The great Aussie merger mystery
3 September 2012 | By Yun Kriegler
4 July 2012
13 December 2010
20 February 2013
21 June 2012
Transatlantic Elite 2011
In the past three years eight UK firms have launched Down Under, but only a couple have done it through full equity mergers. Read on to find out why
There is more than one way to skin a cat. From Norton Rose’s Swiss Verein, Allen & Overy’s (A&O) team-poaching and Clifford Chance’s merger with boutique firms to the alliance between Linklaters and Allens and the recently announced full merger between Herbert Smith and Freehills it is intriguing how many ways international firms are using to fulfil their Australian aspirations. So just what is it about Down Under that is generating such a multitude of structures?
While each expansion strategy is largely dictated by the firm’s philosophy, the Australia phenomenon is a reflection of the issues that international firms have to deal with when they expand into a new, yet relatively mature, market.
“International firms are approaching the Australian market in different ways,” says Brad Hildebrandt, founder and managing director of Hildebrandt Consulting, who has participated in numerous law firm merger discussions, including King & Wood Mallesons’ Swiss Verein. “That’s partially driven by the complexity of doing global transactions, particularly when entering a very different market.”
Differences in regulatory requirements, tax regimes, risk profiles, average fee rates, overheads, and equity structures are among commonly identified challenges firms have to overcome when considering a full financial merger with a foreign entity, but fundamentally it is disparity in profitability between firms that has made integration a sensitive topic.
Here’s the lowdown on how they’ve tackled the issue.
The pace of change in the Australian marketplace has been phenomenal. In the past two years four of the ‘big six’ national firms have lost their independence. Australia has become a key part of the global market, largely driven by its proximity to Asia and its richness in natural resources.
Strategically, Clifford Chance’s Australian merger options highlight more than most the challenges and risks for top international firms when looking to merge with large Australian counterparts.
In December 2008 Clifford Chance terminated its six months of merger talks with Australian firm Mallesons. In 2011 the magic circle firm launched in Australia through mergers with boutique firms in Sydney and Perth. The double tie-up, which went live in May 2011, saw the firm join forces with Chang Pistilli & Simmons in Sydney and Cochrane Lishman Carson Luscombe in Perth, creating a 14-partner presence in the country. Equity partners of the two legacy firms joined the full Clifford Chance lockstep.
Although aborting the Clifford Chance-Mallesons merger plan was said by both firms to be a result of post-Lehman Brothers market conditions, the magic circle firm ultimately chose to have a more focused, smaller and lower risk presence Down Under two years later.
“Australia is a G20 country – it is an important economy, but also a small one,” says Michael Lishman, managing partner of Clifford Chance’s Perth office and founding partner of Cochrane Lishman Carson Luscombe. “Its GDP accounts for less than 2 per cent of the world’s total. As a global firm, we need to align the firm to its clients and the global economy. That means the ideal size of the Australian practice should be in proportion to the country’s weight in the global economy.”
In other words it may be out of proportion to have a global firm with one third of its partners based in Australia.
The problem of size is magnified when the fluctuation of exchange rates is taken into account.
“On the back of a strong Australian dollar the proximity of profitability between a UK and top Australian firm has never been so close,” Lishman adds. “But if you have a A$400m (£263m) practice in Australia, when the exchange rate against the pound drops by 20 per cent there will be a huge impact on the whole firm’s economics.”
At the moment the British pound is around 65p to one Australian dollar. In 2008, it was around 45p to one and back in 2002 it was 35p to one – almost half what it is now.
“Economically, a merger with a big firm will be okay for the next a few years, helped by the exchange rate,” Lishman relates. “But in the longer term if the Australian dollar value goes back to its historic level the profitability gap will be too big.
“You have to have most parts of the business within a range of profitability. You can’t have one part diluting the profits for a long period of time. Given our size relative to the whole of Clifford Chance we can double our profit per equity partner [PEP] or halve it without having a material impact on the global profit pool.”
