Despite much hype over mid-market consolidation recently, the number of mergers between law firms in the UK has been modest. LB discovers why not every struggling firm is looking for a tie-up
If you were to slap an ‘at risk’ sign on any segment of firms in the LB100 then it would have to go somewhere on that diverse group of City firms that pull in between £20m and £70m in turnover. The list of threats to their businesses is growing. From pricing pressures in a crowded market to a lack of differentiation and a stagnant transactional market, there is much to think about. ‘If you’re not growing turnover now, you’re not going anywhere nice,’ one commentator suggests.
Before the global financial crisis, common consensus had it that consolidation at every level of the market was a given, but specifically in the so-called mid-market. That analysis remains true. Such a fragmented market, with too many firms offering roughly the same service, needs to evolve, and that’s before the wider context of a flagging domestic economy is taken into account. Speechly Bircham’s 2009 acquisition of Campbell Hooper aside, deals in the City have been scarce. Much of the activity has come in the regions, with the likes of Hill Dickinson, Weightmans and Shakespeares pursuing aggressive growth strategies.
A second piece of conventional wisdom suggests that competitive pressures bubbling under from the bottom of the market will force the strategic hand of the mid-market firms. So far that theory has been debunked – if anything the competitive pressure has come from the top of the market with transatlantic mergers in the shape of Hogan Lovells and SNR Denton. In recent months, sector-specific mergers have become more prevalent, particularly in insurance, with Clyde & Co taking over Barlow Lyde & Gilbert and Major UK firm Beachcroft merging with insurance specialist Davies Arnold Cooper.
‘You normally expect the consolidation to start at the bottom and work its way up but it’s happening in reverse at the moment,’ agrees Tony Williams, principal at Jomati Consultants.
We took a look at a group of firms in the London Midsizers peer group to find out why mergers have largely been off the table so far and what, if any, are the chances of a slew of mergers in the foreseeable future. From Manches and Mishcon de Reya to Bristows and Penningtons, these firms occupy different places in the market in terms of size, turnover and profitability. However, they are all facing the same challenges. How they are tackling them is an entirely different matter.
Going nowhere?
In 2006 the average revenue of the London Midsizers peer group was £33.9m across 15 firms compared to £39.1m across 21 firms in 2010/11 – hardly the look of a group that has come out of the last few years in good shape. In terms of profitability, recent years have been tough. In the same year average revenue per lawyer stood at £226,000 whereas now it stands at £253,000. Over a similar period, the average number of equity partners in the peer group has remained broadly static at 25, while average lawyer headcount has slightly increased from 150 to 160. Firm finances have suffered and grappling with that alone is enough for any firm to handle. The firms that are adept at balancing internal issues and eyeing external opportunities will come through the next three-year period the strongest.
‘We are clearly due a shakeout and I think part of the reason it has not happened yet is that firms have tolerated their internal economics being squeezed,’ says Stephen Mayson, director of the Legal Services Institute at The College of Law. ‘Firms have been good at hiding (or taking) the pain, but attitudes are changing.’
Many of the firms in the London Midsizers group appear to be in a holding pattern. Having staved off the worst effects of the recession they have spent the last few years reorganising internal issues and attempting to clarify strategy. While there are some real success stories in there, there is a question as to what happens next beyond some collective head scratching.
‘Firms are not quite at the point of feeling the pressure enough to make a move yet,’ says Alan Hodgart, managing director at Huron Consulting, who has long foretold a significant amount of consolidation in the mid-market. ‘In addition there is a general lack of a clear strategy and as a consequence of that, when firms talk to other firms they don’t get far enough because it becomes quickly apparent that they are not suited. That shows a total lack of forward thinking.’
The accusation of a lack of a coherent strategy is often levelled at firms across the market. One example is Manches, a firm that has been in slow decline in recent years. This is in part down to its practice mix, which has left it exposed to the real estate and lower
mid-market corporate worlds that have all but stood still for the last few years. It posted £30.6m in turnover in 2010/11, down from a high in 2008 of £34m.
While there have been bigger falls – LG’s five-year revenue compound annual growth rate (CAGR) is -2% for example – it is illustrative of a firm that has found it hard to cope with losing market share to competitors. Manches’ revenue per lawyer has stagnated. In 2002 it stood at £209,000: this year it is £196,000. Its profit margin stands at 14% this year, compared to a high of 20% in 2005. All this, while its equity has been kept tight with 19 equity partners currently down from a high of 26 in 2002.
‘We are extremely ambitious for growth so we are not satisfied with where we are right now but the numbers have been solid through a very tough period and in profitability terms we are on the up,’ says Louis Manches, London office head. ‘Shaping and articulating our message is a continual process and it may be fair to say that we are better at doing it internally than externally. It is certainly something we can improve.’
To try to define what Manches stands for and its strategy is difficult, and this is the firm’s most pressing problem. Its business is being squeezed by competitors that have been able to communicate a clearer message. Manches contests this, saying that its focus on doing private client and commercial work for high-net-worth individuals across a number of sectors, including real estate and fashion has served the firm well. The idea of being a full-service firm with a turnover of barely £30m is just not sustainable in this climate. It has the look of a firm that is ready to be acquired, or at least parts of it could be cherry-picked.
