Description

EPIQ Long Write-Up

Summary Investment Thesis

• Strong secular trend of increasing digital data volume growth is making it more difficult to search/organize data and increases the need for eDiscovery services; in addition, eDiscovery is expanding into additional use cases and customers are looking to save money vs. traditional law firms

• Masked growth as decline in the bankruptcy business line masks the growth of the eDiscovery business.

• Counter-cyclical characteristics of bankruptcy business provides natural hedge to an economic downturn

• Leverage helps equity returns and equity value will rise as company de-levers

• Multiple targeted areas for potential cost cuts and margin improvement, on a business with a pro forma ~14% LTM PF FCF yield

• Potential for reinvigorated strategic review and M&A given large constructive / activist shareholder base

• Interest from buyers as a market leader in a consolidating fragmented space.  Both strategic and private equity buyers with multiple constructive hedge funds in the stock, two of the largest activists collectively own >30% of the company; one of the two (Villere) recently proposed a new board slate

Key Risks

• Competitive Pricing Pressure

• Risk of price pressure in both document review and in technology processing as competition increases

• Offshore review is an option for some litigants

• MITIGANTS:

• While the space is partially commoditized, cost is currently not the primary basis of competition

• Scale helps Epiq compete for national and spike volume accounts vs. smaller local providers

• Decreasing costs and growing volumes have helped to offset processing ASP drops

• Reliance on 3rd-Party Technology

• The absence of a disruptive technology innovation in eDiscovery threatens to increase pricing competition and commoditization

• Half of Epiq’s ESI revenue is generated through the use of 3rd-party software providers

• MITIGANTS:

• Experts currently believe that proprietary software is not a key differentiator and often results in a lack of competitive flexibility

• Epiq has invested in developing in-house along with strategically acquiring technology and has proprietary data centers

• Technology Disruption

• Technology Assisted Review (TAR) or predictive coding may reduce the number of documents reviewed by human services

• MITIGANTS

• Rapid data volume growth has more than offset predictive coding efficiencies

• Highly sensitive documents and large litigation will still require human review

• Continued Decline in Bankruptcy Business

• Total U.S. bankruptcy filings continue to decline due to the strong macro economy.  This has hurt Epiq’s bankruptcy and settlement division.

• MITIGANT:

• The businesses are countercyclical, so should recover if the macro economy turns

Business Description

Technology Segment Overview:

Bankruptcy and Settlement Admin Segment Overview:

Investment Considerations

• Secularly growing market

• The accelerating growth of corporate electronic data demands automation and eDiscovery solutions as companies shift from more costly traditional law firm reviews

• Growing awareness of eDiscovery issues in Europe and Asia and aggressive investment in those areas will drive growth internationally

• Misunderstood Multiple Business Lines

• EPIQ is often seen as a bankruptcy and settlement business despite eDiscovery representing 70% of Epiq’s revenue today

• Growth of the eDiscovery business is masked by the declining bankruptcy and settlement business

• Aggressive investment in eDiscovery international growth temporarily depressed earnings but margins are starting to re-accelerate and the company is implementing cost cuts

• Profitable Business Model

• 50%+ gross margins and 20%+ AEBITDA margins

• Flexible cost structure allows Epiq to maintain margins as document review volumes vary yoy

• Heavy investment in international expansion has depressed margins and created one-time capex, but the growth in eDiscovery should provide earnings leverage vs. largely fixed costs

• Consolidating Market

• As eDiscovery matures, law firms cannot ignore the technology and will acquire or eDiscovery players will seek to consolidate.  Consolidation should help stabilize margins

• Epiq is a leader in the space and brand name/scale matter to large enterprises

• Strategic Review Dynamics

• Tom Olofson, CEO and Chairman since 1988, is 73 years old and owns 8.9% of the company

• Villere is actively pushing for a sale of the company

• There is broad private equity interest in this asset. P2 Capital already submitted a $20/share buyout offer in August 2014 (that was rejected by the company)

• Valuation

• 8.3x LTM PF EBITDA and 13.8% PF FCF yield for a business with 52% gross margins and historically higher EBITDA margins; Epiq’s valuation does not reflect the emerging growth of its eDiscovery business, which is a 50%+ recurring revenue business.

Catalyst

-M&A (ongoing strategic review & activist involvement)

-Growth in eDiscovery business; potential counter-cyclical recovery of bankruptcy business

-Margin improvements as company cuts costs