Legal tech stocks are disrupting the legal industry

Disco’s dead, but legal-tech is just getting started. CS Disco (NASDAQ:LAW), which provides much-needed automation to the legal services industry, is up 25% since going public in July. But there are a couple questions investors should be asking…

Law firms are stuck in the 80’s

The law industry has been historically slow to adopt technology and McKinsey estimates 23% of lawyers’ work can be automated by tech.

Lawyers – against the risks of AI handling important documents – are pushing back against tech but according to the global research firm Gartner…

• 81% of legal departments are unprepared for digitization.
• 20% of generalist lawyers will be replaced by nonlawyer staff by 2024.

Businesses want one thing (and it’s disgusting): to improve efficiency. The $18b legal tech industry expects spending to increase 200% by 2025.

Law-tech is bringing Disco back

Disco’s financials tell the story of a company growing without burning too much cash. Disco’s first-quarter 2021 results showed…

• Sales of $21.1m, up 35% from the same period, a year before.
• Net loss of $2.9m, down 75% from the same period, a year before.

At its current price, Disco is valued at nearly $3b – not cheap considering its 35% growth and 26x forward price-to-sales multiple. Investors might also question how Disco is going to grow…

• 75 of the top 200 law firms in the US are already customers.
• 122% net dollar retention ratio in 2020 — meaning existing customers spent 22% more the following year.

Meaning: With such a concentrated customer base, part of Disco’s growth depends on getting existing customers to spend more. Which leads us to the 122% dollar retention ratio, which is strong, but has trended downwards since peaking at 146% in 2019. Customers are spending more each year, but not as much as they used to – which could impact growth moving forward.

Investors: Dunder Mifflin gets a tech makeover

Disco isn’t the only interesting play in legal tech. Another Canadian law-tech company, Dye & Durham (TSX:DND), is making waves less than a year since going public:

• DND started out as a paper supply company, but began buying up tech firms in 2016 — reinventing itself into a legal-tech company.
• Private investors recently offered to buy the company out for ~$50/share – nearly $5/share over its current value.

Law-tech is in its infancy but if it follows the trajectory of other industries, tech is making its way into legal departments. For investors, the question is determining whether these companies’ growth can sustain their valuations. And if they can’t, the disco might be over.