Slater’s $2BN Personal Injury - Australian Financial Review
By Alan J. McDonald
Judgement Day for one of the country’s largest and most recognised law firms approaches rapidly. Managing director Alan McDonald discusses the need to audit Slater and Gordon in the face of their ongoing financial loss.
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Slater’s $2BN Personal Injury
Judgement Day for one of the country’s largest and most recognised law firms approaches rapidly.
Slater & Gordon, with its long and storied history of substantial victories against corporate giants, must present to its bankers by close of business tomorrow a detailed plan of how it intends to claw its way back from the brink of financial disaster.
It is a month since the practice reported a loss of nearly $1 billion for the first half of the financial year. Now it has one more month to reach an agreement with banks led by Westpac or risk its debt being called in far earlier than scheduled.
Its shares, once more than $8 each, are now worth less than 30c, creating losses of $2bn for investors. Rivals are circling, edging closer to filing class actions on behalf of Slater & Gordon’s shareholders. Managing director Andrew Grech has been talked out of resignation — for now.
This is a story of accomplished lawyers out of their depth in the world of hedge funds, of poorly executed deals as the firm attempted to build itself into the world’s largest plaintiff law practice. It is a story of how a proud company, which launched the careers of Julia Gillard, Richard Marles and other Labor figures, became the first publicly listed legal practice in the world — then became unstuck.
It was not always so. Bambini Trust is the kind of Sydney institution where members of the city’s high-flying legal and corporate fraternity regularly lunch, and it was into this busy restaurant that Grech walked one day four months ago — and dismissed long-running market concerns about the financial health of one of this country’s greatest law firms.
“Our investors, I think, are very comfortable with the business model because its proven that it works. I think what they are concerned about is whether we have bitten off more than we can chew and whether we can deliver the synergy benefits of scale,” Grech said over lunch in November.
Now it appears many of those concerns were well justified. They raise questions not just about the appropriateness of the company’s financial arrangements but about the very nature of the juncture of law and commerce.
“What people are waiting for is to see whether we can prove that we’re not just an acquisition business, that we’re also a business that can grow organically and deliver earnings growth,” Grech said.
“We’ve done that before, we’ve done that through the period, but it’s masked quite a bit by the acquisition, and it’s understandable that people would be sceptical, so we have to prove that, and we will.”
The acquisition? Australian companies have a poor track record of expanding into Britain. It ended in disaster for the National Australia Bank, for AMP and for Fosters. And the end was no different for Slater & Gordon.
The acquisition Grech spoke of was Slater & Gordon’s $1.2bn deal in April to purchase a large part of British firm Quindell.
It is true the Quindell acquisition was big, bold and, as Grech described it, “transformational”. It was also risky.
The aim of the deal was to tie Slater & Gordon’s substantial British personal injury practice to a suite of ancillary services provided by Quindell — road traffic accident claims management as well as health service processing. It would create a one-stop shop for anyone involved in a car accident. Call a number, organise a medical appointment, book a car repair and, while you’re at it, lodge an insurance claim to be run by Slater & Gordon’s legal practice.
But Quindell, once described by New York outfit Gotham City as “a country club built on quicksand”, was already under a cloud.
For much of its existence its main business was the operation of a Hampshire golf club, from which it went on to acquire companies in telemetry, insurance and related operations.
Quindell, which admitted to “aggressive” accounting practices, handed over 53,000 hearing-loss cases to Slater & Gordon as part of the deal. Britain’s Financial Reporting Council and Serious Fraud Office are investigating it.
Grech assured investors Slater & Gordon had done its homework. Thousands of cases were scrutinised by dozens of lawyers over three months. Ernst & Young conducted independent assessment of the value of the business.
Clearly, that due diligence was not enough. Many of the cases it acquired have not delivered, and the acquisition built up considerable debts for the company, says Angus Nicholson, an investment analyst at IG.
“When you start buying businesses you are buying revenue, and the issue is that revenue needs to keep growing … if it starts running out or you don’t buy more revenue, this can be a real problem,” Nicholson says.
“Slater & Gordon’s roll-up strategy worked fine up until the Quindell acquisition and that seems to be where they had bitten off more than they can chew in terms of debt and in terms of consistent revenue.”
Most reports place the blame for the past dismal year on that disastrous deal. But it is now clear the rot had set in well before. At the heart of the many woes that have befallen Slater & Gordon is a set of very questionable accounts.
Over the past year, it has twice altered its accounts relating to 2014 and 2015, dropped its earnings guidance and changed some accounting standards altogether. These changes have played a significant role in the $2bn plunge in its share value.
Last month Slater & Gordon was forced to write down two-thirds of the total value of the Quindell acquisition — $814.2m.
But figures contained within the company’s latest financial report paint a picture of a company with more troubles than one bad acquisition.
Slater & Gordon is best known for its successful class actions, representing Papua New Guinea landowners in a fight against BHP’s OK Tedi mine that resulted in a $400m settlement.
