The widespread stock-options investigations have forced companies to spend millions of dollars to collect, sift, restore and review massive amounts of old emails and other electronic documents to pinpoint any unscrupulous behavior.But having to quickly locate important documents is not limited to nefarious cases -- it's part of doing business now. Huge amounts of electronic documents, emails, instant messages and text messages all fall into the record-keeping basket in the digital age, and there is a growing list of rules requiring companies to manage the information. Thus far, companies that can step in with the tools and expertise to assist in what's called e-discovery and litigation consulting seem to be little known, but they should be on investors' radar. "This is a booming space that's basically tied to the data explosion that's occurred with digital communications," says Colin Gillis, an analyst with Canaccord Adams who covers several companies that provide e-discovery services. And the options backdating situation "is a good catalyst." "Interest rates go up and down, technology spending and oil prices go up and down," Gillis says. "High-stakes litigation is going to be around." With hundreds of tools and vendors, the e-discovery market is fragmented and confusing, making the market size difficult to judge, Forrester analyst Barry Murphy wrote in a December report. He estimates that e-discovery technology spending alone (not including consulting services or forensic work) will jump from $1.4 billion this year to over $4.8 billion by 2011, "as enterprises realize that they have no choice but to prepare for electronic discovery."
Though IBM's ( IBM) FileNet, EMC ( EMC) and Oracle ( ORCL), among other enterprise vendors, offer storage, archiving and search used for e-discovery, it's companies like Marsh & Mclennan's ( MMC) Kroll, Attenex, Zantaz, KPMG and Guidance Software ( GUID) (which went public on Wednesday and jumped 32% on its debut) that offer the full range of services. Another e-discovery specialist, FTI Consulting ( FCN), has snagged a hefty chunk of the backdating business, assisting more than 40 of the companies that have publicly disclosed stock-options issues. FTI counts a number of former Securities and Exchange Commission officials in its forensic and litigation consulting group, according to Tony Lopez, the senior managing director of the group, which helps "give companies an insight into what they need to do to get things fixed from an SEC perspective." FTI's services range from checking their customers' internal stock-options review to complete forensic examination, along with regulatory preparation for meeting with the SEC or Nasdaq, for delisting hearings. "Our services run the gamut," Lopez says. The backdating situation "has been a big shot in the arm." As for the costs to its customers, it depends on the scope, the number of grants and number of years under review, Lopez says. "In some cases, we're brought in and we look at specific grants. In others, we might be looking at every single option grant that was issued in a period of 15 years."
(As an example, Jabil Circuit ( JBL) CEO Tim Main said on the company's
latest quarterly call that it spent $3 million in its fourth quarter alone to restore over 340 backup tapes, which generated a database of 175,000 documents with more than 850,000 pages of data. Over 13,000 option grants were issued in the period being reviewed.) Jim Wilson, director of research with JMP Securities, sees FTI and its competitor Navigant Consulting ( NCI) each snagging about one-third of the business generated from the backdating investigations and thinks there are more to come. Upside potential from the backdating business "is part of the reason I like both of them," he says. Wilson has a buy rating on both of the companies. He does not own the stocks and his firm does not have a banking relationship with the companies. He estimated that a smaller competitor, LECG ( XPRT), has less than 10 backdating cases. He also recommends the shares. "If the economy is slowing down, these would be pretty good growth companies with fairly recession-resistant businesses," Wilson says. In the financial services and insurance industries, for instance, "a lot of these companies have regulatory issues they have to deal with all the time, and will use these consulting firms to help them," Wilson says. "Regulatory and litigation are not very cyclical." Since mid-August, FTI has mirrored the rise in tech stocks, pumping up its shares about 39%. Navigant, meanwhile, has lifted 7.4% and LECG has risen almost 15% in the same period of time, as of Friday's close.
As of Dec. 1, the federal rules of civil procedure were amended to include "electronically stored information" as part of the discovery (evidence-sharing) process. "Those rules had not really been updated to account for digital records," says French Caldwell, an analyst with Gartner. The change essentially means that companies should have a reasonable electronic-records retention policy in place and adhere to it on a routine basis. The amended rules "will drive short-term growth for reactive e-discovery solutions, while the desire to wrap e-discovery into broader retention management strategies will drive significant market growth for years to come," Forrester's Murphy wrote. He anticipates market consolidation over the next three to five years -- a trend already in the works. Over the past several years, Pitney Bowes ( PBI) picked up CompuLit, CA ( CA) bought iLumin and LexisNexis nabbed Applied Discovery. First Advantage ( FADV) bought the assets of EvidentData in October, then picked up DataSec earlier this month, both to boost its computer forensics and e-discovery services. "As long as there are attorneys, there is going to be a market here," Caldwell says. With many ongoing backdating investigations yet to be completed -- and with all companies facing ongoing management of massive amounts of data -- investors should take time to "discover" this sector.