In this regard the full financial merger between Herbert Smith and Freehills will probably face a big test. At the moment, Freehills’ average PEP is estimated at £618,000, a manageable distance from Herbert Smith’s £840,000. However, should the Australian dollar value drop by 20p the gap will almost double to £413,000. If 190 partners are in Australia, that would mean a reduction of £36m in the combined firm’s total net profit.
“The three big factors to consider when contemplating a merger are name, money and power,” says Lishman. “There was no question we would adopt Clifford Chance’s name and we fit into its structure easily without upsetting its existing management power and firm culture. The way Clifford Chance entered Australia is easier and lower risk way than a merger with a large firm.”
It may be a low-risk entry strategy, but it is not without its shortcomings. Clifford Chance’s absence from the Australian government’s Legal Services Multi-Use List, the government-wide legal panel, is one example. The Australian arms or alliance firms of all other UK firms that have entered the market in the past three years are featured in the list.
Similar to Clifford Chance, Allen & Overy’s (A&O) strategy in Australia is also to stay focused on top-end transaction work in its core areas. However, it opted to set up an office from scratch with a group of carefully selected partners from top-tier Australian firms instead of doing a merger.
“Look at the size of the Australian economy – a 200-partner Australian firm is too big to swallow for a global firm,” says Grant Fuzi, managing partner of A&O in Australia, who led the exodus of 14 Clayton Utz partners to the UK firm in 2010. “There are ways around it but it’s very hard.
“Our strategy is to have a clearly defined offering. We’re here to focus on the firm’s core practice areas. The way we entered the market and the team we’ve assembled here is reflective of that strategy. It’s a competitive market, but we’re an integral part of a global firm with a single profit pool and partnership. That’s attractive to clients and talent.”
Clyde & Co is the latest UK firm to enter the market. It has also chosen to establish a new practice with cherry-picked partners to focus on specific practice areas. In July it hired a number of partners from Linklaters’ Australian ally Allens, who will launch the firm’s offices in Sydney and Perth on 1 October.
Starting with a clean slate and a carefully assembled team in Australia surely has its merits, but it also comes with drawbacks and risks.
“If you look at the initial cost, entering Australia through a merger or a Swiss Verein with an already profitable firm involves quite modest costs,” says George Beaton, executive chairman of Australian consulting firm Beaton Research & Consulting. “But setting up an office from scratch is more capital-intensive. It’s common to spend A$10m to set up a greenfield operation, and it usually takes three years to make it profitable,”
In addition to costs, another area where issues are easily underestimated is in managing a newly established firm.
“Managing the integration of merged firms is not something to underestimate,” says one managing partner at an international firm in Australia. “But making a newly formed firm work carries a different set of risks. The risks associated with putting together a group of partners from different firms are generally about whether they have the required management skills to run a business and keep it together, and how well and quickly people can adapt to a new working environment and an organisational hierarchy that is very different from the firm they came from.”
When Norton Rose added Australia’s Deacons to its Swiss Verein there was no lack of skepticism over its nature and the degree of integration. K&L Gates’ chairman Peter Kalis famously claimed the Norton Rose deal was closer to an “arrangement” than a merger in the true sense, when the firm merged with Canadian firm Ogilvy Renault and South Africa’s Deneys Reitz in 2010.
“The Verein structure offers great flexibility in structuring a global deal and is a convenient choice, but the question remains why a partner in one law firm office should refer work to a partner in another office who doesn’t share either profitability or liability,” says one partner at an international firm. “There’s little incentive for cross-referrals and client-sharing, and there’s also the danger that people can’t work together as a seamless unit across jurisdictions to service clients’ best interests.”
However, there are also counter-arguments, mostly from firms that have adopted the Swiss Verein structure. One common argument states that financial integration is not the only way to motivate and encourage ‘good behaviours’ such as collaboration, cross-selling and client-sharing within a firm.
“By having common systems, policies, management and strategy, we can ensure a ‘one-firm approach’ and ‘one-firm culture’ among the members in the group,” says Wayne Spanner, managing partner of Norton Rose Australia.
