The increase in uncertainty rating from very high to extreme means we consider the range of valuation possibilities too high to provide a recommendation to clients. Slater and Gordon lacks clear structural trends to support the thesis that the U.K. operation can trade itself out of difficulty in the short to medium term. That said, if the renegotiation of debt financing and the U.K. turnaround succeed, the value of Slater and Gordon's equity could be hundreds of millions of dollars. However, a zero or significantly impaired equity value is also a realistic scenario under the status quo, assuming further earnings and cash flow weakness. The recent appointment of insolvency expert McGrath Nichol to review the business supports this view to some degree. A more optimistic scenario could be painted if a significant and deeply discounted equity raising occurred, along with a distressed asset sale of the U.K. operations.
Risk (Last Updated: 12-Jan-2017)
Slater and Gordon operates in a highly regulated environment and is exposed to multiple regulatory risks. Recent proposed changes to personal injury legislation could significantly affect Slater and Gordon's U.K.-based businesses.
The acquisition of the professional services division has increased the risks of integration and execution, particularly as Slater and Gordon has acquired a large business containing several small segments that practise in legal niches in which it has no experience.
Competition, particularly in the personal injury space, is increasing, and while Slater and Gordon's strong market position and geographical spread provide a cushion, aggressive pricing can hurt margins and result in a loss of market share. Other risks stem from acquisition indigestion, rising transaction multiples and integration risk.
Slater and Gordon provides legal advice; therefore, like any law firm, the company is subject to potential liability from breach of client contracts, negligence and other claims by clients. In addition to the risk of financial damage, such claims carry a risk of reputational damage, and although the company has professional liability insurance in place, this insurance may not cover all potential claims. Slater and Gordon is also exposed to the risk of employee misconduct, which could result in harm to the company's reputation, in addition to regulatory sanctions and financial damage.
As a large portion of the group's earnings is generated in pounds sterling but reported in Australian dollars, the company is exposed to unfavourable currency movements.
Financial Health (Last Updated: 12-Jan-2017)
Slater and Gordon is in poor financial health. The company reported a loss after tax of AUD 1 billion in fiscal 2016. Net debt increased by 9% in fiscal 2016 to AUD 722 million and debt metrics deteriorated, with gearing (net debt/(net debt plus equity) increasing from 32% at 30 June 2015 to 70% at June 30, 2016, largely due to the goodwill impairment, with net debt/underlying EBITDAW and EBITDAW/net interest cover both negative. However, the capital-light nature of the business means assets are mainly intangible in nature and valuations have a large degree of subjectivity and dependent on future earnings. Further earnings weakness could well see more write-downs, higher gearing, and potentially debt covenant issues.
SGH Price at posting:
26.0¢ Sentiment: Hold Disclosure: Held
