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18 December 2012
The logic behind Allen & Overy's (A&O) merger approach to Freshfields Bruckhaus Deringer (The Lawyer, 31 July) was simple: marry the muscle of the finance giant (that is A&O, by the way) with Freshfields' considerable international corporate strength.
The fact that Freshfields snubbed A&O is irrelevant; the bid was an admission that the latter's figures had fallen behind all three of its magic circle rivals'. Only radical action would see it back on equal terms and still in the game of becoming a top-tier global and full-service firm.
A merger with Freshfields would have certainly ticked the box marked 'radical', although whether it would ever have got further than dessert (the approach was made over lunch earlier this year) is doubtful. Too much overlap in support areas, too much pain in realignment. And in reality the resulting firm, although still lagging behind other professional services giants such as PricewaterhouseCoopers, would probably be too unwieldy to achieve both firms' ultimate ambitions - a major US merger.
What the bid did represent was an admission by A&O's management that action was needed. That its attempt to build a world-class corporate practice strong enough to drive profitability up to levels that would make a (decent) US merger a reality had failed. That it came in the firm's best 12 months for years is both coincidental and ironic.
It is the six-year figures, to be published next month in The Lawyer UK 100 Annual Report, that tell the real story and put A&O's move into context. They prove that A&O's failure to build a credible international corporate practice means it is in danger of losing its place in the magic circle.
It was six years ago that the UK legal market last hit the kind of heights witnessed in 2005-06. Since then average profit per equity partner (PEP) at Clifford Chance and Freshfields has grown by 18.2 per cent and 23 per cent respectively. Linklaters' PEP has ballooned by almost 50 per cent.
And A&O? All but stagnant, with just a 6 per cent rise in PEP in the years since 2000.
But that is not the only measure by which A&O, over the past six years, has lost ground on its key UK rivals. A snapshot look at PEP among the magic circle in 2000 shows A&O (on £744,000) trouncing all three of its rivals. That year Clifford Chance, Freshfields and even Linklaters all lagged behind A&O with average profits of £685,000, £675,000 and £710,000 respectively.
Although A&O increased its PEP last year by around 20 per cent, that increase is still behind Clifford Chance's 24 per cent rise and Linklaters' 26 per cent hike. The actual PEP figure also now lags behind all three firms'. A&O will legitimately point to the fact that it is the sole magic circle firm to publish its accounts, which, as a spokesman puts it, "makes any meaningful comparison on a like-for-like basis near on impossible".
But at most firms throughout the market, the past year has been all about making money, and in real terms A&O appears to have failed to capitalise. The reversal in its PEP relative to its closest competitors' is the clearest indication that the firm has lost ground.
But it is not the only indication. More digging throws up more evidence. Such as A&O's international growth. Contrast Linklaters' 111 per cent growth in total partner numbers since 2000 and its corresponding 49.6 per cent hike in PEP with A&O's 73 per cent increase in partners and that measly 6 per cent PEP rise. Its performance in this respect is closer to Lovells', which has grown partner numbers by 28 per cent but seen a fall in PEP of 10 per cent since 2000.
For global growth to translate into PEP growth requires tight quality control and active management. Compared with Linklaters, Clifford Chance and even Freshfields, A&O's management has failed to deliver. The swashbuckling Bill Tudor John era, when A&O took Gide's capital markets team in Paris and invaded Benelux with the Loeff Claeys Verbeke deal, was highly opportunistic and successful in terms of expansionism. But Paris has never consolidated its presence, while if anything the Dutch outfit is too big a fish in too small a pond.
In comparison, the absolute conservatism of the consensus-driven Beringer/Morley era has yielded little. In essence it has been dilutive but with no boost to market share in key jurisdictions.
The key underperforming jurisdictions are Germany, Spain, Italy and the big hole, the US. Of those, Germany has actually rebounded in the past 12-18 months, with strong results for the last financial year. In Neil Weiand it probably has the leading debt finance lawyer in the country and it has another star in banking and restructuring partner Peter Hoegen. "The two have helped build a practice independent of London referrals," said Aled Griffiths of Juve Rechtsmarkt. "It's just taken a while for A&O's investment in Germany to pay off."
In contrast, the US, and in particular New York, remains a major issue for A&O, where despite years of investment it is still largely invisible. In fact, its very size in New York is becoming a disability. As a former insider put it: "It's large enough to be somewhat visible in the marketplace, but not high-profile enough or large enough to be a real success. You need 250-300 lawyers to operate. They've got around 80-100." A&O refused to divulge the actual figure.
Equally, A&O can still only point to a handful of name partners, such as former Cravath Swaine & Moore star Dan Cunningham, Michael Feldberg in litigation and corporate partner and US public M&A head Eric Shube. And this goes to the heart of the firm's troubles. "A&O is hamstrung by its inability to offer major packages because of the way partners are incentivised," says the former A&O insider.
The firm's 15-year lockstep, plus the two-year wait at salaried partner level, means it takes 17 years for a new partner to reach plateau. It is the longest ladder in the magic circle and the longest in the City. The succession of partners that A&O has lost in the past couple of years suggests that the patience of partners waiting for the firm's management to address this in a meaningful, rather than tinkering, manner is wearing thin.
A silver lining
The figures are not all bad news for A&O. One area where it has gained ground on its rivals is in its revenue per partner (RPP). Six years ago it lagged well behind the other three firms with an RPP of £1.31m. A 32 per cent increase in its performance over six years to £1.73m has
seen it overtake Freshfields (£1.69m) and close the gap on Clifford Chance (£1.79m) and Linklaters (£1.88m). Its growth is the best performance of the four, even if the actual figure still lags behind.
Equally A&O's revenue per lawyer (RPL) figure bears comparison with its rivals'. A&O's RPL is £418,000, compared with £424,000 at Clifford Chance, £438,000 at Freshfields and £451,000 at Linklaters.
The past 12 months in particular have seen A&O get to grips with this figure, with a massive 41 per cent recovery in its RPL of 2004-05, which stood at a measly £297,000.
A weighty 22 per cent reduction in the total number of lawyers at A&O over the last 12 months goes some way to explaining this increase. But any firm can improve its PEP by cutting people. And a 22 per cent reduction in fee-earners in one year is a lot to lose. "Yes, A&O has pared down a lot," says the former insider. "But some of those numbers are partners they lost rather than got rid of, including in the area they're best known for - banking and finance."
Where does A&O's lacklustre performance over the past six years leave it? Its merger bid with Freshfields points to where its ambitions continue to lie - namely its ongoing quest to be a top-tier, full-service global law firm. But another option, one that would be at least as turbulent, is for A&O to transform itself into a global finance boutique built on a core of banking and finance, capital markets and financial services litigation.
"A strategy of this kind is absolutely a possibility," says one management consultant familiar with the firm. "If their strength is banking, they should maintain and deepen and broaden that strength. Never lose sight of it. That's what makes you a really tough competitor in the marketplace. The issue for A&O is that is has lost sight of its banking franchise, tried to develop a corporate practice and hasn't succeeded."
Is A&O, or more accurately A&O's management team of David Morley and Guy Beringer, willing to implement such a massive strategic turnaround? Or capable? The track record over the past six years suggests that the answer is no.
A&O did not comment.