The badly tarnished state of listed law firms Slater & Gordon and Shine Corporate is making lawyers take a second look at the “listing model” for law firm growth and expansion.
Slater & Gordon has a ‘hero to zero’ style fall from ASX grace after being the much-heralded first-in-the-world to list in 2007 and now tumbling into penny dreadful territory.
The financial picture for Slater’s is not pretty.
As at December 31 2015 the group had drawings of $783 million on its debt facilities and with a net debt position of around $741 million with available liquidity of around $119 million.
The question is whether they can buy enough time to reverse the disaster that was the first half of 2016 operating performance that saw a cash outflow of over $83 million.
A $1.3 billion UK acquisition of a law firm group was followed by investigations by UK and Australian regulators into the firm’s accounts. The firm was valued at $2.75 billion in April 2015, but by the beginning of this year it was just $250 million.
Lustre Off Shine Too
The situation with Shine Corporate, an Australian plaintiff firm that listed on the ASX in 2012 has also fallen dramatically, with a trading halt called after a halving of profits this year.
But why has this happened?
There was a major novelty factor to the listing of law firms on the stock exchange, following major deregulation in Australia and the UK, which has been the focus of Slater & Gordon’s growth.
Slater and Gordon’s IPO was followed by the listing of Integrated Legal Holdings Limited (ILH) in August 2007.
As LawyersWeekly reported this week, Slater and Gordon quickly gobbled up firms using cash provided by shareholders and swelled in size, building up a staff of 2,500 across 70 locations in Australia and 18 locations in the UK. Meanwhile, ILH became the first listed law firm to go into voluntary administration after pursuing fast growth and experiencing difficulty retaining senior lawyers.
Between 2014 and 2015, two of intellectual property firms, Xenith IP and IPH Holdings, also launched IPOs. But, despite the apparent success of most listed firms up until last year, other Australian law firms have remained reluctant to follow suit.
Lawyers Weekly approached Slater and Gordon, Shine Corporation, Xenith IP and IPH Holdings for this story but only Xenith IP chose to provide a response to our questions.
The Trap
LW reports Gareth James, equity research analyst at Morningstar, who says that Slater and Gordon has fallen into the trap of attempting to consolidate a highly fragmented industry – a business strategy known as a ‘roll-up’.
The legal industry contains a multitude of independent practices because value sits primarily with individuals, he says.
“There has not been much sense for it to be consolidated because if you are a good lawyer, then you can just set up on your own,” Mr James explains.
But now, Slater and Gordon has taken advantage of changes in restrictions around corporatisation of law firms to start consolidating the industry through acquisitions, according to Mr James.
“The key attraction to the roll-up is that there tends to be a difference in price between what you pay for a small business and what it is valued at on the stock market – very large companies are valued much more highly than very small companies,” he continues. This valuation uplift, called ‘evaluation multiple arbitrage’, means that rapid acquisitions increase company profits without any extra value being added to the acquired business, says Mr James.
Slater and Gordon also expanded massively overseas once it felt it had outgrown New Zealand.
But how wise was the achievementy of over 30 takeovers, which include Blessington Judd, Crane Butcher McKinnon, Carter Capner in 2008; Trilby Misso Lawyers, Keddies Lawyers in 2010; and Biddle Lawyers last year.
All of those however were overshadowed by the massive acquisition of the UK buyout of Quindells, which badly burnt them with massive borrowings.
“Roll-ups tend to go very well for a long time for a few years and it is not uncommon for them to collapse.”
Roll-ups in the professional services area are particularly risky as it is difficult to “extract synergies” or cost-savings from businesses which rely on individuals fee-earners, Mr James explains. “If you buy two law firms there’s not really many costs that you can pull out,” he says. These rollups also suffer from retention issues, as the departure of key senior staff following an acquisition can seriously affect the value of the business, he adds.
In this sense, listed law firms face the opposite challenge to those of private law firms, says consultant Peter Frankl, director of the Legal Practice Specialist.
“The default setting of most private law firms is a lack of liquidity in the business. The challenge of the listed law firms up until now has been to make effective use of the funds that have been made so readily available to them.”
Both the troubled law firms have plenty of work on the books, but because some are no win no fee they will not all generate revenues.
This build up of ‘work in progress’ (WIP) creates uncertainty in accounting, which only becomes more problematic if the company is rapidly acquiring businesses, according to Mr James.
Both Slater and Gordon and Shine acknowledged WIP as a factor in their lower than expected earnings towards the end of last year. Two weeks after reaffirming to investors that it would meet its earnings guidance on 1 December, Slater and Gordon abandoned its revenue earnings guidance for financial year 2016, citing a “poorer than expected case resolution profile” as a factor.
