Like bunnies in a rabbit hutch, like coat hangers in a darkened closet, so too are the red flags beginning to multiply at data collector, collator, and disseminator ChoicePoint (NYSE: CPS).
It all started with the revelation in February that ChoicePoint had unwittingly been selling personally identifiable information to a ring of identity thieves. This part was not really ChoicePoint's fault; the thieves stole identities and set up shell companies beforehand in order to hide their criminal intentions. It was through these front companies that they purchased access to ChoicePoint's databases. Everything looked kosher, and so ChoicePoint probably was no more at fault there than is the local 7-Eleven (NYSE: SE) owner who is conned into accepting a forged check.
Were that all there was to the story, investors might rightly have considered the company's subsequent 15% decline in stock price a good chance to open a position. ChoicePoint's business has been going like gangbusters for years. Its profits were up nearly 60% over the past year, up 17% per annum on average over the past five years. In short, this company was beginning to look like one of the clear winners of the information age. Considering the company's swift action to win the public over to its side of the story and head off congressional calls for regulation, ChoicePoint looked to have a decent chance of making it through this trauma alive.
Unfortunately, as is often the case when a hole is poked in an investing success story, investors and regulators alike begin taking a closer look -- and lo and behold, find other holes in the story. (For a good case in point, read Tim Beyers' column on Krispy Kreme's (NYSE: KKD) recent legal woes.) In ChoicePoint's case, the fingers are already a-poking. Shareholder lawsuits have begun to roll in, meaning we can expect future earnings to be impacted by legal fees, settlement offers, jury verdicts, or a combination of all three. The Federal Trade Commission has begun investigating the company for failure to protect its data adequately. The SEC has started its own investigation into massive insider selling by ChoicePoint's CEO between the time management learned of the security breach and the time it informed the public.
If that weren't enough to frighten you off, consider the likelihood that, at some point in the future, people are going to learn that their identities were stolen as a result of the security breach. Yes, they're going to sue ChoicePoint, too. Then factor in the cost of revalidating 17,000-plus small-business customers to ensure they're legit, and/or abandoning this revenue stream entirely, and how this will weigh on ChoicePoint's numbers in quarters to come.
Foolish investors should ensure their eyes are wide open before buying ChoicePoint. And if their eyes are truly open, it'll be red flags as far as the eye can see.
Fool contributor
Rich Smith
owns no shares in any company mentioned in this article.
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