Listing the Benefits
Article, Law Society Gazette – March 2008
Legal / Corporate / Disputes
Raising external capital will soon become an option for law firms. But if that means floating on the stock market, says James Stanbury, high-volume firms may have the advantage.
The Legal Services Act has paved the way for law firms to raise external funds. Whether this will be in the form of private equity or an IPO remains to be seen. But if a law firm were to be listed on a stock exchange, how would it perform? Would it be a good investment?
Firstly, the appetite for external finance needs to be gauged. A recent survey by Smith & Williamson suggested most of the firms considering this route are medium and small firms rather than the magic circle.
The survey found 22% of the sample expected to raise external capital within the next five years. The timeframe is not surprising as it will be in three years (2011) before the provisions for outside investment actually come into effect. But the differing attitudes go to the root of why a firm would want outside investment. What would the attraction be.
Top-tier firms are not, I consider, so likely to seek the listing route, on the general basis that they feel they are “doing all right, thank you very much.” The opportunity for the injection of financial capital becomes a risk to the exit of human capital – that the one-off bonanza for existing equity partners becomes a barrier to prospective partners and a “brain drain” ensues. Where the asset base (and ultimately the value generation) of an entity is its people, the danger of that risk to its value is obvious.
However, it also becomes an opportunity as investment in a firm can be made available earlier to staff through shareholding schemes. Of course, if a firm were to float, its value would be inherently tied to its provision to retain and attract staff.
The same considerations would apply to any law or professional services firm, whatever its size. However, industry commentary suggests that the external financing route would be most attractive to firms that specialise in a particular high-volume area, such as personal injury or conveyancing work, where investment in IT can drive down processing costs and therefore generate better earnings. A public listing may also assist in profile raising in a very competitive market.
Would such a law firm make an attractive share? It may be argued that a “high-volume” firm would be a steadier performer than one which was not. Such work tends to exist whatever market and general economic conditions prevail. Thus, assuming that costs - such as human resources, IT, marketing and finance – could be adequately controlled or improved, earnings and value would increase. In addition, mergers or acquisitions of similar practices - funded through external capital –would enhance earnings if economies of scale could be exploited.
Market speculators in the UK do have the benefit of the Australian example to assess likely stock market performance. Slater & Gordon (S&G) from Melbourne was the first law firm to debut, in May last year, followed by integrated Legal Holdings from Perth, which listed in August. Both have followed an active acquisition strategy. The graph above shows the share prices of both firms since their listings. Comparison is made with the sector index in which they have been placed (Consumer Discretionary Services). The latter has been resized to provide comparability in trend but not absolute value.
The divergent fortunes of the two firms are clear – both in relative terms and to the sector index. S&G’s stock has risen but levelled off - the rise in August coincided with the acquisition of the Sydney-based practice, McLellands. However, ILH’s price – which did not debut as high - has declined. Despite having the same strategy of acquisition, the share price movements may reflect their relative success in integrating subsequent acquisitions. Pre-flotation, S&G was a long-established business whereas ILH was created from the merger of three Perth practices. Where a volume-driven law firm is concerned - and both firms fit that description - the ability to integrate operations is key as it should provide growth in revenues, synergistic cost reductions and therefore improved earnings.
It is also instructive to look at how another professional services grouping has fared in the UK - the accountants. Three have floated - Tenon, Vantis and Begbies Traynor (in that order). Their share prices since April 2000 are plotted in the graph below and comparison has been made to the AIM index trend with Tenon performing the least well of the three.
As with the Australian law firms, Tenon followed the “consolidator” model – an acquisitive approach which relies on the effective integration of acquired firms and consequent cost benefits. Commentators have pointed to the relative success of Vantis (as an already established firm) in this consolidation process as one of the main reasons for the divergence in share price, citing its successful integration of Numerica in May 2005.
So what lessons can be learned by the lawyer? For those with an appetite for external capital to fund acquisitions, the imperatives are to integrate the businesses properly so the cost savings are realised, earnings grow and your share price follows. If they can, lawyers need to ensure that they float their boat, not sink their ship.
As appeared in Law Society Gazette, March 2008.