LZ - LegalZoom: Management's Focus On Profitability Is A Good Sign

Summary

• Initial adj. EBITDA guidance for FY23 is $100 million, due to cost-cutting measures and a focus on streamlining administrative tasks.
• Management assumes that new business formations in the US will fall by a mid-single-digit percentage as the recession deepens into 2H23.
• Reiterate buy rating on LZ stock due to strong value proposition and management focus on profits.

Recommendation

The 4Q22 results for LegalZoom ( LZ ) demonstrated management's dedication to cost control in the face of an uncertain macro backdrop. While new business formations slowed throughout 2022, growth held up better than I expected , coming in at 474 thousand in FY22.

Moving onto the P&L, Revenue guidance for FY23 was 2% lower than expected, but cost cutting measures led to an initial adj EBITDA guidance of $100 million, $7 million higher than consensus expectations. The midpoint of LZ FY23 revenue forecast is an increase of 1.5% year over year. In my opinion, it is important to understand the underlying factors driving this guidance. Firstly, management assumes that new business formations in the US will fall by mid-single-digits % as the recession deepens into 2H23. In spite of this, I have a feeling that LZ will do better than expected, as there is no concrete evidence that this is happening and no indication that LZ's businesses are entering a downturn. Lastly, management also forecasts a drop in AOV for all of 2023, with the impact felt most strongly in 1H23, and a slowing of ARPU growth for FY23 as a result of the introduction of cheaper prices and the LZ tax. Regarding margins, the initial margin guidance of $100 million in adj EBITDA assumes that total OPEX will remain flat in 2023 at $180 million if CAM is excluded. When it comes to spending, management plans to put more money into research and development, which should result in more frequent product releases as we head into 2H23. In contrast, the S&M and G&A lines are both trending downward as management concentrates on finding ways to save money on marketing and on streamlining administrative tasks, both of which are welcome developments for investors because they will eventually lead to structural long-term improvements in margin. Management's willingness to make adjustments and steer through cost volatility remains an encouraging sign, so I'm keeping my buy recommendation.

Latest earnings highlights

LZ ended the year with a revenue figure that was just slightly higher than expected. Subscription ARPU growth in the high single digits was driven by LZ Tax and Earth Class Mail, and prudent operating spending significantly expanded margins in the quarter, despite the impact of tough macro headwinds on transactions. Management also shared their guidance for new business formations in FY23, which they believe will slow to single-digit growth this year. For FY23, management guided to range of $620 million to $640 million in revenue, with EBITDA of $100 million.

Market share

New Business Formations at LZ increased by 12% year over year in 4Q, which was significantly higher than the 2% year over year growth in US business applications and resulted in the largest quarterly increase in market share for LZ in 2 years. Results for FY22 suggest that LZ left the market with a share in the high single digits, which is consistent with FY21 levels.

According to guidance, business formation is expected to slow down in the United States. However, I expect LZ to expand via share gains. This is triangulated using management's aim to achieve a 15% increase in market share by 2023, and their anticipation of a decrease in the overall number of business formations in the US by a mid-single digit percentage, which implies that the rate of new business formations will rise by a high single digit percentage. Overall, considering the company's focus on profitability has led to a decrease in marketing expenditures just as competition from low-end rivals has intensified, I believe it is important to track the rate of future market share growth.

Growth and margin

Without going deep into the nitty gritty, I think LZ has done a fairly good job in maintaining its superior marketing efficiency, cutting customer acquisition costs while meeting or exceeding quarterly revenue goals. The EBITDA margin for the quarter was 18%, which was 15% higher than consensus estimates. For FY23, LZ guided to an EBITDA of $100 million, which implies a margin of 16% at the midpoint, a significant increase from the 8.3% recorded in FY21.

Business model change

To broaden the base of potential subscriptions, management has promised to roll out a free product option in 2Q22. Management claims that the transition to more subscription-based purchases, which is at the heart of these business model changes, will have no impact on revenue in 2023 but will be beneficial in the years thereafter. While this shift will likely improve the company's long-term growth prospects, I believe it will lead to volatile financial results, making it difficult to assess the company's underlying economics for some time.

Summary

The premise of me recommending a buy remains. Due to the complexity and high cost of hiring a lawyer to help them, many small and medium sized businesses in the United States have difficulty navigating the legal and compliance systems. LZ's goal is to alleviate stress on consumers and bring down prices by making their services available on a national scale and standardizing procedures. The management's emphasis on profitability is another encouraging sign in the current economic climate.

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