King & Wood Mallesons’ pioneering pan-Asia vision cannot be denied. But the task in front of the combined firm is immense
On a cool, sunny day in May 2011, in a stylish oceanfront resort on Queensland’s picturesque Sunshine Coast, hundreds of partners at Australia’s Mallesons Stephens Jaques gathered for their annual conference.
This was not a typical retreat. Relaxing, mingling, enjoying the panoramic views of the golden sand beach over a dazzling array of tropical cocktails was, for once, not top of the agenda.
This time the future of Mallesons and its partners was at stake. The firm’s senior management, led by then chief executive partner Robert Milliner and managing partner Stuart Fuller, dedicated the retreat to presenting and promoting a seismic proposal that would change their destiny dramatically.
One partner who participated in the conference recalls the message the firm’s senior management was trying to convey: China is the United States of the 21st century and the world power centre of gravity was shifting eastwards.
To give the message a visual impression, a PowerPoint slide was shown illustrating the centre of gravity as a red dot moving east.
The global economic shift, combined with many other factors, had made Mallesons’ management come to the conclusion that the best option for the century-old Australian firm was to tie up with a top Chinese rival. Enter King & Wood.
It came as a shock to many Mallesons partners, but senior management had already started working on the proposal. The project, which kicked off in November 2010, was treated as top secret internally. Code names were adopted from the off. The future merged firm was referred to as ‘Panda’. King & Wood was dubbed ‘Cherry’, hinting at China, while Mallesons, signifying Australia, was ‘Apple’.
Following a six-month period of intense discussions, negotiations, due diligence and reciprocal visits between partners of the two firms, a final deal was reached and was subsequently voted through by both partnerships at the end of last year.
Eventually, on 1 March 2012, a new firm was born, King & Wood Mallesons, and was quickly dubbed ‘Asia’s powerhouse law firm’. At The Lawyer Awards last week the tie-up received the market’s seal of approval when King & Wood Mallesons was crowned International Law Firm of the Year.
Three into one does go
King & Wood Mallesons is the result of the combination of three partnerships. People’s Republic of China (PRC) firm King & Wood and Australia’s Mallesons combined to form King & Wood Mallesons on 1 March 2012 through a Swiss Verein structure that initially comprises three separate partnerships in Australia, China and Hong Kong (formed by the merger of the two legacy firms’ local partnerships).
The new firm won The Lawyer’s award primarily for the boldness of its vision in securing this, the first deal of its kind. In reality its success or failure will take years to assess properly. Already, though, it can rightly be seen as a global market trailblazer.
The marriage between Mallesons and King & Wood is unique and unprecedented in every sense. It is the first Swiss Verein combination between a Chinese and Western law firm.
Both firms are very different in culture, management, organisation, billing, compensation and their respective client bases, and the groundbreaking deal has caused a big stir in the global legal community. But besides many hearty congratulatory messages, there is also no lack of doubts and questions over the rationale and strategy behind the
tie-up. A prevailing view in the global market regards the deal as ‘bold but puzzling’.
Mallesons’ former chief executive partner Milliner, one of the masterminds behind the deal, emphasises that the move is a new solution for a new century.
“A merger with a UK firm is an old solution for an old world. It may have been a sound strategy five or 10 years ago, but the world’s changing fast,” says Milliner, who retired from the top job on 31 January after eight years at the helm. “We’ve seen a compelling shift of focus of our clients to Asia and have noticed the increasingly dominant role of China in the global economy. We’ve envisioned that our future development focus should be Asia.”
In the words of the management, the firm has an aspiration to join, or create, a leading international network, but organic growth to achieve this is too slow and expensive, meaning inorganic combinations are preferable.
At a strategic level the tie-up is a logical step. But when you drill down, there is a more urgent reality at play.
Mallesons has spent more than $60m (£38.64m) on developing its overseas practice over the past decade. The firm has built a reasonable overseas capability, with offices in Hong Kong, Beijing, Shanghai and London; but the management is known to believe that the global legal market was moving too quickly for Mallesons to compete effectively for clients, work and talent in its former, pre-merger shape.
Since 2008 the Australian legal services market has experienced a sea change, with an influx of leading UK and US firms via mergers or the recruitment of established teams. Mallesons tried but failed to merge with Clifford Chance, not once but twice, in 1999 and 2008.
This bitter experience made management recognise that no top-tier global firm was prepared to combine with it in any meaningful way or on suitable terms.
“With Mallesons’ own footprint and exposure to Asia, it’s not valuable or accretive enough to a global firm for a meaningful combination,” says a source close to the firm. “Creating a new regional powerhouse through combining with a number of leading firms in the region is an alternative path to becoming a top-tier international firm.
