Should you in­vest in the le­gal ea­gles join­ing the mar­ket?

For the first time law firms are go­ing public in ma­te­rial num­bers

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When Gate­ley (GTLY:AIM) listed in London in June 2015, it be­came only the sec­ond law firm in the world to join a public stock ex­change. Only Aus­tralian firm Slater & Gor­don had made the move be­fore, back in 2007.

Now there are four le­gal ‘com­pa­nies’ on the AIM mar­ket and while all fea­ture lawyers as their main em­ploy­ees, they are all very dif­fer­ent busi­nesses.

Key­stone Law (KEYS:AIM) has been de­scribed as a ‘vir­tual law firm’ prob­a­bly due to its lack of bricks and mor­tar of­fices. In­stead it al­lows its lawyers to work re­motely. The busi­ness re­vealed that its fee earner head­count grew by 17% to 266 in its re­cent full year re­sults.

Michael Don­nelly, an­a­lyst at Pan­mure Gor­don, says Key­stone ‘con­tin­ues to at­tract the best talent in the busi­ness’.

The value of a law firm is in­her­ently linked to its hu­man cap­i­tal. The more lawyers it has charg­ing clients for its ser­vices, the greater revenue and prof­its it can make. For 2018, Key­stone’s revenue had grown by 23.6% to £31.6m while un­der­ly­ing pre-tax profit hit £2.9m, a 63% im­prove­ment on the prior year.

THE RE­MU­NER­A­TION IS­SUE

Key­stone CEO James Knight says ‘Key­stone’s model is at­trac­tive to in­vestors be­cause the deal fee earn­ers re­ceive is un­af­fected by equity, it doesn’t di­min­ish their earn­ings’. Knight is re­fer­ring to how traditional law firms pay their part­ners and po­ten­tial prob­lems it could cause new hires and share­hold­ers.

If a law firm op­er­ates an equity part­ner­ship model, this may cause prob­lems if it floats on the stock mar­ket. Part­ners are paid from the equity of the busi­ness and as Knight says, if a listed le­gal busi­ness was to of­fer lots of free shares to an in­com­ing part­ner, it would have a di­lu­tive ef­fect on the equity which is bad news for share­hold­ers.

This is prob­a­bly the biggest bar­rier to traditional law firms join­ing the stock mar­ket and an is­sue that Adrian Biles, chief ex­ec­u­tive of an­other listed law busi­ness Gor­don Dadds (GOR:AIM) is well aware of.

He de­scribes the traditional lim­ited part­ner­ship model of law firms as ‘cash ex­trac­tive’. ‘Part­ners want to profit and not in­vest for the fu­ture. It mit­i­gates against the busi­ness hav­ing an en­ter­prise value of any great ex­tent,’ he says.

KNIGHTS, ONE OF THE UK’S TOP 100 LAW FIRMS BY REVENUE, HOPES TO FLOAT ON THE UK STOCK MAR­KET IN LATE JUNE.

IT HAS CIRCA 7,500 CLIENTS IN­CLUD­ING ALDI AND ROLLS-ROYCE

Trad­ing at 150p, Gor­don Dadds is a highly ac­quis­i­tive le­gal busi­ness, hav­ing bought four law firms since its IPO in Au­gust last year. Its most re­cent deal with Cardiff’s Thomas Si­mon cost £1.88m and will be merged with Gor­don Dadds ex­ist­ing of­fer­ing in the Welsh cap­i­tal.

Ben The­faut, an­a­lyst at bro­ker Ar­den Part­ners, says since the com­pany’s IPO his full year 2019 earn­ings per share forecast has in­creased by 70% to 13.1p. The­fault ‘be­lieves tan­gi­ble ac­qui­si­tion de­liv­ery and sig­nif­i­cant earn­ings up­grades are not re­flected in the cur­rent share price’.

FIRST MOVER AD­VAN­TAGE

The first UK law firm to list, Gate­ley, took some time to get the at­ten­tion of in­vestors. Its share price was stuck in a nar­row band for the first 18 months.

How­ever, in­vestors who had got in on the first day’s trad­ing would have en­joyed see­ing their hold­ing in the com­pany ap­pre­ci­ate by al­most 80%.

Nick Smith, ac­qui­si­tions di­rec­tor at the com­pany, says that al­though he and his col­leagues knew they had a profitable busi­ness they wanted to float be­cause in the ‘non-quoted en­vi­ron­ment what peo­ple are try­ing to do is some­times more dif­fi­cult to see’.

The firm is also ac­quis­i­tive, re­cently an­nounc­ing its third ac­qui­si­tion since IPO of GCL Solic­i­tors. The com­pany re­leased a bullish pre-close state­ment for its year end­ing April 2018, say­ing rev­enues will be no less than £84m with EBTIDA (earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion) reach­ing at least £16m.

Given these fig­ures ex­ceed house bro­ker Can­tor Fitzger­ald’s own fore­casts at the time, its an­a­lyst Keith Baird up­graded his earn­ings fore­casts by 4% for 2019 to 12p and by 5% for 2020 to

13.2p re­spec­tively.

LIT­I­GA­TION

The most re­cent ar­rival to the mar­ket is Rosen­blatt (RBGP:AIM) which listed last month. While all the le­gal com­pa­nies have in­sti­tu­tional in­ter­est, this com­pany has par­tic­u­larly stel­lar share­holder list with Black­Rock, Fidelity and Schroders among its top hold­ers.

The rea­son could be the stated aim of the com­pany to not just be a law firm but also de­velop a sep­a­rate en­tity that will be a lit­i­ga­tion fun­der. The success of ex­ist­ing AIM quoted Bur­ford Cap­i­tal

(BUR:AIM) in this area may have stoked these in­vest­ment ti­tans’ ap­petite.

Bur­ford’s share price is up nearly 16-fold since its own list­ing at 100p in 2009.

Ni­cola Foul­ston, CEO of Rosen­blatt, says it’s not pos­si­ble for a law firm to fund third party ac­tions (con­flicts of in­ter­est), so the fund­ing part of the busi­ness will have no lawyers in­volved.

The com­pany has prac­tice ar­eas of real es­tate, cor­po­rate and em­ploy­ment all with con­tentious el­e­ments, or the chance of lit­i­ga­tion.

All the lawyers and oth­ers as­so­ci­ated with the le­gal com­pa­nies be­lieve there are go­ing to be more firms on the mar­ket. Some think that it may one day be its own sub­set of the FTSE.

There are rea­sons to be­lieve a di­ver­si­fied and well-man­aged law firm could per­form well whether the econ­omy is blow­ing hot or cold. In good times, lots of deals are be­ing done and cor­po­rate lawyers are busy.

When the econ­omy is in a down­turn, peo­ple want money they’re owed so con­tentious prac­tices do well. For this rea­son the law space may turn into one of the more in­ter­est­ing parts of the mar­ket. (DS)

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