Slater & Gordon IPO

The Professor's Questions

1. Analyze S&G’s “No Win—No Fee” business model. Does S&G’s consolidation strategy create value? Will it continue to create value as it grows?
2. Does it make sense for growing entrepreneurial businesses to go public? What are the plusses and minuses? Should law firms and other professional service companies such as accounting firms be publicly owned?
3. How much is S&G worth as a company? Use the financial model and assume WACC = 11%. Would you invest in this deal?

My Answers

Q1. Analyze S&G’s “No Win—No Fee” business model. Does S&G’s consolidation strategy create value? Will it continue to create value as it grows?

S&G combines legal expertise with financing and case selection. Consolidation can create value, but only if the firm keeps its discipline as it grows.

Clients can pursue valid claims without paying the legal fee upfront. S&G takes the risk of not earning a fee and pays expenses before collecting cash. In the case example, it funds A$12,750 before receiving payment. A successful case produces A$4,500 in pre-tax profit, but that profit is not available as cash during the case. Some clients may still have to repay disbursements even if they lose, so “no fee” does not always mean “no cost.”

WIP makes this timing easy to miss. It reflects the expected fee, completion percentage, and probability of success. It is an accounting asset, not cash in the bank. Faster growth can raise reported revenue and profit while increasing the funding gap. Management must monitor collections, case duration, and changes in WIP estimates alongside earnings.

At 11%, the worksheet values a successful case at about A$1,408 and an unsuccessful one at about minus A$8,940. Using the historical 95% success rate as a scenario gives expected NPV of about A$890. The break-even success rate is about 86.4% under those assumptions. Extending each period from six to nine months roughly halves the successful-case NPV to A$701. Good selection and timely resolution are central to the economics. These calculations assume the worksheet's cost, recovery, and tax treatment; the 95% historical rate is not a guarantee for new cases.

Consolidation can improve client acquisition through a shared brand and referral network. Central systems, training, specialist knowledge, and administration can improve productivity and service consistency. A larger pool of cases can reduce some case-specific volatility, although changes in law or common defendants can affect many cases together. S&G's consumer brand also makes client relationships less dependent on an individual lawyer.

The financial test is whether these benefits exceed the acquisition price, integration costs, and additional funding needs. In the supplied model, the acquisition plan adds about A$6.83 million to enterprise value compared with no further acquisitions, with other assumptions unchanged. That is positive value, but most of the company's value comes from the existing business and organic growth. The base model assumes no annual margin improvement, so its acquisition value cannot be presented as proof of realized cost synergies.

I would continue selective acquisitions, with limits on price and integration capacity. As S&G expands, attractive targets may become scarcer, prices may rise, and local legal work may be harder to standardize. I would measure acquired firms by cash returns, lawyer and client retention, case outcomes, and cash collection. Revenue growth or EPS growth alone would not justify another deal.

Q2. Does it make sense for growing entrepreneurial businesses to go public? What are the plusses and minuses? Should law firms and other professional service companies such as accounting firms be publicly owned?

Going public makes sense when permanent outside capital supports valuable growth and the firm can accept the demands of public ownership. For S&G, I support the IPO, subject to strong professional governance.

The main benefits are access to capital without a fixed repayment date, a broader investor base, liquidity for early owners, and shares that may help recruit staff or fund acquisitions. Public reporting can also improve discipline. These benefits matter for a firm that pays costs long before it collects fees.

The costs include dilution, issuance and continuing compliance costs, disclosure burdens, market volatility, and pressure to produce short-term results. Liquid shares do not make the underlying cases liquid. A public valuation can also tempt management to overpay for acquisitions in order to meet growth expectations.

For S&G, the alternatives had real limits: employee shareholders could not or would not supply enough capital; additional debt was risky given irregular cash flows and limited collateral; and private equity investors wanted unacceptable changes to the business model. The IPO therefore addresses a funding need. The case does not show that an IPO is the only reasonable choice for every growing firm; slower growth and more selective acquisitions remain alternatives.

I would separate the company's financing from the founders' liquidity. Of the A$35 million offering, A$17.3 million goes to selling shareholders and A$2.3 million to issuance costs. The remaining A$15.4 million reduces net debt. The company does not receive a fresh A$35 million acquisition budget. The transaction improves its financing capacity, but future growth still requires a cash plan.

Law and accounting firms should not be ruled out merely because they sell professional expertise. A transferable institutional brand, repeatable processes, diversified clients, and durable incentives can support outside ownership. A practice that depends almost entirely on a few partners is less suitable.

However, the source of capital must not determine professional advice. S&G's stated duty order is court first, client second, then other corporate obligations and shareholders. I would protect independent case and settlement decisions, maintain clear escalation procedures, and reward quality and cash outcomes rather than short-term reported earnings alone. For audit firms, public-interest and independence duties also require their own safeguards. Listing eligibility depends on the jurisdiction; the case's Australian rules are not a statement of today's rules everywhere.

Q3. How much is S&G worth as a company? Use the financial model and assume WACC = 11%. Would you invest in this deal?

