It is a sign of the times when a listed law firm sponsors a rugby league team, appears on TV infomercials, conducts live chats with prospective clients on its website, and uses a lawyer who was portrayed in a Hollywood movie as its brand ambassador.

Shine Corporate’s bold marketing strategy is no surprise. In its 2013 prospectus, Shine includes “dare to be different” as one of three core values. The strategy is working: the well-run Shine is one of the best floats in recent years and even after stellar share price gains is only marginally overvalued.

The Brisbane-based firm should have a prime spot on portfolio watch-lists, such is the long-term potential of the personal legal services industry in Australia and the United Kingdom. Shine arguably has a more compelling valuation than its nearest listed rival, the impressive Slater & Gordon, at current prices.

I described Shine as one of 2013’s top five floats for The Bull in January. And earlier nominated Slater and Gordon as one of two stocks with excellent prospects for The Bull in May 2013. Shine is up 30 per cent since January 2014, and Slater is up about 80 per cent since May 2013.

Shine is benefiting from the global trend of law becoming a buyers’, rather than a sellers’, market. The days of snooty, clubby law firms charging exorbitant hourly fees, and clients begrudgingly accepting the bill, are fading, at least in some areas of consumer law.

Slater & Gordon, and its formidable unlisted competitor Maurice Blackburn Lawyers, have built strong national brands and are superbly positioned to benefit as consumers use the internet to shop around for legal services, in areas such as compensation law, and gravitate to the best-known firms.

Although much smaller than Slater & Gordon, Shine is rapidly building market share in Australia’s personal legal services market. It listed on ASX in May 2013 after raising $45 million at $1 a share, in a dreadful market for initial public offerings (IPOs) at the time.

Keen judges saw Shine’s potential to mirror Slater & Gordon’s success, and provide a rare opportunity on ASX to gain exposure to the legal industry.

Shine soared after listing and some fund managers took quick profits, mistakenly confusing price with value. A stronger-than-expected half-year result, announced in February 2014, helped Shine more than double its $1 issue price within 12 months of listing.

Shine is not the bargain it was upon listing and its growth trajectory could slow slightly in the next few years, albeit off a high base. But there is enough to suggest early investors should hold on to Shine and prospective investors should look to buy on any significant share price weakness.

Understanding the history and rapidly changing dynamics of the personal legal services market in Australia and the UK is critical when assessing Shine. Founded in 1976 as a tiny practice in Toowoomba, Queensland, Shine now has more than 30 offices and 600 staff. It is Australia’s third-largest plaintiff litigation firm.

Shine earns most revenue from personal industry litigation services, in areas such as workers compensation, motor accidents, medical negligence and public liability claims. It also has an emerging practice in product liability, professional negligence, class actions and other areas.

Shareholder and consumer class actions, such as those led by Slater & Gordon and Maurice Blackburn, and funded by Bentham IMF, have good growth potential as more litigation funders set up in Australia and as law firms take on huge cases, such the Maurice Blackburn-led bank fees action.

High-profile class actions can be a publicity goldmine for law firms that specialise in them. But in terms of earnings, they are more sizzle than sausage. Slater & Gordon and Shine live or die on their ability to attract high case-volumes, choose the best to pursue, and manage cases efficiently.

In some ways, these firms are like giant processing centres. That is not to downplay their legal expertise, but the personal legal services market is ultimately about volume and economies of scale. For that, firms need a strong brand, well-trained lawyers and excellent systems to process high case loads.

In 2012, Shine settled 3,760 claims and recovered $399 million in compensation for clients. Of that, 90 per cent of cases were settled out of court and one case in every five client enquiries was accepted.

Shine has cleverly built its brand in recent years. Its recent sponsorship of the Parramatta Eels rugby league team will help stgelop stronger brand awareness in western Sydney as Shine, still concentrated in Queensland, expands nationally.

The firm’s marketing coup was securing the internationally acclaimed US environmentalist activist Erin Brockovich as a brand ambassador /consultant from 2010-20. Movie buffs will recall Julia Roberts won the Best Actress Oscar for her performance in Erin Brockovich in 2000.

Strong brands are critical in compensation law. As the industry consolidates, it is likely that a few national, household-name firms will dominate. Their size, skill, systems – and access to capital, which is vital in a no-win, no-fee model – will become bigger barriers to entry.

