Buy Sell Hold: Trade mémoire
3 September 2007
The legal market has evolved, and with the post-Clementi prospect of external equity moving ever closer to being a reality for UK firms, the big-business nature of the legal market is all but sealed.
Never one to shy away from the cutting edge of legal journalism, The Lawyer was quick to recognise that firms are likely to seize the opportunity for an equity market flotation once regulations allow.
As part of The Lawyer UK 100 Annual Report last year we entered a hypothetical world where all 100 of the UK's top firms were listed entities, donning our trading caps on the way. Based on the 12 months the firms had just had, and more importantly on the year that lay ahead, we gave our recommendations on whether the investors that populated our parallel universe should buy, sell or hold their positions in said firms.
This year the process has been repeated, and given that last year's recommendations can be used as a comparator, is has been given more depth.
Of course, in reality the flotation ball has already started rolling, with Australian personal injury specialist Slater & Gordon raising A$35m (£14.67m) when it listed on the Australian Stock Exchange in May. With UK firms on the cusp of being able to follow suit, the buy, sell, hold measure is legitimate.
Everyone knows that investing is a subjective occupation, with one man's opportunity another man's dog.
The methodology behind our recommendations is simple. Firms that have had a strong year, but still have some way to go before reaching their peak, we have advised should be held. Of course, that assumes they are already owned. Hold is very obviously the middle ground between buy and sell, so within the recommendation is a tentative tip to buy, given that the shares are expected to rise. On the flipside, with no huge gains on the horizon some investors might just want to take the money and run by selling.
That said, the hold tag is a recognition of the potential for future strength, whether or not recent performance has been impressive.
Buy and sell almost speak for themselves, but some clarification is required. The buy recommendation has essentially been applied to those firms whose value is going to increase. That can be because they have reached rock bottom, but after a dire few years their fortunes are about to turn. On the other hand, it could apply to a firm that has been plodding along nicely, resulting in a low share price, which through some notable client wins or quality lateral hires is about to see its value rise. Similarly, a blip in an otherwise strong partnership's performance could have caused its share price to fall, resulting in a buying opportunity. The expectation in this case is that the firm will recover and be revalued in the coming year.
A sell can apply to those firms whose performances have been so poor that they do not warrant being held any longer. However, that implies an investor is selling at a loss due to a significant drop in share price. The recommendation has also been applied to those firms that have seen strong performances, but are considered to have reached their peak: continuing to hold will not see any increase in value, so it is best to cash in shares while they are at a high.
So how have these recommendations actually been applied? For the magic circle firms the trading tips have remained largely unchanged from last year.
Clifford Chance remains a hold. The firm has had a rocky time over the past few years, but the 2006-07 period marked a real turnaround. Firmwide revenue rose by 15 per cent to £1.19bn, while a 25 per cent rise in average profit per equity partner (PEP) saw that figure crash through the £1m barrier for the first time.
Obviously this means the firm's shares will be expensive, so investors would probably see greater growth by investing their money elsewhere. That said, the firm is far from hitting its peak, with the potential for growth most definitely on the up: Clifford Chance has unveiled bold plans for an attack on the US market, while its Eastern Europe presence continues to go from strength to strength.
Holders of this firm's shares still have a long way to go before they should consider selling. Definitely worth sitting on in the meantime.
Last year we reckoned Linklaters was worth investing in and that view remains unchanged this year - the firm is a buy.
Linklaters posted a record PEP of £1.29m in the 2006-07 financial year, with its revenue overtaking £1bn for the first time. Impressive stuff, especially after the torrid times it experienced just a few years ago, when profit fell, revenues stagnated and dozens of partners were de-equitised.
As a result the firm is probably still undervalued, but with a focus on complex deals and cross-border work helping it close in on Clifford Chance's dominant revenue position over the past year, those shares definitely have some way to go. Buying a stake in Linklaters would clearly be a sound investment.
