Taking Stock: When Bankruptcies Are Good For A Company's Bottom Line

Bankruptcies make me think of unpleasant things. Your car is mysteriously towed away; threatening letters arrive in the mail; big, burly guys with scars ring your doorbell. And then there's somehow figuring out how to pay debts that you weren't able to pay before. But assisting in the resolution can be good business, especially if you're Epiq Systems Inc. (EPIQ-Nasdaq), a provider of bankruptcy-management software.

Epiq was founded in 1988 and went public in 1997. The company has had revenue growth of 35% on average during the last five years, although some of this is due to acquisitions. Unlike so many young technology companies, Epiq has a long history of profitability. The company has three main lines of business: Chapter 7 bankruptcy software, Chapter 13 bankruptcy software, and enterprise-application integration software tailored to financial institutions. About 85% of its revenue comes from bankruptcy-management software.

The two most common bankruptcy filings are Chapter 7, which is liquidation of assets, and Chapter 13, which is reorganization of individual debt. Chapter 7 cases often involve individuals or companies who are overwhelmed by their debts. During the bankruptcy, most assets are liquidated and the money is paid to the creditors in a process that can last several years. A Chapter 13 bankruptcy involves repaying the debt, but using a new arrangement worked out among the debtor, the creditors, and the courts. This repayment plan typically takes 36 to 60 months to complete.

In each bankruptcy case, a judge appoints a trustee who's responsible for tracking all the assets involved, collecting the debt owed, and disbursing payments to creditors. In addition, the trustee must report back to the court every so often and file statements with the court and the Office of United States Trustees. Epiq's software helps the trustee administer these cases, which for a Chapter 7 trustee can be a caseload of more than 100 cases and for a Chapter 13 trustee more than 1,000 cases.

For dealing with Chapter 7 filings, Epiq offers Trustee Case Management Systems 7.0 and DCI Ch/7. This software lets the trustee track assets; as these are liquidated, the money is transferred into a bank account set up just for that case. Epiq isn't paid directly by the trustees. Instead, it has teamed with Bank of America to provide software and related services to trustees. In exchange, the trustee deposits any funds with Bank of America. Epiq is paid a fee based on the amount of money held in Chapter 7 accounts. At the beginning of this year, there were cases involving $3 billion in assets under Chapter 7 nationwide.

Chapter 13 cases tend to be less complicated, but the large number of these cases and different filing requirements demand a different software solution. In this case, Epiq is paid based on the number of cases administered by the trustee.

At the end of last year, there were approximately 700,000 cases nationwide pending under Chapter 13.

Most of Epiq's competition comes from software developed internally by banks and other financial institutions. Epiq has done a nice job of consolidating the competitive landscape by acquiring software and customer bases from a number of banks, including its latest transactions involving the bankruptcy management divisions of Imperial Bank and Comerica. Competitors include J.P. Morgan Chase and a number of regional banks.

Epiq last week reported solid third-quarter results, with revenue increasing 26% from a year ago to $7.7 million. Bankruptcy revenue increased 54% relative to a year ago to $7.3 million. Operating margin increased to 26% from 19% in the year-ago quarter. Earnings per share are expected to be 83 cents for next year. This means that Epiq is trading at 36 times 2002 earnings-not exactly inexpensive for what is a cyclical company, like so many other tech companies. It happens that its cycle is tied to bankruptcy filings instead of technology spending. My fair value is around $20. At the current valuation, the stock is too expensive for this investor.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at [email protected].

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