The Motley Fool, 10/1/97: The Daily Double

Wednesday, October 1, 1997

Pre-Paid Legal Services Inc.
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Phone: 405-436-1234
Website: http://www.pplsi.com
Price (9/30/97): $28 1/4

HOW DID IT DOUBLE?

All rise. The verdict is in. For PRE-PAID LEGAL SERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: PPD)") else Response.Write("(AMEX: PPD)") end if %>, stellar sales growth has found the stock racing up the courthouse steps. Over the last three years it has been a stunning 15-bagger.

With earnings growth in excess of 40% so far this year and net income margins a gavel sliver above 20%, there is little not to like. A double? Guilty as charged.

BUSINESS DESCRIPTION

Oklahoma-based Pre-Paid Legal Services designs, writes, and markets legal-expense plans. Much like medical reimbursement plans, the company's legal-expense plans provide for or reimburse clients a portion of the fees associated with a variety of legal services.

FINANCIAL FACTS

Income Statement
12-month sales: $75 million
12-month income: $15.1 million
12-month EPS: $0.67
Profit Margin: 20.1%
Market Cap: $625.2 million

Balance Sheet
Cash: $19.6 million
Current Assets: $34.3 million
Current Liabilities: $4.1 million
Long-term Debt: N/A

Ratios
Price-to-earnings: 42.2
Price-to-sales: 8.3

HOW COULD YOU HAVE FOUND THIS DOUBLE?

To understand this legal eagle's success one only has to look at its business model. The company's revenue comes from two primary sources. The bulk of it comes from membership sales.

We live in a litigious world. "I'll sue you," is no longer an empty promise. So, the same way one insures a house or a car, it is understandable that one might want to pony up for some legal liability protection. And even though this type of insurance is not legally required, the company has maintained a healthy 76% annual renewal rate.

The other, smaller side of the revenue mix, which accounted for $5.6 million, or 13% of revenues so far this year, comes from the sales associates themselves. The company has introduced its "Fast Track to Success" training and classroom program where associates pay $184 to learn ways to drum up sales. The class concludes with the objective of closing on three membership sales and recruiting a new sales associate within 15 days. So like IDS and Amway, it is also an active service company with a subtle multi-level marketing ring to it.

That is why the growth has been so phenomenal. With high-profile court cases alerting the public to potential liabilities, membership has been easy to sell. And, for that very same reason, it has also been easy to recruit new sales associates.

WHERE TO FROM HERE?

What if someone throws the book at Pre-Paid? As in book value? The company is selling for more than 10 times equity and 8 times trailing sales. While this attractive niche is definitely worth a premium relative to its traditional insurance peers, maybe it's time someone slammed the gavel down.

Its valuation is simply out of order. Earnings per share grew 42% so far this year, in line with its price-to-earnings ratio, but is it sustainable? This is not a case of greater fool theory or a Ponzi scheme -- the business model and company are both on the level and offer a needed product.

But will the time come when there are no more sales associates to recruit or litigation-fearing civilians to sign up? Will the company be able to maintain its high renewal rates? Are the barriers to entry high enough to keep heavier players from playing off the niche? Especially given the company's juicy operating margins, which are in excess of 30%?

The recent fiscal performance shows the company is having no problem signing up new members and salespersons, and for the short term, it the Wall Street jury has ruled in its favor. Next year the analysts expect earnings to rise 37%, but I'm still not convinced. For now, sign me up for the hung jury.

- Rick Aristotle Munarriz, [email protected]

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