Following what was an annus horribilis for Freshfields Bruckhaus Deringer, we have recommended that investors hold their position in the firm, having advised buying its shares last year.
The firm certainly still deserves its place in the magic circle elite, having posted strong double-digit growth for the past two years, while revenue fell by just short of £1bn in the 2006-07 financial year.
However, signs that all is not well have crept in over the past year, most notably with a restructuring programme that saw 100 partners de-equitised, costing a whopping 40 per cent more than was anticipated.
Then, of course, there was the age discrimination case brought by former partner Peter Bloxham, the outcome of which will be decided imminently.
There is still strength there and Freshfields' value is likely to rise, but the troubles that have dogged the firm over the past year have not been enough to make its stock appear cheap. To sell would be foolish as there is still room for growth, while the high price and recent management woes are enough to dissuade anyone from buying. Definitely a hold.
Allen & Overy (A&O) is also a hold, although for different reasons. The firm, which lagged behind its magic circle rivals in terms of PEP last year, has finally caught up, with a figure of £1.03m placing it just ahead of Clifford Chance.
Last year we reckoned A&O was a hold and, with this strong PEP showing in mind, the recommendation was justified. This year the recommendation remains hold, with the firm still having some way to go before it catches up with the rest of the magic circle in revenue terms.
At 20.5 per cent turnover growth A&O was strong in the past financial year, and with its fee-earner headcount increasing by 120 and the firm entering Japan and Germany and ramping up its Middle East presence, the coming year should be even better.
The potential for growth is most definitely still there; investors just need to bide their time with this firm.
Elsewhere in the top 100, Addleshaw Goddard, which last year was marked as a buy, has moved to a hold position. The reason for this is simple: the firm more than exceeded expectations in 2006-07, breaking its £500,000 PEP target by £42,000, so it is no longer cheap. That said, Addleshaws is on the up and, with managing partner Mark Jones eyeing a top 15 position by 2009, it is definitely worth holding on to.
Withers has gone from hold to buy after turning its fortunes around over the last financial year. The firm, which saw average PEP drop in the 2005-06 period, came back robustly, with the expectation of further growth on the horizon. Due to past woes investors should be able to get a cheap stake in this firm and watch it grow.
Top 100 debutants Gordons and Sacker & Partners have both entered the list tipped as buys, with their strong performances and positions as relative unknowns making them prime high-growth players.
Niche pensions firm Sackers, which made a name for itself this year by acting on major pensions disputes at Sea Containers and Alliance Boots, is well placed to benefit from the growing importance of pensions concerns. Acquisitive Bradford and Leeds-based Gordons is set to continue its recent strong showing, having boosted its ranks through the purchase of Bradford practice David Yablon Solicitors.
So the recommendations are in. What happens now is in the hands of the (imaginary, we know) markets.
YOU SAY GOOD BUY, I SAY SELL NOW
Barlow Lyde & Gilbert (BLG)
A hold last year, but litigation-heavy BLG does not look a good bet in the current market.
rom a sell last year, Eversheds' stock is worth hanging onto as it continues a spectacular run of panel wins in the Du Pont mould. Profit per equity partner (PEP) cracked the £500,000 mark for the first time - up by 20 per cent.
Our advice to buy last year would have been a good tip: profit is up by 20 per cent. However, after four years of growth the firm may be looking to consolidate, with less spectacular gains in the coming years.
Another hold last year, but this midmarket stalwart has not capitalised on the corporate boom, with turnover flatlining at £66m.
Has it peaked? We think not, or not just yet. Macfarlanes is superbly well hedged, and its real estate (25 per cent of total turnover) and private client practices are at the top of their game. Even with an M&A downturn, Macfarlanes' position as the premier mid-market corporate firm is unassailable.
Watson Farley & Williams
A steady hold last year, Watson Farley's figures were not stellar, with PEP dipping by 6 per cent. However, it could be a canny investment: Watson Farley's talks with US firm Chadbourne & Parke could propel it into the global energy big league.