When the magic has gone

Linklaters is now top dog in the UK and Clifford Chance has been pushed down to third place. Kit Chellel reports on the battle for supremacy among the UK elite

After years of blazing a trail for the rest of the UK legal market, the magic ­circle’s march towards global domination has stuttered, stalled and, many would say, come to a complete halt. The rapid expansion of previous years has gone, to be replaced by job cutting on an epic scale, partnership restructures and ­international retrenchment. Among all the upheaval, a new ­hierarchy has emerged, with the magic ­circle being split into two distinct groups.

Peak practice

Linklaters is now the UK’s largest firm with a global turnover of £1.3bn. But it is not the world’s largest. Thanks to the weakness of the pound, Skadden Arps Slate Meagher & Flom can claim the top spot. The US firm brought in £1.47bn last year after its end-of-year 2008 ­figure is converted into sterling. The previous ­global title holder, Clifford Chance, slipped down to third place in the UK 200 after its core banking practice was decimated by the credit crunch. Bolstered by a ­successful year in its large German practice, Freshfields Bruckhaus Deringer moved from third to second place. The firm came within inches of the top of the table – its revenue was just £11m behind that of its bitter rival Linklaters.

It is the first time in four years the order at the top of the table has changed, and the first time in more than a decade that ­Clifford Chance has not been number one, ­signalling how much the collapse of Lehman Brothers and the subsequent banking crisis have affected the UK’s elite firms.

Reaction stations

Three of the magic circle firms have responded by reshaping their businesses. Linklaters got in first when in January news broke that it would shed up to 50 partners as part of a project dubbed ‘New World’.

Within weeks Clifford Chance followed suit with a restructure that would result in 120 lawyers and between 15 and 20 per cent of the firm’s partners leaving.

“We took our medicine and made some difficult decisions,” says Clifford Chance senior partner Stuart Popham. “I feel things are now going in the right direction.”

Taking into account Allen & Overy’s (A&O) cuts, more than 500 magic circle lawyers lost their jobs in the 2008-09 year, along with some 200 partners.

Only Freshfields has refrained from significant reductions. The firm’s management has repeatedly pointed out its commitment to retaining staff, but the lack of action has more to do with the fact that Freshfields had already slimmed down with a major restructuring two years ago, which led to the exits of 100 equity partners.

“We had our restructuring and we’ve been disciplined and focused ever since,” reveals joint senior partner Konstantin Mettenheimer, who also points out that there is now a clear divide in the magic circle between the firms focused heavily on banking and finance and the rest.

On one side are the two of the most profitable firms in the country, Freshfields and ­Linklaters, which have benefited from strong listed client bases and some ­lucrative restructuring mandates. On the other is A&O and Clifford Chance, whose growth has been fuelled by financial ­institutions and whose fortunes have waned correspondingly.

Freshfields vs Linklaters

The longstanding rivalry between these two firms has taken on a new intensity this year. Linklaters’ New World restructure is seen by many as a response to the fact that the firm’s average profit per equity partner (PEP) was overtaken by Freshfields’ in 2007-08.

It is the first time Freshfields has taken the lead in the profitability race since 2004. Linklaters ­managing partner Simon Davies has made no secret of management’s ­desire to make the firm the most profitable in the world.

In 2008-09 Linklaters probably won the more eye-catching mandates. Its role acting for the administrator of Lehman Brothers looks like one of the instructions of the decade. The firm has engaged several hundred fee-earners and is reportedly billing more than £1m a week.

Being key corporate counsel to Lloyds TSB has also helped the firm stay at the top of the M&A tables. The bank’s emergency takeover of HBOS and government bailouts have been keeping relationship partner Jeremy Parr busy.

But it has fallen still further ­behind Freshfields in terms of ­profitability. PEP has dropped by nearly 10 per cent to £1.3m and the profit margin has fallen to 40 per cent.

The reason for this is the cost of restructuring. Linklaters will have to pay up to £50m to axed partners alone, and that figure does not ­include payoffs to the 400 lawyers and support staff made redundant.

Davies has elected to take on as much of the cost as possible in the 2008-09 year. It will be interesting to see how sharply this will rise this year – and rise it surely will.

Freshfields has seen the largest rise in revenue of any magic circle firm, helped in large part by euro revenues from its ­market-leading German practice and strong ­corporate performance.
The firm acted on most of the bigger rights issues in 2008-09, ­including a £4bn cash call by miner Xstrata. It was also drafted in by the administrators of Woolworths.

And despite a slight fall in PEP, those at the top and bottom of the equity scale both took home more money last year. Freshfields’ plateau partners earned £1.64m in 2008-09, overtaking the top billers at Linklaters for the first time in five years.

The fact that Freshfields’ equity spread could rise against a fall in PEP suggests a subtle shift in the make-up of the partnership.

“If the majority of partners sit at the younger end, then the PEP would go down even though bottom and top of equity go up a bit,” says Mettenheimer.

It is a marked contrast to ­Linklaters, which has tried to ­retain as many of its older partners as possible, with the majority of the firm’s partners nearer the top of the equity than the bottom.
Winner: Freshfields on points (this year at least)

Allen & Overy vs Clifford Chance

Of the two banking and finance-­focused firms, Clifford Chance has had the more ­difficult year. It is down in almost every key measure of financial ­performance and the market is rife with rumours of the firm’s plight.

“You hear of whole floors of ­people not doing anything at Clifford Chance,” says a City corporate ­partner at a rival firm. “If you’ve got people doing nothing, that’s the thing that murders your financials.”

Particularly alarming is the drop in profit margin to just 24 per cent. “We’re the pre-eminent firm in ­financial services globally. That’s the bit of the economy that’s been hit hardest,” says Clifford Chance senior partner Stuart Popham.

The firm’s troubles in the US, where the axing of 20 litigators has been followed by a slew of partner departures, has not helped. On a more positive note, mandates on the financing of the merger between InBev and Anheuser-Busch and a string of instructions for Barclays have helped keep the coffers ringing.

Allen & Overy (A&O) has scaled back drastically some areas of its business, London leveraged finance in particular, in response to the changing market conditions.

The restructuring has cost £44m and has hit the firm’s bottom line, but revenue has increased. Managing partner Wim Dejonghe puts this down to growth in Western Europe and the Middle East, but the firm has also reported that its finance practice had a better than expected year.

Debt refinancing has been a welcome source of fees. A&O was called in by lenders to William Hill, McCarthy & Stone and Crest Nicholson during 2008-09 on the restructuring of several billions of pounds of debt.

The key issue for both firms over the coming months is cost management. With recovery in the banking sector looking a long way off, A&O and Clifford Chance will have to keep a lid on salaries to prevent further falls in profitability.

“Costs continue to grow for some time after revenue stops growing. It’s like a traffic accident – costs run into the back of you,” warns Stuart Popham.

That said, with major restructurings out of the way and the worst phase of the banking crisis probably behind them, do not be surprised to see both of these firms bounce back next year.
Winner: A&O by KO