According to Spanner the group is governed by a global executive committee, while each practice area is led by a global group practice head who works closely with sector leaders in different regions. He refers to the Norton Rose group as “an integrated business aligned along practice groups and industry groups”. The group also has a dedicated global mobility function to encourage the movement of partners and staff within the global network.
The Swiss Verein has worked well from the Australian partnership’s perspective, says Spanner, as Australian revenue has grown by 10 per cent each year since the tie-up in 2009.
Norton Rose’s argument is seconded by several management consultants.
“A Swiss Verein can work perfectly well, but it needs more management effort and a fair bonus system to reward partners who are moving work to the network,” says Hildebrandt. “I’ve seen global firms with a fully integrated partnership structure have a much lower level of collaboration between offices than Vereins,”
“There are various tools and mechanisms available to motivate one-firm behaviour,” adds Beaton. “The importance of a single profit pool in making a global merger work is overstated. In a sense, having a single profit pool doesn’t mean full profit-sharing, while members can still share profits within a Verein even there are separate financial centres,”
Evolution vs revolution
The Herbert Smith and Freehills deal has attracted great interest in the industry, as the two are set for full financial integration from day one of the merger. When the announcement was made it sent shock waves through the global legal community. Word was that the deal looked like too ambitious a leap, given the two firms’ very different partner remuneration systems. For example, Freehills is known for its merit-based renumeration system, while Herbert Smith operates a traditional lockstep system. In addition, Freehills has considerably more equity partners than Herbert Smith, where more than half of the partners are non-equity.
But it turns out that ‘full financial integration from day one’ means only that the two will share a single profit pool – it doesn’t mean a single system of distributing the profits.
There is no clarity yet on the details of how the combined firm will allocate profits, with Herbert Smith managing partner David Willis keeping things pretty much under wraps. Nevertheless, he is willing to provide a rough picture of what the new system will look like.
“The key thing is that we’ll have a single profit pool from day one and we’ll have a single management in place,” he says. “The rest of [the merger arrangements] still need to be finalised. One profit pool can best incentivise partners to work together towards a common goal – that’s why we decided to make the jump straight away.
“We’re in the process of creating a new international LLP that all partners of the merged firm will be in. There’ll be a new partner agreement to the new vehicle, which will present a new set of arrangements. The terms are still being discussed with both firms’ partners. We’ll have to converge the two renumeration systems and the result will be a modified lockstep. It will take some time to complete the process.”
A source close to the deal reveals that before the new system is in place the two sides will split profits on a pre-determined ratio and then distribute these to partners according to their current remuneration systems.
It may be a disappointment for some market participants to find out that Herbert Smith’s supposedly revolutionary move with Freehills is in essence not an entirely different beast from Ashurst’s Blake Dawson deal, which has been labelled as an evolutionary process towards a true merger.
Linklaters’ alliance with Allens has been widely categorised as the least integrated tie-up and, in some sense, least effective in terms of creating value for the firms and their clients. The relationship has been described in some quarters as ‘hand-holding, but no marriage’.
Even so, Allens’ managing partner Michael Rose insists it is the best solution for his firm and its magic circle ally.
“Clients want us to have execution points in more places,” says Rose. “To continue to work with our clients we have to gain greater global capability. The alliance will focus on developing energy and resources projects across Asia and servicing existing clients in Asia through joint ventures. We only want to bring our businesses together in places we’ve identified as growth engines for the future. We don’t want to change other parts of our business.
“In relation to the Australian market we already have a strong position. We want to offer a broader global network, but it’s not necessary for us to cease to exist. Both firms value their independence and we decided that this was the best structure for what we’re trying to do.”
He also emphasises that “the alliance is not a trial run for something else”.
In the coming years the Australian market will evolve and more international firms will arrive. The next development to watch will be how K&L Gates structures its merger with Melbourne-based mid-tier firm Middletons, an outfit with a total revenue in 2011-12 of A$112m – roughly 11 per cent of K&L Gates’ global revenue. Perhaps the firm that does not believe in Swiss Vereins will introduce an innovative way of tackling the Australian merger mystery.
