AI Competition Will Erode Margins Amid Rising Ad Costs

Key Takeaways

• Increased AI-driven competition and higher marketing costs threaten revenue growth, profitability, and customer acquisition in LegalZoom's core markets.
  
• Low product differentiation and rising regulatory/compliance pressures expose the company to market share losses and higher operating expenses.
  
• Transition to subscriptions, investment in AI and premium services, strategic partnerships, targeted acquisitions, and strong cash flow are supporting growth, margin expansion, and customer retention.

Catalysts

Operates an online platform that supports the legal, compliance, and business management needs of small businesses and consumers in the United States.

• Advances in generative AI and automated legal document platforms are expected to increase price competition and erode LegalZoom's ability to maintain premium pricing, likely pressuring both revenues and gross margins over time as legal services become more commoditized.
  
• Rising digital ad costs combined with heavy dependence on online marketing will make customer acquisition substantially more expensive just as alternative legal service providers and AI-centric incumbents flood the market, which is poised to shrink LegalZoom's net margins and slow customer growth.
  
• LegalZoom's low product differentiation, especially in its core compliance and business formation offerings, leaves it exposed to disruptive market share loss as new entrants leverage AI to provide direct-to-customer solutions at lower costs, threatening both top-line growth and long-term profitability.
  
• Persistent concerns over data privacy and increasing regulatory scrutiny around online legal services are expected to drive up LegalZoom's operating expenses and compliance costs, undermining earnings and stifling the company's operating leverage as legislation stiffens.
  
• Structural shifts in small business formation rates due to broader economic automation and market consolidation are likely to contract LegalZoom's total addressable market in the years ahead, resulting in persistent revenue headwinds and increased risk to subscription-based growth.

LegalZoom.com Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on LegalZoom.com compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming LegalZoom.com's revenue will grow by 5.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 4.1% today to 9.1% in 3 years time.
• The bearish analysts expect earnings to reach $75.8 million (and earnings per share of $0.31) by about August 2028, up from $28.8 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 26.6x on those 2028 earnings, down from 67.2x today. This future PE is greater than the current PE for the US Professional Services industry at 26.3x.
• Analysts expect the number of shares outstanding to grow by 2.64% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.0%, as per the Simply Wall St company report.

LegalZoom.com Future Earnings Per Share Growth

Risks

• The ongoing shift to a subscription-based business model, with 22% growth in total subscription units and 10% growth in subscription revenue, increases revenue predictability and customer stickiness, improving both top-line revenue and net margins over the long term.
  
• Strategic investments in artificial intelligence, automation, and premium DIFM (do-it-for-me) product suites are enhancing customer engagement, driving higher average revenue per user from premium segments, and reducing churn, which can support sustainable earnings and margin expansion.
  
• Successful partnerships and integrations with industry leaders such as OpenAI and Perplexity demonstrate LegalZoom's ability to leverage cutting-edge technology and AI, expanding its addressable market and strengthening its competitive differentiation, which could accelerate revenue growth.
  
• The acquisition and seamless integration of Formation Nation brings a high-performing sales and service team, enables upselling and cross-selling, and broadens LegalZoom's reach to higher-value customer segments, supporting long-term revenue growth and operational efficiencies.
  
• A strong balance sheet with $217 million in cash, robust free cash flow generation (up 82% year-over-year), and increased share repurchases position LegalZoom to invest in innovation, pursue additional M&A opportunities, and drive shareholder value by supporting both future growth and improved earnings.

Valuation

• The assumed bearish price target for LegalZoom.com is $8.5, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of LegalZoom.com's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $13.0, and the most bearish reporting a price target of just $8.5.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $831.9 million, earnings will come to $75.8 million, and it would be trading on a PE ratio of 26.6x, assuming you use a discount rate of 7.0%.
• Given the current share price of $10.72, the bearish analyst price target of $8.5 is 26.1% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.