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The stock to buy when regulators call

Investor Daily: A British company has built a thriving business helping companies to minimize legal risk when watchdogs come knocking.

By Michael V. Copeland, senior writer
November 19, 2008: 5:19 AM ET

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Autonomy CEO Mike Lynch predicts revenue growth next year of 10% or more as demand for the company's records management software surges.

NEW YORK (Fortune) -- In the mess that has enveloped companies and the broader economy, there is a lot of finger pointing and blame being thrown about. Some people have the patience to wait for karmic retribution. For the rest of us, there are securities lawyers and regulators aplenty to mete out punishment.

Both should be very busy in the coming years. New lawsuits brought on behalf of shareholders when a company's stock tanks have more than doubled in the last two years and are well on their way in 2008 toward eclipsing the flood of cases that followed the dot.com and Enron debacles in 2002, according to NERA, a Washington, D.C.-based economic consulting firm.

Few doubt that, as the government scrambles to clear up the credit crisis, that a lot of loosely regulated markets are facing a lot more regulatory oversight.

The big winners? Vendors like U.K.-based Autonomy Corp. (AU, £8.58 on the London Stock Exchange), which sells specialized software that helps companies sort through employee e-mails and other records after they're sued or when regulators come knocking.

Autonomy isn't the only company to sell services like this. Giants like Hewlett-Packard (HPQ, Fortune 500), Symantec (SYMC, Fortune 500), Computer Associates and Iron Mountain (IRM) have units that compete with Autonomy, and there are a host of privately-held companies, like Casecentral.com, too. But if you are looking for a public company with the most to gain from these litigious times, Autonomy is by far the largest pure-play.

The company also has the most cutting-edge technology. Here's how it works: Say you are a bank and regulators call up wanting to check your records. They won't tell you what they're looking for; they just want access to your data.

Before the regulator comes through your door, Autonomy's software can be set loose on company data and highlight issues that might run afoul of securities regulations or other laws. And once the regulators are done searching your records, Autonomy can recreate their search and help you get a sense for what they were looking - and of what you're up against.

Autonomy's software is also preemptive. It can flag questionable behavior early, thereby minimizing the risk of potential damage later on.

The company's technology does this by drawing connections between seemingly disparate pieces of data contained in employee e-mails, documents, video - even phone calls. All of this algorithmic brawn can help companies show they are in compliance with regulations like Sarbanes-Oxley, the post-Enron law that dramatically increased the amount the information that public companies must disclose.

Profiting from the gloom

Today, government probes into the collapse or near-collapse of some of the country's largest corporations has companies everywhere racing to uncover any hidden problems - and ensure they're in compliance with existing regulations. Mike Lynch, the CEO of Autonomy, says recent demand for the company's services has been "exploding."

Some analysts predict that Autonomy will be a big beneficiary of the increased regulatory oversight that most experts say is coming in the wake of the financial crisis.

"We see Autonomy as a long term leader," Morgan Stanley Europe analyst James Dawson said in a report following the company's third quarter earnings call Oct. 15. Dawson estimates that earnings per share will grow 35% in "a tough year in 2009" for public companies generally. "This business has stronger fundamentals than others we cover," wrote Dawson, who has a buy rating on the stock.

Autonomy's services are selling well these days. Revenue for the third quarter ended Sept. 30 was $127.1 million, up 42% compared to the same quarter last year. Operating margins are about 40% and should reach 44% next year, according to Lynch. Based on rising demand, Lynch and his team are projecting 10% to 20% revenue growth in 2009.

Not surprisingly, banks have been good customers for Autonomy. Tom Gidley-Kitchin, an analyst with Charles Stanley and a buy rating on the stock, predicts there's a giant wave of business headed toward Autonomy as the credit crisis unfolds. Customers include Bank of America (BAC, Fortune 500), Deutsche Bank, HSBC and the New York Stock Exchange.

Autonomy is also seeing an uptick in business across industries, including oil (Statoil), chemicals (Bayer) and government (the European Commission). Other customers include Ford (F, Fortune 500), Toyota, Nokia (NOK) and the U.S. Department of Justice.

Despite the positive outlook, Autonomy shares, like most stocks this year, have taken a big hit. At £8.58, they aren't far from their 52-week low of £7.04. But shares so far this year have fallen only 2% while London's FTSE 100 is down more than 34% year-to-date.

With a 2008 price-to-earnings ratio of about 30, Autonomy shares aren't cheap. But in these dark times, Autonomy is likely to continue to thrive.

Not sure how to invest with the markets down sharply and no sign up a rebound? Ask us your investing question and we'll answer it in an upcoming Investor Daily. E-mail Fortune.  To top of page

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