What does the future hold for the UK’s largest listed law firm?
City trainee Clive Wong examines the fall in its share price from a pre-COVID market high of 143p
There is no kind way to put it: DWF’s share price has largely underperformed in the market since its Initial Public Offering (IPO).
Having started at an IPO price of 122p per share in March 2018, which subsequently peaked at 143p per share in mid-February 2020, the share price is currently at 65.5p*. If you are an investor who bought into the DWF IPO, you would have suffered a 53.9% loss. Compared to the FTSE 100 index, this represents an approximate relative underperformance of 26.5% over the same period of time.
It should however be noted that DWF is not alone in the wider group of listed law firms. In fact, the shares of the wider group of listed law firms are all down from their 52-weeks high: Gateley is down approximately 38%, Keystone Law is down approximately 19%, Knights Group is down approximately 17% and Rosenblatt Group is down approximately 35%*.
Looking at the business
The latest of audited annual results we have on DWF is the annual report for the year ended 30 April 2019. The results are generally positive: net revenue increased by 15.2% to £272.4 million, largely driven by new partners and teams acquisitions internationally, including in jurisdictions such as Poland and Australia. Gross profit increased by 16% to £145.5 million, while gross profit margin remains largely consistent at 62%.
And how about the impact of COVID-19? The latest trading update on 9 July 2020 provides that there was strong trading in the first two months of the financial year with revenues and EBITDA (a company’s earnings before interest, taxes, depreciation, and amortisation) ahead of budget. Unaudited FY 2020 results show that adjusted EBITDA comes in around £35 million, exceeding the expected £34 million. It is, however, not clear what ‘adjusted’ means in this context nor what the adjustments were. Furthermore, we should note that both figures are under the new IFRS 16 rule which requires companies to shift operating leases back onto the balance sheet, and that the figures are currently unaudited. DWF has also announced related cost-cutting measures including office closures and role reductions.
What is perhaps more concerning is the fact that the company announced that it was seeking relaxation of certain covenants. A recent update on 24 April 2020 stated that the group had secured an increase in its committed Revolving Credit Facilities and relaxation of covenants, in relation to, among other things, financial covenants for leverage. DWF already carries a fair amount of debt on its balance sheet, with its long-term liabilities standing at around £50 million, as reported in its 2019 annual report. This is a significant amount, particularly for an industry traditionally associated with conservative management and tight financial discipline. By way of contrast, Norton Rose Fulbright and Bryan Cave Leighton Paisner, both of which are firms larger in size in comparison to DWF, have net debt at £29 million and £22.6 million respectively.
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The share price: An explanation
The extent of the underperformance of DWF’s shares is comparable to a cruise line operator or a homebuilder — stocks that are hit the hardest by the COVID-19 crisis. Carnival, one of the world’s largest cruise line operators, saw its share price plummet by 75.6%* from its 52-weeks high. Similarly, Taylor Wimpey, a leading British homebuilder, saw its share price drop by 39.7%* from its 52-weeks high.
This is quite peculiar. Unlike a cruise line or a homebuilder, whose businesses have been in complete stalemate with virtually no revenue being generated as a result of COVID-19, DWF was still trading throughout the entire pandemic. The COVID-19 pandemic would certainly hit DWF’s business, but it should not be to the extent that one would expect for a cruise line or a homebuilder. The trading updates from DWF, even if taken with a pinch of salt, indicate that it’s largely business as usual down in Spinningfields, Manchester, where the firm is headquartered. Perhaps it’s fair to say that law firms and other professional services firms are generally weathering this pandemic better than the rest of the economy. So why has its share price been punished so severely?
It appears that the answer largely boils down to a fear of uncertainty. In uncertain times such as a pandemic, investors tend to ‘flight to quality’, and rotate out of risky assets into safe-haven assets such as gold, defensive stocks or bonds. Unfortunately, law firms as an asset class is still an unproven quality. Indeed, the first-ever law firm flotation occurred only back in 2007 when Slater and Gordon made history by going public in Australia. To date, only a handful of law firms are publicly traded in the UK. Publicly listed law firms as an asset class is largely untested in an economic downturn. As a result, in a pandemic or a financial crisis, investors would sell off their speculative bets and pour their money into tried-and-tested assets where they can safely rely on. Irrational perhaps, but the market is not always rational. Warren Buffet had once famously said, “reaching for yield is really stupid… but it is very human”. The reverse is unfortunately also very true in an economic downturn.
To reinforce the above point, one can take a look at the major investors in DWF. There is a large proportion of insider holdings with The DWF Group Plc Employee Benefit Trust, which is an employee owned trust and owns 7.5% of the firm. This is excluding the members (partners) holdings in the firm. However, it is also clear that there is a lack of hedge funds’ interest in DWF’s shares. This could maybe be explained by how law firms as a business is perceived. It is not a defensive utility or consumer staple stock that investors can seek comfort in a bear market. Nor is it a fast-growing cutting-edge technology company that promises to deliver explosive growth. When you factor in the available options and the associated opportunity cost, one might question whether it is worth it to own a listed law firm’s share over other options, at least at this stage. The lack of so-called long-term ‘smart money’ further escalates the panic sell-off in the case of a pandemic.
Facebook, when it was first listed in 2012, had its share price trading sideways for one and a half years until an uptick in late 2013. Back then it was a brand new industry, and it took investors a while to grapple with the fundamentals in valuing a social media stock. The share price subsequently took off and the rest is all history.
DWF’s share price is perhaps at a split road now. How the company reacts and performs in the crisis will perhaps determine the public’s perception of law firm shares in general. If the firm weathers the storm well, it could give investors the confidence to invest in law firm shares in the future. The ball is in DWF’s court now.
*All share prices as at 9 July 2020. All data from www.investing.com.
Clive Wong is a trainee solicitor at a City law firm. Prior to this, he worked as a financial analyst at an investment bank in Shanghai. He completed his masters in law at the University of Cambridge, and his undergraduate degree in law at the University of Birmingham.
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