Mayson suggests: ‘The undifferentiated firms have to deal with a classic strategic fudge as well as dealing with cultural issues. Partners have been relatively autonomous for years and have been encouraged to be so. In a sense perhaps the biggest threat now lies in themselves.’
At face value Howard Kennedy is an ‘at risk’ firm. Historically lumped into the West End bracket and labelled a property firm, it has struggled in recent years to maintain revenues and profitability. Now a limited liability partnership, its revenues have bounced back by 7% to £29.5m from £27.5m but it is easy to forget that this was a business that pulled in over £40m a few years ago. Its five-year CAGR stands at -3%. Its profit per lawyer at £30,000 is way below where it needs to be and its profit margin of 14% smacks of the high-volume insurance firms. In short, Howard Kennedy is suffering from an identity crisis. Its property business and corporate work for mid-cap companies would make a nice acquisition for an ambitious firm but as a whole it does not make for an appetising merger partner.
Not that it is of particular concern to Mark Dembovsky, the firm’s chief executive: ‘Firms like ours would benefit enormously from scale and I believe in mergers but I do not see Howard Kennedy as a firm that needs to merge.’
Since joining the firm in January from the now defunct Dawsons and taking over from long-serving managing partner Trevor Newey, Dembovsky has done a lot of work on crystallising the firm’s message inside and out. Various discussions have taken place and the message that Howard Kennedy is more than just a property firm is perhaps clearer now more than ever. He stresses that the firm is focusing on acting for high-net-worth individuals, entrepreneurs and the decision makers in mid-cap companies.
‘The style of service that we provide is different in the City to a lot of the other firms and we have to use that to our advantage,’ says Dembovsky. ‘This has always been the case but in the past I do not think the message was articulated particularly well.’
Dembovsky is certainly impassioned by his subject but there is much to do to turn around the slightly stodgy image of a firm that has past its prime. If he does everything he says he wants to achieve then he and the firm should be rightly applauded.
Successful singles
One firm that is justifiably happy with the way it has aligned itself in recent years is Bristows. Its tight focus on representing clients in the technology sector, leveraging off its leading IP practice, has served it well, enabling growth throughout the recession.
‘In a benign climate of growth, and once the value of doing a large number of transactions falls away, the firms that do not stick to their guns struggle,’ says Iain Redford, Bristows co-managing partner.
Having the chops to ‘stick to its guns’ has paid off so far. The firm’s five-year revenue CAGR currently stands at 5%; income in 2010/11 was £26m, up from £19m in 2005. Despite a blip in 2008, the firm has been in steady growth mode. Its profit margin stands at 35%, one of the highest in its peer group. The firm has benefited from strong leadership and clear strategy laid out before the recession.
Redford and co-managing partner Mark Watts recognise that, in its current shape, Bristows could make for an appetising acquisition target for another ambitious firm but say that is not their plan. Growth for them will come from stealing market share from competitors, something that is much easier to do when there is a crystal clear strategy in place.
‘A firm needs strong leadership to make bold decisions and if you look at the firms that have done well in recent years the management has invariably been very strong,’ says Hodgart.
Mishcon de Reya, another firm not looking for a tie up, has also benefited from a clear direction. This year it increased its turnover by 37% from £47.5m to £65m, in one of the best performances of the entire LB100. A staggering increase in any sort of market – during the recession the firm budgeted for no growth and counter-intuitively invested in transactional and private client practice areas as well as opening an outpost in New York. The plan now is to convert its £65m business into an £80m business and bring profits per equity partner up to £750,000.
James Libson, Mishcons’ executive partner, says: ‘We have a plan for growth in place and we are making progress but it is also about making growth sustainable for the long term.’
Mishcons is a firm putting growth at the top of its agenda but not through acquisition. In fact, speaking to a good number of the firms in the London Midsizers group, merging is not on the agenda at all. As Williams points out, merging is not a strategy in itself.
‘We have a subdued market that does not look like it will come into life any time soon,’ he says. ‘Firms have cut costs and there can’t be much more to come out of the businesses now. If you want to grow going forward it will come from stealing market share from others.’
What we have emerging then is a split in the group – one camp includes Mishcons, Bristows, Lewis Silkin and Sacker & Partners, all of which have stuck to their knitting, have a clearly defined direction and at the moment at least are not in the market for a merger. The second group is essentially the opposite – turnover and profits have been falling and strategy is fuzzy at best.
For the first group the question is why bother merging from a position of strength? If your partnership and practice spread is settled, your clients are happy and bottom line is growing, a merger could disrupt all of that. Conversely, if a firm is coming from a position of weakness, the moment the decision is taken to merge it is on the back foot and a merger quickly becomes a takeover.
The will of the partnership to go through with a merger is an issue that management comes back to again and again. As one managing partner of a City firm says: ‘If a firm has got to a point that it wants to do a merger, that immediately puts it into a position of weakness. If you need to merge you have to get exactly the right match otherwise it’ll be very difficult.’
