found this very amusing. Can you read this?Â
Sciple: Yeah, I went to their about me page on their website to see, “Hey, what does this company do?” I’ll read this and you tell me what you think they do. Intapp provides best-of-breed connected firm management solutions to the professional and financial services industry, powering the world’s largest private capital, investment banking, legal accounting, and consulting firms. Intapp technology has transformed these industries with intelligent Cloud-based solutions purpose-built for the complexities of partner-led firms, operationalizing the entire relationship life-cycle from strategy through origination and execution. Can you translate that to English for me, Asit?
Sharma: Unfortunately, I can’t, Nick, and that’s why I found this so funny. I mean, to be frank, maybe I could a little bit. [laughs] Here’s my attempt at a translation. But we should say, this is not the way to present your company on the web. This is gobbledygook. It’s so full of corporate jargon that even people who analyze companies for a living and have to read through this stuff, yourself and myself, we don’t get this, but I’m going to try. We provide the best software that connects firms to each other within these different industries. Our technology, which is there in the cloud, driven by artificial intelligence and machine learning, has been designed specifically for the parts of these relationships which are very complex to make it easier for companies to transact with their customers. We do this from the very beginning when you were trying to scout and make deals to the end of your relationships with these customers. Whether you are a private equity firm, an investment bank, a venture capital firm, a law firm, an accounting firm, or a consulting firm. That’s what we try to do, and see even my condensed explanation isn’t much better because this is just so fake.Â
Sciple: The basics of it is in these industries when you bring on a client, it’s a whole list of processes you have to go through. No. 1 is you ought to make sure that you don’t have another client that you work for that’s an adverse party because they’re going to disclose confidential information to you, and so you have to make sure that you don’t have any conflicts of interest in place. That can be incredibly complicated, especially when you talk about some of these firms that have hundreds, and hundreds of lawyers. Lots of firms with 500+ attorneys, you have 500+ relationships all over the world that you have to navigate. Also, you have to build these clients, and various clients can have very particular billing requirements and services and things like that.Â
The other thing is, you can look at, “Okay. We’ve done business with these people in the past. How long do these projects tend to take? How much staffing should we allocate to this project? What should we charge these clients?” that sort of thing. Intapp’s software helps to solve that for you. Another thing that they talk about is they have a law code personalized user interface that helps work for every particular law firm. That jumps out to me because you think that every law firm is its own unique business, or every particular type of private equity firm is unique in its own special way. The environment that I think maybe parallels to me or that came to mind as a comparison, is there are some companies that operate in government software and you have these same types of things. Every government is unique in its own special way. Governments tend to be managed by people who are elected versus people that are maybe experts in some of the industries they operate in. If you look at these partnership-based businesses like law firms, who have a managing partner who is an attorney, who is running the business operations of the company and trying to stand up some of those operations, it is kind of complicated. It’s one of these things where you need a service that can scale across the world.Â
There are some similarities for all these applications, however, every particular entity is unique. To just give some context on their client base and who they offer services to, they have 1,600+ clients, 96 of the MLaw 100 law firms are their customers, seven of the top eight global accounting firms, 900+ private capital and investment banks. The way I think about it basically, is if your company is like dude and some other dude, you probably have a relationship with Intapp. On the software side, if you bill by the hour and have to do a conflicts check for your business, you’re probably someone who might get some benefit from Intapp. What do you make of the customer base opportunity here for the company, Asit?
Sharma: I think it’s a really good customer base and a large opportunity. I especially like that they are focused on deal flow, so the products you were describing before, they’ve got two main products. One of those is called DealCloud and that rests in the financial services industry. Deal transactions are extremely complex among larger companies, so you have a whole phase. One great example [inaudible] is mergers and acquisitions, one company acquiring another. You have a whole phase of due diligence that you have to go through to understand the company that you are buying and make sure that what you are looking at checks out. You’ll have, in a typical deal, a lot of the investment in understanding the information one party is presenting to another, and the software is geared toward this. Again, they have that AI component which is going to root out inconsistencies, places that an investment banker should look for an acquirer, let’s say it’s a principal or a private equity firm. The fact Nick that they’ve got all of these in different industries, the top firms, speaks well to their market. No. 1, it says that they probably have already addressed most of their market and now it’s a question of expanding where they’ve landed. But two, I think that this is really good for the layer just below the largest companies in the space, because what this is is like LegalZoom. It levels the playing field for the budding entrepreneur who doesn’t have $2 or $300 an hour to pay a local attorney to make all of his or her documents.Â
In the same way, Intapp provides to the middle market company, that is a smaller company’s revenues could be anywhere from a few million dollars up into the tens of millions. It allows them to have the same infrastructure that the top firms have built in-house. The top firms, like you mentioned, the 96 of the MLaw 100 legal first, these companies were developing technology in-house then they became subscribers to Intapp, but Intapp is available to much smaller firms that just don’t have the money, if you are let’s say a private equity firm, to build a due diligence document flow that is enhanced by machine learning to help you keep that edge. I really like that aspect of it.
