Hi Jim, please see below:
Slater and Gordon has a highly uncertain future and extreme fair value uncertainty rating. Over the past several years, the company has destroyed a considerable amount of value, highlighted by the disastrous acquisition of the Professional Services Division, or PSD, from United Kingdom-based conglomerate Quindell for AUD 1.2 billion in 2015 that led to a AUD 1.0 billion loss in fiscal 2016. The PSD acquisition significantly increased net debt but the promised earnings simply didn't materialise, putting Slater and Gordon in a precarious financial position and raising questions about management's judgement and ability to allocate capital. Our poor stewardship rating reflects the transaction, its aftermath, and the fact that the same management team remains in place. The reiteration and subsequent withdrawal of earnings guidance in late 2015 reflected particularly poorly on management and led to key competitor Maurice Blackburn launching a shareholder class action.
Slater and Gordon is exploring refinancing and recapitalisation options but we expect few, if any investors, will be willing to commit new equity to the company. We expect a debt for equity swap with material dilution of existing shareholders to be the most likely outcome. The company continues to lack an economic moat and we maintain our extreme fair value uncertainty rating, indicating the shares are too risky for most investors. Our effectively zero fair value estimate assumes the existing equity is worthless. Citigroup reportedly sold its Slater and Gordon debt in early December 2016 for 38 cents in the dollar implying an enterprise value of around AUD 300 million and zero equity value. Considering the outstanding class action, the new investigation by the Australian Securities ands Investment Commission into historical accounting practices, and the very poor outlook we have decided to cease coverage to focus on more attractive investments.
Slater and Gordon has been a key beneficiary of a deregulated Australian legal services market that allowed incorporation of legal firms in 2001 and the subsequent listing of the company in 2007, making it the first listed law firm in the world. The application of the United Kingdom Legal Services Act in early 2013 also introduced new forms of legal services ownership, providing an opportunity to enter a market about three to four times the size of Australia's.
Slater and Gordon operates in personal injury law, or PIL, and General Law, or GL, in Australia and the U.K. Australian PIL and UK PIL contributed 22% and 25%, respectively to the fiscal 2016 revenue base, while Australian GL and UK GL and Slater and Gordon Solutions contributed 53%. In PIL, Slater and Gordon is the market leader in both Australia and U.K., with 25% and 12% market share, respectively. Most of the work is performed on a "no win, no fee" basis, where legal fees are paid on the successful conclusion of a client's matter, with a 95% success rate. PIL is relatively immune to the impact of economic cycles, but the U.K. business faces material regulatory risk. Recent regulatory changes in New South Wales and Queensland have also adversely affected the company.
GL practice is made up of personal legal services (including family law, conveyancing, wills, and estate planning) and business and specialised litigation services (including commercial, employment and professional negligence litigation). In business and specialised litigation services, the company has a long history of involvement in some of the most high-profile class actions in Australia, where it was regarded as a pioneer. Work in this area is predominantly performed on a fixed-fee basis, with an average transaction size of AUD 15,000. GL is a highly fragmented market 2-3 times the size of PIL.
We expect revenue to be driven primarily by organic growth during our forecast period. The company generates top-line increases through sustained marketing, leveraging its brand awareness and tapping into the strong relationships with unions and professional services, as well as through its legal helpline. A key driver of operational efficiency is the company's focus on metrics, such as increased calls answered, decreased wait times and increased client satisfaction. Slater and Gordon's case-management system is another key strength: The company uses paralegals to handle administrative matters, thereby freeing up time for lawyers. The introduction of 'no win, no fee' has resulted in a highly outcome-focused culture, as fees are paid only on a conditional basis.
Bull Points (Last Updated: 12-Jan-2017)
- Slater and Gordon will be a key beneficiary of further consolidation across the consumer law markets in both Australia and the U.K.
- Expansion into non-personal-injury consumer legal services in Australia further diversifies the company's offering.
- The increasing availability of litigation funding in Australia provides upside for class actions.
Bear Points (Last Updated: 12-Jan-2017)
- Regulatory changes in Australia and the U.K. could have an unfavourable impact on earnings. The U.K. consumer legal market is also going through rapid changes with potential negative implications.
- There is a risk Slater and Gordon will overpay for businesses, eroding returns for investors. Furthermore, there are integration risks associated with such a rapid roll-up strategy.
- The threat of new entrants, as well as an increase in competitor activity, could result in significant price declines, squeezing margins.
Cheers
