Should you invest in the legal eagles joining the market?
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.
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.
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)