Business forecaster IBISWorld estimates the personal legal services industry was worth $3.1 billion at December 2012. It had 3.1 per cent annual growth between in 2008 and 2013 and IBISWorld forecasts 4.1 per cent annualised growth between 2013 and 2018, partly because of stronger demand for property conveyancing services.

This is fiercely competitive, fragmented industry. IBISWorld data shows about 9600 business fought for $881 million of profit in personal legal services in 2012. On revenue of $3.1 billion, the industry still enjoys decent, although contracting, profit margins as competition intensifies.

Slater & Gordon has 7.4 per cent of this market, and Maurice Blackburn and Shine are thought to hold less than 5 per cent and 4 per cent respectively, on IBISWorld estimates. That suggests these firms still have years of growth ahead as smaller firms are acquired, and as they move into other legal services or expand overseas.

The United Kingdom, a market four times the size of Australia’s personal legal services industry, has huge potential for Australian firms. In October 2011, the UK allowed a range of alternative business structures, including incorporated law firms that could be owned by non-lawyers, as does Australia. The upshot was that incorporated firms could raise external capital and rapidly acquire smaller players.

Slater & Gordon has quickly seized the opportunity through a series of astute UK acquisitions. In its prospectus, Shine said expansion in the UK was an option, as was a market-entry strategy in the United States, thanks to its alliance with the well-known Brockovich.

For now, Shine seems content with rapid expansion through Australia. It is a simple strategy: broaden the geographic footprint, add on higher-margin legal services, and become more efficient. Shine describes this strategy as an “inch wide, mile deep”, meaning it will stick closely to personal services law and avoid the temptation to become a full-service national law firm.

Shine says it has several acquisition in the pipeline and its 2013 prospectus identified many greenfield sites for expansion. It has acquired more than 20 firms since formation, and clearly has a knack of integrating smaller firms. Shine raised almost $30 million in an entitlement issue in July, to pay for the acquisitions to two legal firms, Emanate Legal and Stephen Browne Personal Industry Lawyers. Both acquisitions are expected to be earnings-per-share accretive.

Shine’s first-half result for FY14 showed 16 per cent revenue growth to $56.7 million over the previous corresponding period, and 42 per cent growth in net profit to $11.4 million. A maiden interim dividend of 1.75 cents was declared.

Directors confirmed the full-year prospectus revenue forecast of $115 million and increased guidance for underlying earnings (EBITDA) to $34-37 million, from $33 million. Investors cheered the results, driving Shine almost 20 per cent higher after the February result.

However, Shine said in July that it expected profit at the lower end of that guidance, although it will still be up more than 20 per cent on the previous corresponding period.

More important is how that profit translates into return on equity – or the return that Shine is achieving on each dollar of shareholder funds invested. Shine’s ROE was a solid 17 per cent in FY13, according to Morningstar.

At $2.35 a share, Shine looks fully valued for now. Its short history as a listed company, and the low number of analysts covering the stock, means a higher margin of safety is required to buy. A key concern is whether profit margins will be maintained as industry competition intensifies and as the mix of services changes.

The industry’s bread-and-butter service – litigation for workplace injuries and car accidents – may become less dominant in the next decade. The number of workplace injuries in Australia is trending lower as firms lift their safety efforts, to reduce litigation risks. The demise of Australia’s manufacturing sector, and rise of service industries, will also lead to fewer workplace injuries.

Moreover, newer, safer cars on the roads – and the gradual introduction of accident collision technology – should, thankfully, lower road injuries and fatalities in coming years, and potentially lead to fewer personal injury claims in this area.

Also, the rise of Alternative Dispute Resolutions (ADRs), now the fastest growth area in legal services, could lift the volume of work but pressure profit margins. ADRs are required in areas such as family law, where a family dispute resolution is held before a parenting order application is made.

One can imagine the big listed law firms taking on higher volumes of increasingly lower-margin work, and adding on more profitable services. Under this scenario, industry consolidation will accelerate, big firms will get bigger, and sustainable competitive advantages will be built on brand, intellectual property, people, systems and access to capital.

Shine has so far capitalised on its early-mover advantage as a listed law firm. The share price, however, now reflects its progress and its near-term prospects. Still, Shine is closer to fair value than most, and an interesting idea for long-term portfolio investors, who can buy it on any price weakness closer to $2 a share.

Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at July 24, 2014.

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