PrePaid Legal Services: Look Beyond the Luxury

| About: Pre-Paid Legal (PPD)
PrePaid Legal Services (NYSE:PPD) markets a fee-based subscription for accessible legal services and plans to the middle-market (80%) of Americans and Canadians through its network of independently contracted "provider firms."

There are currently 1.5 million members (i.e. subscribers) in the company’s plans. Based on their estimated target market size of 100 million Americans, this is a 1.5% market share. The company seems to have run into some difficulty expanding this critical subscriber base, as they sign up around as much as they lose each quarter (around 150,000 members per quarter).

Nonetheless, the company appears attractive for its high returns on capital, relatively consistent profitability, high margins, and low price/earnings multiple. It also seems to have found a place for itself in the niche market it serves.

But (and here comes my cynical side again), there are some problems with the company. Allow me to discuss.

High Employee Turnover

The company uses multi-level marketing tactics to drive business. 80% of new orders are derived from the multi-level “sales associate” program. Yet, the “Sales Associate” program does not seem to be economically 'incentivized,' at least vis-à-vis other similar programs. I just don’t see how it makes sense to participate. Here’s why:

Members pay an average around $260/yr for services. Sales associates get 80% commission in first year, and 5-25% thereafter. Even assuming an associate sells one membership a day for his first year (which is just about impossible unless he’s damn good and makes it a full-time job), he stands to make just $75,920 before deducting the cost of entering the program and what is owed to the associates who themselves brought him in. Perhaps he ends up with a generous $70,000.

That may seem pretty good, but again, this is significantly more generous than the average (and median) associate and would require a stunning sale of 365 memberships. More realistically, the average associate brings in much less than 10 new members per year (which is around a measly $2000 for the first year, and a paltry $650 thereafter). Granted, the associate can draw some residual dollars by bringing in new associates, but given the cost (of time and money) to enter the program and the offsetting effect of having to pay, on average, 9 associates higher on the pyramid, it’s not all that attractive.

Indeed, a huge majority of associates probably doesn’t make any real money at all. This phenomenon is well-evidenced by the turnover in associates. While the company doesn’t release this number per se, it can be inferred from the numbers. The company had 79716 associates who sold at least one membership in 2004, and 103,248 of the like in 2005. But with 61,238 of the 2005 crowd being first time sellers, we see that 37,706 “old” associates pretty much gave up. That’s an implied turnover of around 48%. Not too good.

But that’s enough about the associates program. There are still more problems to discuss.

Debt to Finance Luxury

Ready? Here’s the cynic again:

I find the ridiculous description of the new corporate headquarters, on which the company spent (read: wasted) $34 million, to be telling. To put this in perspective, they spent the equivalent of over 6% of the company’s market cap, around 10% of 2005 revenues, or substantially ALL of 2005 net income on the following. Here it is straight from the 10K, just for kicks:

The new headquarters contains two long bars of open office area designed to serve as podiums, which stretch east from the northern and southern edges of the tower. Two and three stories high respectively, the podiums house the call centers and Information Technology departments. Only 60 feet across, they are designed to ensure that employees are never more that thirty feet from a source of daylight. Shared corporate services – including a 650-seat auditorium, dining hall, exercise facility, and a connecting corridor containing a company history gallery — are located at the east end of the bars, creating a central courtyard. The courtyard features a reflecting pool and a 12-foot bronze sculpture of our logo, the Lady of Justice, a universal symbol of justice. The building’s main entrance welcomes its frequent visitors, celebrates our history, and is designed to convey the tradition of civic judicial buildings. The building is designed to expand over time without negatively impacting the site layout or the building concept and we emphasized the use of modular furnishings to provide enhanced flexibility. We placed importance on the goal of providing each employee with an excellent work environment.

And that’s not all. As if an exercise facility, company history gallery, reflecting pool and 12-foot statue weren’t enough, the company spent an additional $11 million (!) on corporate jets. Worse than that, they took on the risk of debt to finance it.

If anyone can explain to me this waste of funds or explain how in the world these expenditures will yield any return whatsoever, please drop me a line.

Call me crazy, but I don’t really think I need to delve into the valuation, because it’s not a company I’d feel too happy about owning. And apparently the insiders feel the same way. Just check out their recent stock sales.

PPD 1-yr chart

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