Pre-Paid Legal: Great Business Model, Few Competitors

May.18.07 | About: Pre-Paid Legal (PPD)

Pre-Paid Legal Services (NYSE:PPD) is a company that sells exactly what its name states, pre-paid legal services. This is how it works: a customer signs up and agrees to pay $20 per month. Customers receive a certain amount of legal services from local lawyers, who are part of Pre-Paid’s provider law firms, for the time they are members.

Some of the lawyer services that are provided for the standard fee are: “standard plan benefits include preventive legal services, motor vehicle legal defense services, trial defense services, IRS audit services and a 25% discount off legal services not specifically covered by the Membership.”

Industry
Its main competition consists of Hyatt Legal Plans, ARAG[R] North America, and National Legal Plan and Legal Services Plan of America, but most of its competition markets to bigger employers. According to Pre-Paid, its target market consists of around 100 million households, and it currently has 1.5 million households as subscribers.

This is a big opportunity. Litigation in the United States is a constant; I don’t see how this market can shrink if the population of the United States does not shrink and grows at the steady pace it has been growing. If there becomes a Democrat majority in the government, this can also potentially grow PPD’s member base in the short term since Democrats are more apt for litigation.

Company
Its revenue has been growing very steadily at a rate of 6.1% over the past 5 years. The total of memberships, using the end of the year count, has been also growing steadily - at a rate of 2.7% per annum over the past 5 years. It has expanded from its basic legal service into a few other products, with the Identity Theft Shield being the most important.

The Identity Theft Shield [IDT] is provided by Kroll, which is a part of Marsh & McLennan Companies, Inc. (NYSE:MMC). What IDT does is help monitor a customer’s credit information and offers identity theft restoration services. IDT has been a great product, with 73,525 stand alone IDT memberships as of last quarter, meaning that this is the only product these customers purchase, and that they do not have any legal service plans. There are 562,075 add-on IDT memberships, meaning they have another service besides IDT.

Pre-paid only started this service in late 2003 and already about 1/3 of all their members have legal plans with the IDT service. IDT has been its main growth driver over the past 3 years. It also recently entered into a new agreement with Kroll to extend their agreement and negotiated a significant reduction in payments to Kroll per customer per month of IDT service from $4.25 to $3.75 as of April 1st 2007, to $3.50 in 2008 to $3.25 in 2009 to $3.00 in 2010.

It sells its products through a Multi-Level Marketing program. Members only make commissions when a membership is sold, not when they recruit members to develop their sales organizations. The company is still run by its founder, Harland C. Stonecipher, who founded the company in 1972.

It also recently started to roll out its “ADRS” program which provides businesses and their employees a way to reduce identity theft risk. The associates, who have to pass required training, give presentations about Pre-Paid’s products and provide opportunities for the businesses and their employees to purchase its identity theft solutions and legal plans.

Valuation

It's trading at a trailing P/E of 16.94 and an Earnings Yield based on EBIT of 10%. 38.83% of the float is short. 33.5% of the shares outstanding are owned by insiders. It has been very busy in the past 5 years returning money to shareholders. Its diluted shares outstanding decreased from 19.8 million shares in 2002 to 13.6 million shares as of last quarter. Also, in 2005 and 2004 it paid dividends of $.60 and $.50 a share respectively. The balance sheet does not look exceptional; it has about $80 million of cash and investments and debt of around $100 million. Its cash flow from operations has been strong - $47.3 million, $50.1 million, and $54.4 million in the years 2004, 2005, and 2006 respectively. PPD is a great cash generator. It is a top 25 Magic Formula Stock of over $100 million market cap as of 5/16/2007.

Technicals
Just in April it broke through overheard resistance and sold highs of about $52 a share to its all time highs of over $64 a share. In 2006 it formed a rounding bottom chart pattern. Both of the big advances in the past 2 months were confirmed by large volume. All of the trends are up. It is trading above all 3 of its main moving averages and all of them are trending higher. The first major support is around its old highs of around $52 a share. The stock is currently borderline oversold with RSI and MACD at very high levels.

PPD_05_15_2007

Conclusion
Pre-Paid has a great product and it has its own position in the industry with not a lot of competition. There are a lot of opportunities out there to expand its business. One avenue of expansion can be through the traditional forms of advertisements. PPD’s management has stated that it will continue to buy back shares with its excess cash. It has had and is still having issues with associate recruitment.

The Balance Sheet is not the best looking one either, the debt is not something to be too worried about considering it's such a cash generator. Also, it has taken out two loans to build a beautiful headquarters and buy an aircraft - I’m not sure how wise that was. To conclude, it has a great business model with few competitors, there are avenues for further growth with new offerings, like the IDT, and new ways to market them, like the ADRS. And it has a great valuation, being on the Magic Formula top 25 list of companies over $100 million market cap. Technically I would wait and see if a pull back occurs; there has been a big run up of more than 50% in the past 2 months. The 50DMA or old support at $52 would be great buy points.

Disclosure: I don't have a position in PPD.