“The thinking of the firm is that having significant exposure to growth markets, such as China in particular, will make it more relevant to the global market and more attractive to combine with UK and US firms.
“The firm also believes that UK firms will continue to face challenges in their own business models due to their exposure to constrained economies in the northern hemisphere without any significant exposure to the growth markets.”
In addition, the increased competition in the domestic market has brought new challenges, such as losing market share and flat revenue and profitability growth. At one time, The Lawyer has learnt, there were even talks about a worst-case scenario, in which Mallesons would be forced to cut around 60 partners and become a boutique firm if it did not merge soon.
Not surprisingly, when the firm’s senior partners discovered that King & Wood shared its long-term vision at a business meeting with their Chinese counterparts in Beijing in November 2011, they came up with a new solution and acted quickly.
To pull off a unique transformative deal, both sides have had to dedicate a significant amount of time and resources to consulting with partners and clients to iron out many issues.
High-level discussions and consultations were held around several key issues, including the new firm’s name, Chinese regulatory issues regarding a Sino-foreign tie-up, client confidentiality, conflict of interests and risk control.
External consultancy and advisory firms such as Deloitte, corporate communications firm Brunswick, law firm management consultancy Hildebrandt, Swiss firm Bär & Karrer and US firm Mayer Brown were all brought in by Mallesons to provide opinions on different aspects of the deal.
The agreement on the new brand, King & Wood Mallesons, was straightforward, agreed on at the earlier stage of discussions. It is understood that King & Wood had a non-negotiable precondition for entering into any tie-up discussions: keeping its name intact in the new brand.
What’s in a name?
Among the many concerns was a high degree of sensitivity on the part of King & Wood to the reaction of the PRC’s Ministry of Justice (MoJ) to the proposal if the Mallesons name was to appear first and how that would be perceived by the Chinese market and consequently affect its domestic market position.
This is one of the hurdles that may well have hindered a top-tier global firm from doing a deal with King & Wood thus far.
Mallesons’ more relaxed approach on name arrangements was fundamental to pushing the deal through. On the day the agreement was reached, King & Wood’s principal founder and chairman Wang Junfeng sent an internal email to
all staff announcing that Mallesons had shown its generosity by agreeing to call the combined firm ‘King & Wood Mallesons’, and just ‘King & Wood’ (金杜) in Chinese.
However, many Mallesons partners are concerned about the perceived demotion of the Mallesons brand by putting the Chinese brand first.
Another challenging aspect of the deal is China’s stringent prohibition on foreign firms’ investment, ownership and profit-sharing in domestic law firms. King & Wood and Mallesons structured the combination carefully to comply with the Chinese regulatory requirements, resulting in a Swiss Verein whose members are separate and independent legal entities without financial integration.
This has caused some ambiguity in the definition of the nature of the union. While the combination was regularly referred to as a ‘merger’ globally, in China it is strictly and officially labelled as a ‘closest alliance’ in Chinese (最紧密联盟) by King & Wood.
Before the structure and plans were finalised, it was essential to have the consent and support from the legal industry’s regulatory body, the MoJ. The regulatory aspect is a key risk for both firms, particularly for King & Wood in its home market. The consultation and lobbying process was led by several senior partners at the firm.
“We’ve discussed with the MoJ and have obtained positive feedback from them,” says Wang Ling, a core member of legacy King & Wood’s management committee and now the China managing partner of King & Wood Mallesons. “They’re supportive of such [an] arrangement, which is compliant and encouraging towards the internationalisation of Chinese law firms and that will promote the Chinese legal services and raise the profile of the Chinese legal profession in the global market.”
During the process of the consultation, many of Mallesons’ clients, particularly large energy and resources companies, raised concerns about confidentiality issues, questioning what would happen to their confidential information and files post-merger.
The worries stemmed from the common perception that there is a certain level of interference by the government in lawyers’ work in China and the relatively lower ability of Chinese lawyers to act independently. Recent news reports regarding a new measure from the MoJ requiring newly qualified lawyers to take an oath of allegiance to the Communist Party have intensified this concern.
However, many Chinese lawyers have argued that this perception is a prejudice on the part of Western lawyers against their Chinese counterparts.
“While it’s a truism that the Chinese Communist Party is ubiquitous and omnipotent in China, they don’t normally knock on your door and ask you to turn over your client’s secrets,” stresses a veteran international lawyer based in China. “While their records in rule of law aren’t commendable, there’s been no evidence that they routinely run roughshod on international or domestic law firms in getting confidential information to benefit their state-owned enterprises or other friends.”