David Raine, Penningtons’ chief executive, went through a major acquisition of a team from Dawsons in the past year. ‘Wanting to merge will only work if the two firms are broadly similar in attitude and culture plus the strategic rationale has to be crystal clear,’ he says. ‘Once you start to narrow the list of potential deals down you have to discount a raft of organisations. It takes time to convince people that merging is a good idea.’
The biggest barrier to merging is, in short, people. In a law firm merger you have to take a lot more senior people with you than in a traditional corporate structure. With law being a ‘people’ business, the level of consultation needed, as well as various client discussions that need to happen, are far more in-depth than would happen outside of the sector.
David Harris, Hogan Lovells’ co-chief executive, gives a word of advice. ‘You ask people in any merger to accept a significant amount of change, which lawyers generally don’t like that much. It is critical to lay out clearly the business rationale and demonstrating how it will work is important in bringing people with you,’ he says. Having been instrumental in one of the most significant transatlantic mergers in the industry to date, Harris knows a thing or two about the logistics of consolidation.
Biting the bullet
Michael Lingens, managing partner at Speechly Bircham, says that the point came when his firm needed to acquire in order to achieve significant growth. When Campbell Hooper came along in 2009, it wasn’t a firm that Lingens and his team were particularly looking at but it soon became apparent that the cultural and practice fit was good.
‘Like all firms in 2007/08 we envisaged legal services tracking the upward trajectory of the economy (both real and financial). We saw growth as being a mixture of organic growth supplemented by an aggressive hiring programme. We had hoped to have grown to become a £60m, 250-lawyer firm by April 2010. In the event the credit crunch put paid to that growth strategy from the autumn of 2008 onwards and we, like other firms, went into contraction/cost-cutting mode,’ says Lingens.
‘The deal was an attractive financial proposition that allowed us to grow the lawyer headcount by 20% in one leap and propelled us forward to the top 50, which in turn has given us the confidence to reposition the firm around sectors and internationally.’
What the deal did was to quickly add 50 lawyers to the business, boosting turnover by 27% in its first year. In 2006 its revenue stood at £34m; today it is £59.5m, a 75% increase. After modest gains in turnover for 2010/11, the firm has now turned its sights on a more focused strategy. Lingens says that he is building a full-service firm with particular strengths in private wealth, financial services, construction and technology. The firm has taken the unusual step for its peer group of opening two international offices in Luxembourg and Zurich. The firm looks fully prepared for its next growth phase.
Penningtons, an example of a firm that has moved to strengthen its platform following a turbulent few years, is back on the growth trail. Its £24.1m turnover for 2010/11 is broadly the same as it was in 2004, having peaked in 2007 at £29.1m. Its profits per equity partner (PEP) saw something of an aberration in 2008/09 when they came in at £63,000, a 51% drop. That figure has now returned to a distinctly healthier £241,000. The firm was forced to take drastic action over staff levels in the last few years – in 2004 there were 195 lawyers in the business, this year there were 124 fee-earners. Its number of equity partners has shrunk from 39 in 2006 to 22 this year.
What is surprising about Penningtons is that the firm looks to have arrested the decline that others have struggled with, helped by a strong message from management. It picked up 40 staff, including seven partners, from the now defunct Dawsons in May. The success of the Dawsons acquisition will only become clear this time next year but what it does show is that there is a determination to move forward.
The firm’s chief executive David Raine says: ‘Our approach has been more gradual than any sort of eureka moment: there has been an increasing focus on quality and client care by lawyers across the firm. No one is immune to the competitive pressures that all firms are experiencing. The big thing for us is getting back to basics and delivering quality, which means we have to have an in-depth understanding of our clients and their businesses.’
Why merge?
To merge on any level is always going to be a sensitive procedure but to find that true merger of equals – there is only one example of it currently in Hogan Lovells – adds another level of complexity.
Even if firms have sorted their internal economies out, set their sights on growth, found the perfect cultural and strategic fit – not to mention worked out economies of scale, legacy property commitments and resolved conflict issues – then the people have to be convinced that it is a good idea.
The explaining away of a lack of cultural fit as a reason not to merge needs to stop being an issue. The idea that law firms still have that unifying glue that makes them stand out from the others is a nice marketing story but holds little truth. To have the gumption to consolidate further, lawyers have to be more commercially aware and firms in general must organise themselves in a more corporate way, thereby easing the passage through a merger.
Barriers to consolidation aside, the legal market is too fragmented and it is inevitable that further tie-ups will happen. However, the timescale is less clear. Suggestions that the legal market will evolve in much the same way as accountancy firms did in their Big Bang may be a leap too far but the bottom line is there are too many firms providing too much of a similar service.
The introduction of alternative business structures under the Legal Services Act, when that eventually happens, should prove something of a catalyst, certainly at the bottom of the market, and those competitive pressures should begin to filter upwards. Consultants have been saying for some time now that firms are holding many different discussions but the difference is that, since April, they are much more substantive than they have been for some time. The suggestion is that merger activity will pick up over the next two years.
The position is quite clear: if a merger is not on the cards then, if a firm does not have clear points of differentiation, the next few years will be a long, hard grind.