In the meantime, despite the variety of methods of entering to Australia the consistent message is that clients do not really care about their legal advisers’ underlying business structure so long as they meet their expectations. In that respect Australia is no different from anywhere else.
Allen & Overy
Entered: May 2010
Australia managing partner: Grant Fuzi (pictured)
Size of partnership in Australia: 23
Estimated revenue in Australia (2011/12): A$55m (£36m)
Financial integration: Full (5/5)
Deal structure: Allen & Overy (A&O) took a team of 14 partners from Clayton Utz, a partner from Freehills and two partners from elsewhere for its Australia launch at the beginning of 2010. Fourteen of the partners were in Sydney and three in Perth. The two offices are fully financially integrated in the firm’s global network.
The firm’s strategy in Australia is to have a clearly defined offering. According to managing partner Grant Fuzi, the Australian offices only focus on core practices, such as high-end corporate, capital markets, banking and finance, and energy and resources work.
“The model in Australia works well for A&O’s global strategy - we’re not trying to be all things to all people,” says Fuzi.
Entered: 1 March 2012
Australia managing partner: John Carrington
Size of partnership in Australia: 180
Estimated revenue in Australia (2011/12): A$398m (£262m)
Financial integration: Only shares revenues and costs in the joint operation in Asia (1/5)
Deal structure: Ashurst and Australian firm Blake Dawson reached an agreement in September 2011 to combine their business in Asia under the Ashurst brand, while Blake Dawson would rebrand as Ashurst in Australia on 1 March 2012. The full merger is conditional on a further vote of the partnerships and will be considered in early 2014.
In Asia, the two firms will operate as a joint venture, aggregating and sharing revenue and costs in one integrated vehicle. The businesses remain financially separate, but collaborate on business development and cross-border transactions. The joint venture, which will not include Australia until 2014, is overseen by Geoffrey Green, as chairman of the management committee that contains an equal number of members from the two outfits.
Comparable average profit per equity partner (PEP) is a condition of the full merger. Ashurst’s PEP for 2011-12 stands at £744,000. Prior to the combination Blake Dawson radically reshaped its partnership by boosting the ratio of salaried partners in a bid to improve its PEP, which is roughly 10 per cent less than the UK partnership.
“Both firms think a single profit pool and a common partnership compensation system are important drivers to partner behaviours. But working these things out takes time,” says Charlie Geffen, Ashurst’s senior partner.
Entered: 1 May 2011
Australia managing partners: Mark Pistilli (Sydney) (pictured) and Michael Lishman (Perth)
Size of partnership in Australia: 15
Financial integration: Full (5/5)
Estimated revenue in Australia (2011/12): A$37m (£24m)
Deal structure: Clifford Chance launched in Australia through a double merger with boutique firms Chang Pistilli & Simmons in Sydney and Cochrane Lishman Carson Luscombe in Perth. Both were branded as Clifford Chance when the mergers became effective on 1 May 2011. The two legacy firms’ equity partners are on the magic circle firm’s equity partnership.
The Australia offices focus on high-end corporate and M&A work, complex litigation and financing and regulatory matters, particularly in the energy and resources sector.
According to Clifford Chance’s Perth managing partner Michael Lishman the firm wants to be in Australia but does not want to be too big, or to upset the culture of the organisation. The two boutique Australian firms matched the magic circle firm’s requirements.
“Our intention in Australia is that we don’t want to grow into the size of big firms,” says Lishman. “We do want to grow, and may look at doubling our size to around 30 partners and 100 lawyers over the next three to five years.”
Entered: 1 May 2011
Australia managing partner: Tony Holland (pictured)
Financial integration: Full (5/5)
Size of partnership in Australia: 111
Estimated revenue in Australia (2011/12): A$122m (£80m)
Deal structure: DLA Piper merged with its Australian ally DLA Phillips Fox on 1 May 2011, when the latter became part of DLA Piper’s international LLP. The two had been in an alliance for more than four years before the merger, but the move beyond best friends to financial integration required significant work. For example, DLA Phillips Fox spun off its Adelaide office and New Zealand arm into separate financial entities, and de-emphasised its insurance practice.