Nevertheless, ahead of the 1 March launch date, the two firms addressed the perceived client confidentiality issues by pledging to keep the Chinese partnership out of the firm’s
IT network system. Hence the documents and client information management system will be shared between the firm’s Australia and Hong Kong partnerships only.
The mainland China partnership will not have any connection to the network. At the same time a stricter procedure of sharing client documents and confidential information between the partnerships has also been put in place.
From a business perspective, a frequently asked question among the firm’s international peers is about how the combined firm is going to be value-accretive to its legacy members and whether the reduction in referrals from other firms outweighs the incremental work referred between the Verein members?
While both sides note that they do not track referrals and so cannot quantify a specific figure, they claim the direct referral revenue is not a material amount. And in the view of the Chinese partnership, there is not much to lose in terms of inbound referrals.
“Our experience is that the amount of meaningful inbound referrals from foreign firms is getting less each year,” says Zhang Yi, a member of the legacy King & Wood management committee, who now sits on the international management committee of the combined firm. “Nearly 300 international firms have established a presence in China and many have a sizeable team on the ground. Even if there are referrals they’ll be a small local counsel role, and most of time they prefer to instruct much smaller, less-known Chinese firms that aren’t their potential competitors.”
According to Mallesons’ initial revenue projections, the additional Australian revenue resulting from the combination is expected to reach $25m in the financial year of 2014-15. But this growth is modest given Mallesons’ current $500m revenue.
However, a key part of the business case for the combination is to follow Chinese outbound investors and capital globally, not just into Australia, with the energy and resources sector being a main focus.
Most recently, the appointment of a three-lawyer energy and resources team, led by former Dewey & LeBoeuf Beijing partner Dirk Walker in Beijing, is a reflection of the firm’s growth plans.
“Our role on cross-border deals until now has been limited to local law or reviewing documentations drafted by international counsel,” relates Zhang. “We endeavour to win the ‘deal counsel’ role as a combined firm. Our relationships and understanding of the Chinese clients and local business culture, combined with Mallesons’ international deal execution expertise, will provide us with a unique competitive edge for winning the lead role in cross-border work.”
Large state-owned energy and resources companies usually have their own sizeable, capable in-house legal departments. They rarely instruct external counsel for domestic legal issues unless the law requires them to obtain professional legal opinions. For international transactions they will use exclusively international firms.
Legacy King & Wood key energy and resources clients include Yanzhou Coal Mining Company, China Guangdong Nuclear Power Holding Co, Noble Mineral Resources, China National Petroleum Corporation and CNOOC (China).
The new proposition looks strategically sound, which should help King & Wood move up the value chain and challenge the competitive forces in its home market from global and international firms. That said, the competition in the legal services market for Chinese outbound investment remains brutal and may not be as lucrative as expected.
The upfront and ongoing costs of the combination and integration process are staggering, measuring millions of dollars.
To a certain degree the significant amount is expected to have a negative effect on both firms’ profit per partner figures in the initial years. However, it is regarded as a necessary long-term investment.
For example, a travel budget of more than $2.5m has been included in the budget for the first year of the combination to ensure significant levels of contact between partners, practice leaders and client relationship partners and to drive the effectiveness of the integration.
Under the umbrella agreement of the Verein, the costs relating to the combined firm will be shared by the Australian, Hong Kong and Chinese partnerships on a proportional basis, according to their respective net revenue sizes.
However, the costs incurred in relation to upgrading the Chinese member firm’s systems and operations up to Western standards will be borne by the Chinese partnership alone.
Take, for instance, professional insurance cover. Each of the three member partnerships (or member firms, as they are referred to under the Verein) is obligated to purchase the same level of cover with the same insurer.
The Chinese contingent will obtain $400m of professional insurance cover through Mallesons’ insurance programme at its own expense. This also requires the Chinese partnership to establish appropriate risk management procedures modelled on those of Mallesons.
As each of the three member partnerships has its own financial accounts, a mechanism has been set up to compensate and reward member firms for referrals, based on an agreed attribution system.
In addition, the leaderships of both King & Wood and Mallesons are committed to full integration at the end of the five years from the effective date. The umbrella agreement of the Verein has set out the principles that will apply for financial integration. However, it is subject to the member firms meeting certain financial and non-financial integration targets and a partner vote by each firm.
The Western front
As New York and English laws will continue to be the main ones governing international transactions, another key question that has been raised is how King & Wood Mallesons can become a meaningful competitor globally without UK or US capabilities.
