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Should you buy shares in a law firm?
Economist Staff, The Economist
August 26, 2008
WERE it possible to buy shares in big British and American law firms, they would appear to be attractive investments. They boast double-digit revenue growth at a time when many companies are suffering. Baker & McKenzie, one of America's biggest firms, has just announced a 20% increase in annual revenues, which exceeded $2 billion for the first time. Britain's top four firms have reported revenues up by an average of 15% this year, with all four passing the £1 billion ($1.85 billion) mark.
Investing in law firms is more than just a pipe dream. A change in British law, introduced last year, enables law firms to use business structures other than private partnerships, and allows for external investment and initial public offerings (IPOs). Law firms will have to wait for a new regulator, the Legal Services Board, but everything is due to be in place by 2011. Listing could have a dramatic effect on law firms' behaviour. Slater & Gordon, an Australian law firm that went public in May 2007, used the proceeds to go on an acquisition spree, swallowing up six smaller rivals within a year. The firm's share price has risen 50% since the IPO. Companies could also use the money from a flotation to expand abroad more rapidly, or to poach talented lawyers from rivals.
Law firms have high profit margins (typically 20-40%), grow rapidly when the economy is buoyant and are resilient in downturns. Big international firms have litigation and financial-restructuring departments that pick up work when the dealmakers in corporate and banking departments are left twiddling their thumbs. (On average, litigation departments are thought to account for around 45% of law firms’ revenues in America, and 25% in Britain.) And foreign expansion in the past ten years, particularly in Asia, eastern Europe and the Middle East, acts as a hedge against a slowdown in the West.
So the investment case seems strong. But law firms may not be as invulnerable to downturns as they appear — it may just take a little longer for the symptoms to show. Giles Rubens, a strategist at Hildebrandt International, a legal consultancy, says that the credit crunch has taken time to filter through to law firms' profits because the "deal pipeline takes up to a year to dry out". Moreover, big deals in the pipeline can take months to close, and lingering deals from 2007 may have helped this year's results. Royal Bank of Scotland has kept Linklaters, a British firm, busy well into this year working on last year's €71 billion ($99 billion) takeover of ABN AMRO, a Dutch bank. Tony Williams of Jomati, a legal consultancy, predicts that "2008 will be a black year for everyone."
Another concern for potential investors is that lawyers are not proven business leaders. Clients frustrated with private-practice lawyers often accuse them of lacking commercial nous. Because most lawyers spend much of their time peering at small print, big-picture concerns can go unnoticed. Few managing partners know their firm's profit per billable hour, even though that is the main product law firms sell. Cost control is often an afterthought, trailing far behind revenue generation.
Furthermore, lawyers have never had to endure the same pressures as the managers of listed companies, where the shareholders call the shots. In law firms, equity is held by a small number of partners. Outside investors are sure to be less sentimental and more critical when analysing a firm's performance. For law firms that do decide to go public, success will depend on their managers' ability to run them as public companies, rather than members-only gentlemen's clubs.