Sciple: Likewise. As I mentioned earlier, it’s not your core competency. If you’re an investment banker and you became a partner in an investment banking firm, your core competency is not writing software for conflicts checks, likewise, for the managing partner of any of these big law firms. Just like the example I laid out for government software, this is one of these things where it makes sense to outsource to some other provider. The other thing to think about is clients are getting more and more demanding of lawyers when it comes to what they offer from the tech side. You talk to any lawyer and they’ll tell you, yeah, we used to send out a letter and it would be a week before I’d get it from the client, then I’d have a week to respond and then they’d have a week to respond back to me. Now we’re in an environment where it’s always on, always working, and there is increasing pressure on law firms to be more and more efficient, squeeze down costs wherever they can, and to the extent Intapp can help with that, it’s all to the good for these firms. Makes things easier for them and lets them squeeze out some efficiencies from the business. Let’s move on to the market and the financials for Intapp. Intapp says their serviceable addressable market is much smaller than that laid out by LegalZoom.
Sharma: It is, and maybe, Nick, it’s a more realistic market though. They say that their total addressable market is $9.6 billion, and they attribute about $6.5 billion of that to those large firms with over 500 employees. Now, Nick, you had some thoughts on this. You’ve got a legal background, is this realistic or are they also inflating even this? As you pointed out, LegalZoom might be stretching to say that they’ve got the $8 billion opportunity just in the states and trust.
Sciple: Asit, what do you make of as Intapp establishes these relationships with customers or with individual practice groups and then it’s able to cross-sell to other parts of the business? What do you make of the potential there for Intapp to grow its market and deepen its relationship with customers moving forward?
Sharma: I actually like this opportunity and I would suggest that those of you who might be scared off by the idea that their total addressable market is maybe around $6 billion. Take another look, there is something funny that happens in valuation of small companies that are growing at a double-digit type of growth rate. At some point, the market starts to focus on how much annualized recurring revenue you have and what those numbers could look like, how stable it is, is another big thing that plays into public company valuations. Nick, you had pointed out in our notes that those 100 largest clients represent opportunities in excess of $1 billion in annualized recurring revenue per year. Even if they just tap what they have with these 100 largest clients, that is something that will be very beneficial for the future cash flows of the company and it is certainly something that will help the valuation of the stock as it trades public, of course, in the near future, looking ahead several years into the future. I think that this is something to pay attention to. I’ve seen this repeat over and over. I can name some big companies like Salesforce.com or ServiceNow whose growth rates slow a bit. Autodesk is another example of this phenomenon. Even so, as that annualized recurring revenue pile gets bigger and bigger, investors like nothing better than to sleep on those cash flows. So, the stock has the chance to expand on that. This relatively smaller market opportunity doesn’t bother me as much simply because they’re into so many market clients among these really well-health industries. If you think about financial services, also, the legal profession, the accounting profession, it’s a sweet spot to be in. We just don’t see many companies that play in this space that we have a chance to invest in.
Sciple: Right. You mentioned that opportunity they call in the S-1 that, listen, if just our top 100 clients took our service, took it across the board and put it for all their employees, we would have $1 billion in annual recurring revenue. Let’s compare that to what? They’ve got an annual recurring revenue right now, Asit. We had $201 million in trailing 12 months revenue for March 31st, 89% of that is recurring. You’re looking at a $150-, $170 million range of recurring revenue. They look through opportunities to get up to $1 billion if customers continue adoption. Seems pretty good, right?
Sharma: It does. Now, if only the rest of the picture would catch up, which I think it will. But to me, this is a really nice part of their total revenue. I love the fact that that piece is growing at 32% year-over-year. Now, the rest of the story is that they’re running at a loss, they had revenues last year of what, 24 million. Is this right, Nick, about 24?
Sciple: That’s in the professional services business. I’m sorry.
Sharma: Professional services. Let me go ahead and flip back for those of you listening. I was looking in the wrong place. Let me cite the correct figures here. We’ll take the nine months ended March 31st from the S-1 that they filed, total revenues of $154 million for those nine months. But they had a net loss of about $31 million off of that. That is because for now, even though the company has a pretty decent gross margin, they are pouring a lot into sales and marketing. The cost of the services is undercut a little bit by the need to provide support revenue for their professional services, and that runs at a loss. If you think about it, this is like a customer service investment, which will help as they teach people in these larger companies about the software and its capabilities. We call this a consulting loss in the Software-as-a-Service business, and that’s one of the things that’s dragging down the bottom line. Gross margins could probably be fatter, but they are taking an investment now in order to provide more opportunities to expand within these clients in the future. What they need now, I think Nick is some ability to scale and get some operating leverage out of this picture.