On 1 May 2012 DLA Piper International LLP was converted to an all-equity partnership structure. Therefore, all partners in Australia are equity partners of the international LLP, which has a single profit pool and a common meritocratic remuneration system. The Australian offices brought in £80m in the 2011-12 financial year, short of the projected £100m prior to the merger. The average profit per equity partner across the international LLP was £596,100.
In the words of Bob Charlton, DLA Piper’s new managing director for Asia Pacific, the firm believes in mergers.
“It’s the DLA Piper way to do a full merger,” he says. “We want to operate in all of the G20 economies and want to have the real critical mass and complete offerings in these countries. Being financially integrated with DLA Phillips Fox is a transformational step.”
Entered: 1 October 2012
Australia managing partner: Jason Ricketts (post-merger)
Financial integration: Single profit pool, separate partner remuneration systems in the interim period (3/5)
Size of partnership in Australia: 185
Estimated revenue in Australia (2011/12): A$565m (£370m)
Deal structure: Herbert Smith and Freehills will merge on 1 October 2012. The firms will put their profits into one global pool from day one, and the merged firm will be governed by a team made up of 13 members - six from Freehills and seven from Herbert Smith.
The deal has been labelled by both sides as a “merger of equals” with full financial integration. However, it is understood that while the firms will share a profit pool, they will split the profits on a predetermined ratio and then distribute profits to partners according to their current remuneration systems.
The interim system will be in use until the two have finalised arrangements for a new common remuneration system, which will be a modified lockstep according to Herbert Smith managing partner David Willis (pictured).
Given the high value of the Australian dollar, the gap between the firms’ revenues and profitability has been reduced, paving the way to merger.
Freehills’ revenue for 2011-12 was £370m compared with Herbert Smith’s £480m, while Freehills’ average profit per equity partner is estimated at £618,000, a manageable distance from Herbert Smith’s £840,000.
Entered: 1 May 2012
Australia alliance firm: Allens (formerly Allens Arthur Robinson)
Managing partner of Australian alliance: Michael Rose (pictured)
Size of partnership in Australia: 175
Financial integration: Only share revenues in the Asia joint
Estimated revenue of the Australia alliance (2011/12):
Deal structure: Linklaters entered into an exclusive alliance with Australian firm Allens on 1 May 2012. The two firms have formed a joint venture (JV), bringing together their Asia-focused energy, resources, and infrastructure lawyers, but will maintain separate profit pools, instead sharing revenue on a matter-by-matter basis. The two have also formed another JV focusing on Indonesia, based on Allens’ existing alliance with Jakarta firm Widyawan & Partners.
A collaboration committee will be established to oversee the alliance, with three partners appointed from each firm. The firms will also establish a committee to head the energy, infrastructure and resources JV - comprised of two partners from each firm - as well as appointing a partner from each firm to work alongside Widyawan.
Allens’ managing partner Michael Rose notes that the two firms only want to bring their businesses together in the places they have identified as key growth engines, and emphasises that “the alliance is not a trial run for something else”.
Entered: 1 January 2010
Australia managing partner: Wayne Spanner
Size of partnership in Australia: 140
Financial integration: Separate profit centres and partnerships among Swiss Verein members (0/5)
Estimated revenue in Australia (2011/12): Australian firm Deacons joined the Norton Rose Group under a Swiss Verein structure on
1 January 2010. The member firms remain financially separate entities. All members of the Norton Rose group will share costs associated directly with the Swiss Verein and group initiatives, but revenues from joint work are allocated to members based on the involvement of the partners/associates who are working on the respective transactions.
Everyone is encouraged to refer client contacts to their wider group colleagues - referral of work is one of the key elements of the appraisal process for all partners and therefore one of the considerations when assessing partners’ overall remuneration.
The group will look at the option of full financial integration, but there is no timetable for this. The group believes that having one management structure and one brand will encourage client-sharing and cross-selling between firms, as well as ensure consistent service standards and partner behaviours.
The group’s global executive committee is responsible for directing and shaping the practice of the member firms to create a “harmonious” business structure.