It is a shame some excellent industries are poorly represented on ASX. There are hardly any listed education companies or legal or accounting firms. More law firms, in particular, need to list, given the excellent prospects of the leading ones that have.
The two stand-outs are Slater & Gordon and IMF (Australia). Shine Corporate, due to list this month after a $15-million float, will provide another option, although there has been little aftermarket support for Initial Public Offerings in the past 12 months.
Slater & Gordon, best known as the legal crusader that takes on corporate giants, has rallied from a 52-week low of $1.64 to $2.70, amid strong earnings growth. Slater’s real strength is systems and structures that allow it to process huge volumes of personal-injury claims and other legal matters.
Slater rallied this month on news it had acquired three law firms in the United Kingdom and raised $58.9 million through a placement at $2.55 to institutions. Confirmation of its 2012-13 earnings guidance also buoyed the market.
There is a huge opportunity: the UK legal market is 4-5 times larger than in Australia and no dominant law brand exists in consumer legal services. Slater has the intellectual property, brand and balance sheet to build a huge footprint in the UK and create a new engine of earnings growth.
The market has long underestimated the power of Slater’s brand, which gives it scope to dominate legal categories, such as family law, and the strength of the firm’s systems. Great skill is needed to pick the best cases to purse and manage, given 85,000 client enquiries in a year.
Slater & Gordon has characteristics of a high-performance business: its scale provides a sustainable advantage over smaller rivals; the law industry has high barriers to entry (for large-volume work); and Slater & Gordon does not require huge investments in fixed assets, although it is working-capital intensive.
Slater & Gordon is also more defensive than many small-cap growth stocks because demand for its services is less dependent on the economy’s strength. Although it is due for a pause after recent share-price gains, Slater & Gordon has excellent long-term prospects as it grows globally.
Litigation funder IMF Australia also impresses. Litigation funders typically receive around 30 per cent of the settlement for a class action and have their legal bills reimbursed by the losing side. High returns are needed because class actions are an all-or-nothing pursuit for funders if they go to trial.
King & Wood Mallesons’ latest Class Actions in Australia report said securities class actions exceeded $480 million in 2012, a booming year for litigation funding that saw a record 13 class-action settlements and the prominent $200-million Centro settlement.
Centro’s settlement and the bank-fees class action, the largest collective legal action in Australia in which 12 banks are being sued for charging customers unfair fees, has greatly boosted the profile of litigation funding and sparked complaints from companies and boards that dislike the practice.
Litigation-funding critics believe the industry’s slice of case settlements is too high and that super-normal profits will encourage more funders to set up in Australia and pursue cases with less merit in the hope of early settlement. Critics fear this country, like the US, will become excessively litigious and that the only long-term winners will be law firms and litigation funders.
More competition and the tighter regulation are significant risks for IMF and other litigation funders. But IMF has a dominant industry position and regulatory changes so far have been fewer than expected. IMF has a stellar position in an industry with strong growth prospects.
Moreover, litigation funding is deceptively complex to do well and has higher barriers to entry than is widely known. Its takes great skill to pick class actions to bankroll, for a few bad verdicts can leave a litigation funder with millions in legal costs. IMF’s case-selection record over a long period is exemplary.
Like Slater & Gordon, IMF has good potential to expand offshore – in its case, the United States – and it is also due for a pause after strong share-price gains this year.
Of the two, Slater & Gordon has the lower risk profile and is better suited to portfolio investors who want to increase their allocation to small and mid-cap stocks. IMF arguably offers the better value, particularly with two of Australia’s biggest class actions – the bank-fees case and an IMF-led class action against ratings agency Standard & Poor’s – offering a potential earnings boost in the next few years.
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Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.