The Chinese and Australian partnerships are equally aware of this issue and share the mutual desire to focus on acquiring a capability around US and UK law. A Hildebrandt advisory report to Mallesons, highlighting the success of some global brands in Australia, despite them merging with second-tier Australian firms, also emphasised the importance of an eventual global link.
However, why, how, when and with whom the firm is to do this has yet to be decided.
“There’s nothing that says we have to do it in a particular timeline, but the markets are moving fairly quickly,” King & Wood Mallesons global managing partner Stuart Fuller told The Lawyer in May following a speech at a conference of law firm leaders in California about how the firm was now looking for a tie-up in North America. “Also, there’s a lot of flexibility as to how we achieve it. We can bring in member firms easily because of the structure of the Swiss Verein, but we could also do referral relationships and alliances.”
It has been reported recently that King & Wood Mallesons is looking beyond the UK and US to broaden its global footprint, with Singapore and Canada being two possible locations.
The resource-rich Russia and CIS countries also appear to interest King & Wood Mallesons. It is understood that the firm held high-level talks about the prospect of acquiring Dewey’s Moscow team prior to the US firm’s eventual collapse (the team ultimately moved to Morgan Lewis in early May).
While King & Wood Mallesons’ long-term aspiration is to become an international player, its competitive edge depends heavily on its strong roots in the Asia-Pacific market. The challenge to make the combination work is already paramount – something that is not underestimated by both leaderships. The combined firm also has a tremendous amount of work to do to convince the market of its raison d’être.
“It’s unclear whether the new firm will adopt the Chinese view of law,” muses a managing partner at an international firm. “In China lawyers don’t drive the deals and legal services are valued lowly. It’s a huge point to clarify when accessing their strategy. Unless this is cleared it would be difficult for it to gain proper recognition from prospective clients and member firms.”
“The effort and costs required to make this deal work seem to outstrip its potential benefits,” warns an Asia managing partner at a global law firm. “It’s a forward-looking strategy and will take a few years to see the full potential and seize good opportunities.
“It may be one generation too early, but if somehow everything’s worked out as planned, it will surely cause a shake-up in the global legal landscape.”
The King maker
In its domestic market King & Wood, just 20 years old, has established itself firmly in the top three of China’s legal market. Its growth story is both a product and a testimony of China’s economic miracle in the past two decades.
Lawyer headcount has grown from an initial five to 1,000 in that 20 years. According to the firm’s statistics, the average year-on-year revenue growth in the past 10 years has been no lower than 20-30 per cent – an unthinkable pace in the developed markets.
Prior to the combination with Mallesons Stephen Jacques it was the highest-earning firm in China, with the total turnover in 2011 estimated at Rmb1.6bn (£160m), well ahead of that of its closest rival. It was also the third-largest Chinese firm by lawyer headcount, with 1,000 lawyers, inclusive of 210 partners, across 16 offices.
However, the high speed of expansion has naturally resulted in a certain degree of inconsistency in quality – a common problem among all Chinese law firms.
Outside China the King & Wood brand is probably the most internationally recognised among all Chinese firms. Its foreign-friendly English name in particular stands out from the rest.
At the core of the firm’s senior management is founder and chairman Wang Junfeng, the vision and soul behind the firm’s success.
The King & Wood story began back in 1993, when Wang, who had just turned 30, decided to establish his own private practice firm together with several of his colleagues and university alumni.
Prior to that he had spent seven years as a lawyer at China Global Law Office, which had been set up by government trade body the China Council for the Promotion
of International Trade, where he led the commercial law practice.
This position, his first job after university, gave Wang the opportunity to be involved in high-end foreign-related investment and trade projects and to have regular dealings with international law firms. This valuable experience shaped his vision and ambition:
to build a law firm that could compete on an equal footing with international firms.
Since the firm’s establishment Wang has never stopped pursuing his dream. He has broadened his international exposure and knowledge by obtaining an LLM and JSD at the Berkeley School of Law of the University of California and working in a number of US and European law firms as a visiting scholar.
Under Wang’s leadership King & Wood has broken new ground in many aspects of China’s nascent but fast-growing legal profession. For example, in 1999 it became the first Chinese firm to adopt a modified lockstep compensation system to encourage teamwork and promote a culture of cross-referrals. It is also a pioneer in overseas expansion, having opened an office in Silicon Valley in 2001, in Tokyo in 2005, in Hong Kong in 2006 and in New York in 2008. In 2009 it merged formally with local Hong Kong outfit Arculli Fong & Ng following a three-year association with the 60-lawyer outfit.
