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What does the future hold for the UK’s largest listed law firm?

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City trainee Clive Wong examines the fall in its share price from a pre-COVID market high of 143p

DWF’s London office

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.

Conclusion

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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21 Comments

Bumblebee2.2

It woe work them ay profitable that much

Persual

What sort of dividends are paid out annually?

Anon

Believe dividend is currently suspended?

Anon

Genuinely well written article and enjoyable to read.

Well done!

Hedgie

You forgot to factor in the yield from the dividend paid out

WSJ

You’ve caught the main problem which is that the business of law firms is largely untested in the public markets and that causes institutional investors to shy away.

Another key issue is that revenue growth in large firms year on year is slow and competition is high so once they have expanded internationally there isn’t really much scope for increasing that, which is what really catches the eye of investors. The FAANGs have shown that they can increase their revenues by double digit percentages YoY even after being so established in the market by creating new products and revenue streams.

Also worth pointing out there has been notable insider buying announced at DWF in the past month which would indicate their own management think the stock is undervalued.

Anon

Yeah good point. But wonder whether a lawyer at a different law firm will be permitted to buy DWF shares – conflict perhaps?

anon

Interesting query – any of us can purchase publicly traded DWF stock (if you wanted to). The concern on conflict is one frequently brought up in the topic of regulated professional services businesses going public, especially in the USA where a law firm IPO is not realistic in the foreseeable future.

It might not be an issue for an ambulance chaser firm like Slater & Gordon pursuing £5 – 15k slip and trips, but say your PLC firm acted in a dispute valued at 9 figures or above, for and/or against a number of cash-rich financial institutions (funds, insurers, etc). Any of those institutions could, theoretically, have the cash to take a controlling interest in the publicly traded firm and perhaps not control the outcome of dispute directly, but certainly make life extremely difficult at your firm until the employees start acting in a certain way.

Would this actually would happen in practice? Who knows, but we’d be failing the lawyer profession if we didn’t assume the worst of people.

Anon

Excellent article. I think demand for commercial and contract legal services will only increase in a post covid high risk environment and firms like DWF will thrive

anonymous

Did you not read the article? Have you not seen the news or even talked to someone who works there? DWF is months away from getting the Bain Capital treatment. Via the grapevine, they’re already talking to “management consultants” to plan next phase of redundancies.

A

5.04pm, do you want to buy some magic beans?

blublublu

Very interesting read. thanks Clive

Parcel Fish

Glaring omission of CEO coup.

Gordon

Great analysis, Clive. You’re wasted in law – get back to earning the big bucks in finance!

trainee supervisor

There are a couple of points that this article misses.

1. If the results were that strong why did they boot out their CEO?

2. Why didn’t they furlough staff and cut costs sooner and not wait until after the collapse in the share price to make redundancies?

3. Why many of their own staff don’t have a clue what on earth their connected services divisions do.

4 Why many of the utterings from their management seem in the words of Elton John to be ‘potions in a travelling show’

5 Who on earth can turn a profit on insurance work or other low margin work they do for regional clients?

Flotsam

IPOs in the legal sector are for the middling who think the capital will make them better. It doesn’t.

Anonymous

Floating kills the future of a firm by moving future equity income streams into the pockets of current shareholders, so the most likely outcome of such a move is that the firm dies a long slow death or it collapses horribly at times of stress.

anon

Law firm IPO’s are a golden parachute for the top equity partners at lower tier firms in the twilight of their career. The work you do at Knights, Gateley or DWF may be low value high-churn work, but the partners who made it to the top put in the same hard work in developing legal and marketing skills as their international City firm counterparts. The hours will likely have been very similar, but with 1/3 (at best) the payouts. It’s only human for them to want to make up the lost time just before retiring. Just look at the Beech family – on the Knights IPO the Beech family received millions and retained a substantial share holding.

Anonymous

Exactly, it is the death knell of any firm. That “golden parachute” is the DCF valued future income stream means the future partners earn even less. Over time you cannot attract and keep talent that way.

Al

The esoteric masters could opt to turf up the pasture, but then in what turn would those less well off make? Put it this way – if the majority of 70 vs 30 and the tide is going out, then why would you put your full stack on red or black? I have some severe doubts about the lucidity of this venture. How many rations can you suppress to get to the root? It remains to be seen…

Larry

Pretty incoherent mate. Be better.

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