LZ - LegalZoom: A Promising Story In The Legal Services Market

2023-06-15 00:30:00 ET

Summary

• LegalZoom has a significant opportunity to increase its market share in the legal services industry.
• The estimated total serviceable market for LegalZoom is estimated at $49 billion.
• LegalZoom's penetration in the market is only around 1% based on annual bookings, indicating significant growth potential.
• I view LZ stock as a buy and have a December 2023 price target of $15 on the stock.

Investment Thesis

LegalZoom.com, Inc. ( LZ ) has a great chance to expand its market share in the legal services industry by encouraging more people to use their DIY services instead of opting for costlier lawyer-assisted options. The company's management is prioritizing customer acquisition through consumer marketing and retention strategies, which are expected to result in increased revenue growth in 2024. Despite being the leading player in the DIY segment, LegalZoom has not yet fully tapped into the market, leaving significant room for growth. I view the stock as a buy and have an end-of-year price target of $15.

Company Description

LegalZoom provides do-it-yourself ((DIY)) legal services to small business owners and consumers. Business formation and operations services make up the majority of the company's revenue, with estate planning and family legal matters making up the typical use-cases for individuals. Services are delivered to customers online, and recently the company has expanded offerings to include legal and small business tax advisory services.

Q1 Review: Strong Result Driven by Strength in New Business Formations

LegalZoom exceeded revenue expectations by 7% in the first quarter, driven by a record number of new business formations. The company is in the early stages of transitioning to a freemium model to enhance upselling, and its subscription growth was strong at 15.3% year-over-year. The subscription product ecosystem, particularly LZ Tax, is maturing and contributing to the long-term opportunity. The company also raised its revenue guidance for FY23 by $10 million (both at the high and low ends) and increased its EBITDA based on the beat.

The macroeconomic conditions in the US are improving steadily, as indicated by the first quarter of growth in business formations reported by the US Census in over a year. This growth was a key driver for LegalZoom's transactions, which increased by 32% year-over-year and gained a 27 percentage point market share, primarily due to its freemium initiative. LegalZoom's management expects share gains to moderate in the second half of 2023 as the initial freemium rollout is completed, although the company's 2H macro forecasts were not updated, possibly due to a conservative approach. Overall, the tone of the call was positive, with LegalZoom expressing optimism about upcoming product updates throughout FY23.

Dominant Position in a Large TAM

LegalZoom operates in a sizable market, estimated at approximately $49 billion, for tech-enabled legal services catering to small-to-medium businesses and consumers. However, LegalZoom's penetration in this market is only around 1% based on annual bookings, indicating significant room for growth. Unlike other industries like financial services and healthcare, which have higher online penetration rates, the legal services sector has been slower to adopt online platforms. However, the younger tech-savvy generations, particularly those involved in the gig economy, are driving increased adoption of tech-enabled legal services. LegalZoom's ability to help businesses form quickly, enable online sharing of ideas/products, and meet the growing demand for online options accelerated by the COVID-19 pandemic positions it well for continued growth.

One of the most compelling reasons to like LegalZoom is the company operates in a large TAM with no competition from FANG or any other meaningful pure-play competitors with significant scale. LegalZoom holds a dominant position in the market. Its category-leading position, combined with the increasing desire for online options among younger generations, is expected to drive strong growth in LegalZoom's bookings.

Valuation

The figure below shows the comparable valuation for LegalZoom, which includes a mix of small business enablement software companies. Intuit Inc. ( INTU ), BigCommerce Holdings, Inc. ( BIGC ) and Wix.com Ltd. ( WIX ) would be three tickers that I would call out as particularly relevant for LZ, given their SMB exposure and growth rates. My end-of-year price target of $15 implies a forward EV/Sales multiple of 4x applied to the 2024 revenue estimate of $712 million.

Investment Risks

LegalZoom has had to negotiate individual agreements with all 50 states due to the prohibition against fee splitting with lawyers. These agreements have enabled LegalZoom's flat-fee business structure and access to a network of 1,300 lawyers. If the prohibition on fee-splitting were to be lifted, it could potentially allow for consumption-based business models that would benefit LegalZoom's growth. However, it could also make it easier for other companies to enter the market and compete. Intuit and Avalara are two companies to watch closely, as they could leverage their presence in the market to potentially compete with LegalZoom. Moreover, LegalZoom faces a structural disadvantage compared to its SMB peers like WIX, INTU, and GoDaddy Inc. ( GDDY ). Unlike these companies, the majority of LegalZoom's customers are in the early stages of starting their businesses when they engage with the company. They primarily purchase services related to business formation and filings, such as trademarks. Consequently, a significant portion of LegalZoom's customer base is exposed to the inherent risk of new businesses, limiting LZ's retention ceiling.

Conclusion

LegalZoom is the leading online destination for legal services, operating in a market with low online penetration. The company is headed by an experienced leadership team that aims to replicate its successful market share growth while increasing customer lifetime value. The company has a large TAM estimated at around $49 billion, and LZ has only scratched the surface as of yet. I view the stock as a buy and have an end-of-year price target of $15 derived from a forward EV/Sales multiple of 4x and a 2024 revenue estimate of $712 million.

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