Having reached a large scale and achieved national recognition, improving its management and practice standards further is imperative. The key benefits for King & Wood to tie up with Mallesons are precisely what King & Wood longed for – to gain access to and leverage top-notch international management processes and enhance its ability to support clients, international products and cross-border work.
More immediately, the tie-up has given its brand a significant lift from being a ‘local’ to an ‘international’ firm.
Wang’s achievement and leadership has been recognised by the nation’s legal profession, as he was elected to the role of president of the All China Lawyers Association (ACLA), a representative and administrative body for the country’s 250,000 lawyers.
Sitting at the helm of the ACLA, Wang has committed himself to moving the profession towards further internationalisation.
“Our clients are increasingly going global – so should the Chinese law firms,” stated Wang
in a speech during his inauguration to the top role. “The association will facilitate members to extend their international reach to better service their domestic clients and enhance their competitiveness on the global stage.”
“Everyone’s angling to capture
a piece of this market segment,” says Zhong Lun international managing partner Robert Lewis in his blog on TheLawyer.com. “But it’s still in the early stage of development, and charging and collecting international-standard fees can be challenging. To put it simply, there are more people chasing these outbound deals than there are deals. In an outbound market dominated by mid-cap deals, which any one of a hundred or so firms could do, it’s tough to find a differentiator. A crowded market tends to drive down prices as each firm competes to buy in some deals for its outbound CV.”
Here is a good example. A few years ago a top Chinese state-owned enterprise (SOE) was put out to bid to four top London firms for its M&A transaction. The target had operations in half-a-dozen European countries, plus a small US piece. At several hundred million dollars, the projected deal value would have put it near the top of the mid-cap range.
An objective assessment would have suggested a total fee in the range of $1.5m (£970,000) under normal conditions. However, the winning bid came in at just above $700,000, with astonishingly low internal caps on due diligence and other early-stage work segments.
The SOE general counsel knew that the winning magic circle firm could not make money on the terms offered, but that was not his problem. He knew the winning firm would do an excellent job; and as a relatively sophisticated consumer of high-end legal services he was not going to open up the cap unless the agreed scope of work had in fact been exceeded as an objective matter.
In other words, it was not possible for the winning bidder to bid low, insert itself into the deal and then negotiate. In fact, the deal cratered following the due diligence
stage and the ‘winning’ firm probably ended up eating more than $100,000 in time costs, which is probably a conservative estimate.
Even more remarkably, this ‘winning’ firm’s bid was not an outlier. The next bids were $800,000 and $900,000. Only one of the four bidders came in with a full-price bid.
King & Wood and Mallesons: the real deals
l Thomson Reuters recorded a total of 750 deals from 2007 to 2011 where Mallesons Stephen Jacques was involved either as the target’s or acquiror’s counsel. There are 72 recorded deals for King & Wood during the same period.
l Despite several big-ticket Chinese outbound deals, more than 70 per cent of King & Wood’s transactions were domestic, with both parties based in China. In comparison, around half of Mallesons’ 740 deals had a cross-border element, but only 18 involved a Chinese buyer or target.
l Among Mallesons’ China-related transactions, the withdrawn bid by state-owned Chinalco to acquire shares in Rio Tinto for $19.5bn (£12.56bn) in 2009 is one of the most high-profile. In the same year it scored the Australian legal counsel role for Chinese steel-maker Hunan Valin Steel Co on its $645m acquisition of a stake in Australian miner Fortescue Metals.
l In China Mallesons has a shorter deal list, but enjoys a long-term relationship with Beijing-based property developer Soho China. Although Mallesons has offices in Beijing and Shanghai, it has won only two China mandates from Australian acquirors Telstra and Horizon Oil.
l Outside China Mallesons is an active adviser in US- and UK-related transactions. It has advised on 157 deals with US elements, making the US the largest part of its cross-border portfolio, and played a role in 69 UK-related deals.
l Among the international firms Mallesons has worked with, it has co-counselled on most deals with Clifford Chance (35) – with which it held brief merger talks in 2008 – and white-shoe firm Simpson Thacher & Bartlett (30).
l It is understood that King & Wood Mallesons is contemplating further expansion in Asia, with Singapore being a key location and WongPartnership being an attractive addition for its Verein.
l In five years Mallesons has worked with WongPartnership on no fewer than 10 occasions, including on BlackRock’s $13.5bn acquisition of Barclays Global Investor; China National Offshore Oil Corporation’s $2.5bn takeover
of Norway’s Awilco Offshore; Chinalco’s $14bn share acquisition of Rio Tinto in 2008; and the $645m Hunan Valin-Fortescue Metals share acquisition.