Pre-Paid Legal -- A Trick*
By Rick "The Mummy" Munarriz (TMF Edible)

Every Halloween, before I went out trick or treating, my mother doled out the same two bits of sage advice. Don't eat any unwrapped candy. And never buy into a multi-level-marketing company selling legal insurance.

I always obeyed the first. I never understood the second. Well, that was until last year when I stumbled across the very image of madness incarnate my mother always warned me about. Years of fearing this moment would arrive had finally turned my nightmare into a reality. The tossing. The turning. The flossing. The squirming. This was worse than unwrapped candy!

It's Pre-Paid Legal!

With 600,000 members, Pre-Paid Legal might sound like a powerful legal insurance peddler. Heck, maybe I should be number 600,001 in case they decide to sue me!

This is how it works. A person pays an average of $226 per year for limited legal coverage. It's good business for Pre-Paid Legal because they are only paying out a third of that in claims. While the meager payout should serve as a wake-up call to those who continue to renew the modest premiums, that is the nature of the insurance sector as a whole.

But these policies don't always sell themselves. A major part of Pre-Paid's business is recruiting many of these members as sales associates. Recruits pay $184 for a "Fast Track to Success" course and get bonus rewards if they line up a new sales associate and write up three new policies within 15 days of completing the course.

By now you might be thinking, gee, if I wanted a bearish beat on network marketing why don't I toss in the Asian flu for good measure and go with Amway Japan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AJL)") else Response.Write("(NYSE: AJL)") end if %>? Too easy... and besides, this one still has plenty of room to go on the downside.

Pre-Paid Legal's Stock Performance

After hitting all-time highs in February, the stock has fallen like a stone. The volatility has come with the territory. For the earlier part of this decade, the stock was relatively stagnant. It began 1995 at a split-adjusted $2 per share. It was a five-bagger that year, had a decent run in 1996, and doubled yet again in 1997 -- all told, a 1600% gain over the last three years.

What Wall Street is Saying...

The two lone analysts tracking this company like what they see. They are looking for Pre-Paid Legal to earn $1.19 a share this year and $1.53 next year. After net income of $0.83 last year, and with a history of meeting estimates (and at least for the previous two quarters beating those projections), this might have made for a nice treat if not for one thing...

My mother is always right!

Why the Trick?

Back in July, the company authorized a simple 200,000 share buyback -- tiny... less than 1% of the shares outstanding. At the time, Chairman Harland C. Stonecipher said, "This action reflects both our confidence in the company's continued growth potential and our commitment to enhancing shareholder value."

Over the next two months, the shares went from $37 7/8 when the buyback was announced to $27 1/8. With the shares so much cheaper you'd think the company would have increased the buyback, right? No. It bought back just 25% of the announced purchase and halted the program in order to negotiate an acquisition.

Okay, a marriage! With the stock so cheap, this would be a cash purchase of a sound addition, right? Wrong again. The gavel slammed down hard on an all-stock deal with The Peoples Network, a company whose claim to fame is owning "The Success Channel," which airs exclusively on the PRIMESTAR mini-dish system.

What? Earlier this month the company struck what may have been a solid partnership with Conseco <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CNC)") else Response.Write("(NYSE: CNC)") end if %> that would find the Conseco reps now selling Pre-Paid Legal policies. The catch? Pre-Paid was also to buy Conseco's United Fidelity Life Insurance division.

So in just the past two months we have gone from a focused company selling legal insurance to one with interests in infomercials and life insurance as well. Whether you get sued, you die, or you're up at 3:00 a.m. with nothing to watch on the tube -- Pre-Paid's got you covered!

Concluding Folly

This kind of diworseification (as Peter Lynch would say) scares me. It telegraphs something to me that the analysts have yet to pick up on -- the core business is not as healthy as past fiscal results may lead one to believe. As a matter of fact, as of the end of June, the number of sales associates had only risen by 4% over the previous year.

Making nice with Conseco and lining up an obscure satellite programmer seems like a Hail Mary effort to bulk up a sales force that was once so easy to grow from existing associates.

In Pre-Paid's defense, I have to applaud the debt-free balance sheet, but that only tells me the stock will hold up on any kind of decline once it nears its $3.73 per share book value. When the earnings estimates begin to falter, it will be hard not to throw the book at Pre-Paid Legal.

My mommy says so. Oh, and Happy Halloween!

Related Links:
-- Pre-Paid Legal Message Board
-- Check the Most Recent Price
-- Daily Double - 10/1/97

* A Ghoul's Opinion represents the opinion of one Ghoul and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Ghoul's thoughts.