Sciple: Absolutely. Attaching these other services, they’ve invested to build the relationships. Another thing is the cost of recurring revenue grew faster than the recurring revenue itself during 2020. Hopefully, these are investments to deepen customer relationships and position the company to make those attachments of adjacent revenue streams and build up to that $1 billion number they are telling us about in the S-1, negative operating cash flow. We’re still waiting to see this turnaround. But with this land and expand model, we see this a lot with SaaS companies. It doesn’t mean that things aren’t going to work out in the future, but it does mean that there is more execution ahead to get there. It is reassuring to me that two of the founders are still at the company as the XVP of technology and chief product offers. This officer, these are the folks leading product investments. Like we mentioned with LegalZoom, there’s also a big private equity ownership here as well that we don’t have all the answers on what’s going to happen with them and what their positioning is.
Sharma: That’s true, and I know for a lot of people that can be a dealmaker when you see private equity ownership stick around after a company goes public. Right now there are two big private equity companies, Anderson Investment and Great Hill Partners, that are big funders of the company. They’ll be around for a while. Of course, there’ll be a little bit of a lock-up period after the IPO, and you’ll be able to track if they decide to sell some more shares after that. But I think with two co-founders, this upcoming project has been around for 20 years, as you mentioned, Nick, that are still very much involved, especially on the product side. That jump hole as chief product officer, that bodes well for the company’s product development. Also this whole advantage that we’ve been talking about, the competitive advantage that they are in these big companies, now the job is to expand. I think all in all, they’ve got some opportunity that hopefully their public offering will be able to leverage. They’ll take some capital in on their balance sheet and invest in new products and whatever parts now of the lower markets that they don’t already have a good visible ramp into at the middle market, which I keep talking about. They’ll aim some of their sales artillery in that direction as well.
Sciple: Yeah. Any last thoughts on Intapp before we give our final rulings here on Intapp and LegalZoom.
Sharma: Let’s give our final rulings.
Sciple: All right, Asit. Well, between these two, which do you like better and why?
Sharma: My word, they’re both really interesting Nick. LegalZoom is so consumer-facing, and I am so enchanted by this movement toward a gig economy and an entrepreneurial economy, that I think this is a persuasive type of investment to watch. We gave all the reasons why we’re not excited to go out and buy right now. But I could see following this company literally for three to five years on a watchlist. At the appropriate time maybe some regulations fall in at least some high population states taking a position. If I had to invest today though, I think it would be Intapp, simply because Intapp resembles much more closely the type of Software-as-a-Service market and business model that I’m used to looking at and I’ve seen be successful now. They are negative in terms of net income, in terms of operating cash flow, they are on a path to scale that. It’s a much simpler model in some ways, and I think that there’s not much competition that they have to worry about. In that, so few companies target the inner complexities of deal making, of information slow, of a flow of client management. I think Intapp would be the one that I’d have to lean on if forced to make decisions today. I would say though, for me, both of these are simply watchlist stocks. I’m going to keep them somewhere close to monitor their progress every quarter as reports come out, maybe read some transcripts from management calls. But neither one is screaming by just now as far as some I see, and how about you?
Sciple: Yeah, I would say I’m in the same boat. I really am very interested in the LegalZoom story, because I think there is a strong drive from customers to want to do more and more of this themselves, and have more and more flat rate legal relationships. I also think that they have the strongest brand in the space. To the extent that this future materializes, I think LegalZoom has probably the best opportunity to capture it. That said, there’s a lot of clouds between here and there when it comes to having to fight with law firms. I view LegalZoom as more of a venture capital type investment, where I think the potential upside is very strong. But if things don’t go their way on the regulatory side, you might not be very happy. I think when I look at Intapp, the nature of this market is such that these customers are going to be very sticky, and in a position where it’s a great spot to cross-sell some of these services. I think if you want to invest and be in a scenario where you want to protect your capital at all costs, Intapp it’s hard for me to tell a story where these customers get less stickier over time and other folks take these relationships away.Â
As I said earlier, when this is the software that’s responsible for you collecting fees, and when collecting fees is your whole business, it’s really hard to switch away from Intapp. I see them as being more of a steady grower, whereas the range of outcomes for LegalZoom is much wider. Depending on what type of investor you are, I think it could fit in either type of portfolio. That said, to your point Asit, I think there are some executions I would like to see for at least several quarters, see how they adapt to being a public company, see some more disclosures which we’ll get as we get more and more filings and all these blanks filled in on the S-1. But I really like both of these stories.
Sharma: The stories are good and that’s why they’re worth following as we go forward over the next few quarters. As I said in LegalZoom’s case, the next few years.
Sciple: Asit, thanks so much for spending this time with me. I can’t wait to have you on again sometime soon.
Sharma: It was great, Nick, thanks so much.
Sciple: As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed, so don’t buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show for us. For Sharma, I’m Nick Sciple, thanks for listening and Fool on!
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