2023-05-25 11:43:41 ET
Summary
- CS Disco combines the strengths of a vertical software company with deep domain expertise and disruptive technological potential.
- Disco's technological differentiators, including multitenancy, artificial intelligence, and serverless compute, set it apart in the E-discovery and legal software market.
- The company has a vast total addressable market of $42 billion, allowing it to tap into both vertical and horizontal opportunities.
- With its unique positioning, Disco is poised to lead the disruption in the E-discovery and legal software industry.
Investment Thesis
CS Disco, Inc. ( LAW ) possesses the characteristics of both a top-tier vertical software company, with its profound domain expertise and potential for technological disruption, as well as the potential of a horizontal company due to its $42 billion total addressable market. The company's technological differentiators, such as multitenancy, artificial intelligence, and serverless compute, along with its product development approach centered around lawyers and their specific needs, position Disco as a frontrunner in disrupting the E-discovery and legal software market.
Company Overview
CS Disco provides e-discovery, document review, and case solution software to enterprises, law firms, and service providers. The company was founded in 2013 by former lawyer and current CEO, Kiwi Camara, who had developed an internal tool that was spun out to form a new company. Disco began in e-discovery and, in the subsequent years, has expanded to incorporate AI capabilities along with its Review and Case Builder products in 2017 and 2020, respectively.
Q1 2023 Review & Future Outlook
CS Disco delivered a strong performance in the first quarter, surpassing revenue expectations by 5% and exceeding adjusted EBITDA forecasts. The management even revised its target date for achieving positive EBITDA to the third quarter of 2023, one quarter earlier than previously anticipated. While the full-year revenue guidance remained unchanged, the quarterly guidance for the second quarter indicated a slower growth rate, with the expectation of strong sales in the second half of the year to meet the sales target. The updated full-year EBITDA projection showed a smaller increase compared to the Q1 beat, but it implies margins of -27.2% at both midpoints, slightly better than the initial estimate of -28.6% from the previous quarter.
In March, the company introduced a generative AI chatbot that utilizes private data stores for the E-discovery process and plans to roll it out as a general availability ((GA)) feature later in the year. Additionally, LAW (CS Disco's legal platform) underwent headcount reduction while also investing in employees across all operational expenditure lines, leading to margin compression compared to a year ago. However, I consider these measures necessary for ongoing platform development and sales. Despite some volatility in top-line results due to unpredictable platform usage, I believe that Disco has an exceptional platform and is making progress toward achieving balanced growth and EBITDA goals.
Cloud-Based Technology Platform
The outsourced discovery services firms and legal departments relying on on-premise software face the task of purchasing and managing compute infrastructure, which typically requires refreshing every 3 to 5 years. In contrast, Disco's cloud platform offers a more efficient solution by acquiring compute capacity in cost-effective 100 ms blocks that precisely align with the capacity requirements. Moreover, Disco's full parallelization enables swift data ingestion, and its artificial intelligence algorithms enhance the effectiveness of identifying relevant information in the data compared to conventional approaches. I believe this enables Disco to keep gaining market share in the future.
Large Market Opportunity
Historically, the legal and construction industries have been slow in adopting new technologies. However, Procore is spearheading a transformation in the commercial construction sector with its cloud-based project management application, which is priced according to the dollar volume of construction projects managed within the platform. This represents a market worth $9 billion. Similarly, Disco is making waves in the legal industry by offering a cloud-based discovery application that charges based on the volume of data ingested and analyzed. Although Disco excels as a vertical application, it is versatile enough to be utilized by legal departments in any industry, resulting in a total addressable market of $42 billion . This combination of vertical and horizontal applications is a unique and distinguishing factor within the software industry, in my view.
Risks to Rating
The rapid pace of sales hiring may pose challenges as new representatives may not be trained and productive as quickly as expected. If sales efforts are not properly executed, it can lead to issues and hinder growth. However, the success of this hiring strategy depends on effective training and implementing the right sales methodology.
Moreover, next-generation competitors have an advantage in penetrating the industry due to lower switching costs. While Disco enjoys high gross renewal rates of around 97%, some customers can swiftly switch to alternative platforms if they find them more attractive. This indicates that the actual switching costs for customers are relatively low, making it easy for them to switch away from Disco if a better alternative arises.
Conclusion
Disco offers a unique blend of vertical and horizontal applications in the legal industry. The company's product can be used by legal departments in any industry, resulting in a large total addressable market of $42 billion. Unlike on-premises software, Disco's cloud platform eliminates the need for purchasing and managing compute infrastructure, providing cost-effective and flexible compute capacity. The platform's fast data ingestion and artificial intelligence algorithms enhance the efficacy of finding relevant material in the data. With its unique positioning, Disco is poised to lead the disruption in the E-discovery and legal software industry. Hence, I view the stock as a long-term buy.
For further details see:
CS Disco: Transforming The E-Discovery And Legal Software Market