But its main source of revenue is more mundane. While it continues to act for a range of unions including the Construction Forestry Mining and Energy Union, it is its personal injuries and other small claims practice that are its bedrock. Slater & Gordon has a lot of those small cases under way at any given time. Many are under a “no win no fee” arrangement, making it difficult to estimate their worth until after settlement.
Before buying Quindell’s professional services division, now known as Slater Gordon Solutions, Slater & Gordon had $563m of work under way on its books. The business it acquired had $420m, giving it a total work value of $983m.
By the end of June, that number — the value of cases on its books — dropped to $826m. But the latest accounts show the company now thinks its real value was just $677m, a $149m discrepancy.
Almost 80 per cent of that $149m difference related to Slater & Gordon’s existing business, and had nothing to do with Quindell. In other words, work valued at $118m, which would one day turn into cash, had disappeared.
The reason for the difference, the law firm says, is that it adopted a more conservative approach to preparing its accounts. Late last year, it ditched its long-time auditor, Pitcher Partners, which is under investigation by the Australian Securities & Investments Commission, for Ernst & Young.
Slater & Gordon has declined to comment on the discrepancies, other than to refer to an apology to investors given by chairman John Skippen, who has rejected any suggestion he should resign over the debacle.
It is these accounts that form the focus of the possible class actions being led by Slater & Gordon’s great rival, Maurice Blackburn, and ACA Lawyers.
Maurice Blackburn’s Andrew Watson says the problem with Slater & Gordon’s accounts are “deeper, more systemic and multifaceted” than is being reported.
“(We will be) looking at systemic issues and how it can be that the company could be shocked five times by bad news within a year, and whether or not the accounting for revenue and measurement of goodwill and impairments have been done in a timely manner,” Watson says.
In particular, any litigation is expected to focus on announcements by Slater & Gordon’s management in August and again in November intended to calm the market and suggesting there were no problems with the accounts, which the company walked away from in December.
There were warning signs. Aside from Gotham City’s damning assessment of Quindell in April 2014, there was a review of Slater & Gordon’s accounts by ASIC beginning in June, and two restatements of the practice’s accounts after several errors were corrected over the past year.
None of these appeared to have hit home for the company executives led by Grech — until it was too late. Grech, a stalwart of the Melbourne legal fraternity for several decades, experienced leaner, more difficult earlier years at Slater & Gordon, an experience that convinced him of the need to aggressively expand the practice, which he said was sneered at by the “magic circle” corporate firms.
“All the reading I had done about successful businesses was that diversification was very important,” Grech said in November. “What the learning taught me was that you should never put yourself in a position where any one client can determine your future success, or any one case can.”
But the fast growth of the company, having acquired more than two dozen legal practices since listing on the Australian Securities Exchange in 2007, has made people — many of them managing large amounts of money — very suspicious.
It has also alarmed some in the legal fraternity.
Alan McDonald, managing director of employment law firm McDonald Murholme, tells The Australian he was concerned that pressure placed on Slater & Gordon by bankers to raise revenue in a short time could lead to a conflict of interest. “Who enforces the protection for staff and clients against pressure to settle cases prematurely?” McDonald asks.
“This law practice has written off over $800m … in those circumstances, it is reasonable for the regulator to audit a practice to ensure that the practice is being conducted in accordance to the obligations of the practice.”
It is likely such an audit would be conducted by the Victorian Legal Services Commissioner, which declines to comment.
Those concerns are new. Those about the company’s finances are not. They formed the basis on which hedge funds from around the world began short-selling Slater & Gordon’s publicly traded shares, betting that eventually they would fall.
They have — from $8.07 a share last April, after the announcement of the Quindell deal, to 23.5c a share now, valuing the company at just $83m.
Sydney hedge fund VGI Partners was the most vocal, and one of the earliest, to suggest a series of accounting mistakes and intriguing accounting practices could mean Slater & Gordon’s business was nowhere near as lucrative as it appeared.
The fund, which declined to comment, began short-selling Slater & Gordon shares in November 2014, well before the Quindell acquisition.
Grech has taken exception to claims of account manipulation.
“This idea that they are trying to suggest, that we manipulate, is a very serious allegation to make,” he has said. “You do get lumpiness — there’s no hiding from that, it’s obvious — but that’s not because people are trying to manipulate it. That would involve us having been in a 15 year conspiracy with Pitcher Partners and now Ernst & Young. I mean, I don’t know, maybe I’m just a smart, devious guy, but I don’t fancy myself as much of a mastermind. In the end, people will make up their minds for themselves.”
The truth is, hedge funds and other institutional investors have in the past manipulated the market for their own gain. A quiet word to a journalist, the insinuation there might be a problem, is sometimes enough to crush a company’s share price.
In the case of Slater & Gordon, several major fund managers who had significant money invested in the firm complained to ASIC.
The regulator has taken action in the past. In 2009, it banned a trader at Linwar Securities for spreading false rumours about the health of Macquarie Group’s cash management division.
But if it is simply a case of market manipulation, shares usually rebound. Macquarie’s share price has more than doubled in the decade since those rumours.
It is not expected Slater & Gordon’s will stage a similar recovery.
Reference: Slater’s $2BN Personal Injury, The Australian, 30th March 2016.
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