The supplied worksheet gives enterprise value of A$151.03 million, equity value of A$145.63 million, and A$1.35 per diluted share. At the A$1 offer price, I would make a small investment, subject to checking WIP quality and the funding plan.

I use the model's 10% organic growth through FY2015, 3% thereafter, 24% EBIT margin, and 30% tax rate. It assumes A$10 million of annual acquisitions in FY2009–11 at 1.2 times revenue. NWC is 30% of revenue, and WIP equals PI revenue, or 75% of total revenue. Project litigation is excluded.

Free cash flow is after-tax operating profit plus depreciation and noncash taxes, less capital expenditure, acquisition spending, and increases in NWC and WIP. Noncash taxes equal 30% of the increase in WIP. Since capex equals depreciation, those two terms offset. WIP must still be deducted; otherwise the value is materially overstated.

The model discounts FY2008–16 cash flows to FY2007 year-end. The final-year FCF is A$24.89 million. Terminal value at the end of FY2016 is 24.8876 × 1.03 ÷ (11% − 3%) = A$320.43 million. The present value of forecast cash flows is A$25.76 million, and the present value of terminal value is A$125.26 million. Subtracting A$5.4 million of post-IPO net debt and dividing by 107.78 million diluted shares gives A$1.3512 per share.

The model value is 35.1% above the offer price; equivalently, the offer price is 26.0% below the model value. This is a valuation gap, not a promised investment return. About 83% of enterprise value comes from the terminal value. At a 20% EBIT margin, value falls to about A$0.96 per share. A combined downside of 22% margin, 5% organic growth, and a 1.5-times acquisition multiple produces about A$0.90.

The acquisition years also require financing: FY2009–11 FCF totals minus A$21.64 million. A positive DCF does not establish that the company can fund each year. I would check committed credit, collection schedules, interest and dividend plans, and management's ability to slow acquisitions. The A$5.4 million net debt figure is a valuation input, not a measure of unused borrowing capacity.

My class vote is a small yes, not an unconditional endorsement of the growth story. I would need evidence that WIP turns into cash, that the forecast margin is achievable, and that professional standards survive expansion. If those checks failed, I would pass despite the A$1.35 estimate. The case does not supply enough portfolio information to choose a precise position size.

Case Summary

In 1935, William Slater and Hugh Gordon founded S&G in Melbourne, starting out with workers' compensation work for unions and working people. Years of representing individuals against larger institutions helped the firm build a consumer brand. As of the case date, the firm had nearly 400 staff, more than 140 lawyers and 21 offices across six states; total revenue in 2006 was about A$44.37 million. The headcount and office numbers in the text are as of the case date, while Exhibit 2's 2006 historical data show 114 professional legal staff FTE and 19 offices — the two should not be treated as the same year or the same basis. (pp.1–2; Exhibits 1–3)

The firm's core business splits into personal injury litigation and non-personal-injury legal services, at about 75% and 25% of core revenue respectively. The former relies heavily on No Win—No Fee: legal fees can be charged only if the case succeeds. The firm also runs project litigation/class actions, which can bring sizeable revenue and brand impact but irregular cash collection. An ordinary personal injury case usually takes 6–24 months, with a typical legal fee of about A$15,000. (pp.2–3)

While a case is under way, S&G pays for staff, offices, outside experts and so on, while recognising revenue based on the expected fee, stage of completion and probability of success, booked as a work-in-progress (WIP) asset. Exhibit 5 shows one successful case: A$4,250 spent in each of the first three periods, A$17,250 recovered in the fourth, for a final pre-tax profit of A$4,500. Book profit appears period by period, but cash keeps flowing out first. (p.3; Exhibit 5)

S&G's growth comes from client acquisition and M&A. Its telephone advice line receives about 30,000 calls a year, and its brand and referral network bring in clients. Since 2002 it has acquired and integrated eight small law firms; in the most recent year it acquired four, paying A$9.3 million, expected to contribute more than A$8 million of revenue in FY2008. Personal injury law becoming more complex has put pressure on smaller firms lacking systems and expertise, creating consolidation opportunities. (pp.3–4)

Growth needs capital — both to pay acquisition prices and to fund the outlays on new cases. The original shareholders could not or would not keep putting in enough capital; more debt would worsen the strain on cash flow and the shortage of collateral; and the business changes proposed by private equity investors were not accepted. As Australian rules changed at the time to allow outside ownership, S&G began planning an IPO, and its prospectus set out a clear order for handling conflicts: duty to the court first, then duty to clients, then the firm's other obligations and shareholders' interests. (pp.4–5)

The offer proposes to sell 35 million shares at A$1 each, comprising about 17.3 million sold by existing shareholders and about 17.7 million new shares. After the deal, fully diluted shares are about 107.78 million and net debt about A$5.4 million. Rosen must decide whether to participate, how to assess the growth, valuation and governance risks, and how much to buy. The case text gives differing dates for the listing timetable; this analysis uses only the decision point "before the 2007 IPO" and does not depend on the specific first trading day. (pp.1, 5–6; Exhibits 6–7)

Key Data

Item	Figure / fact	Source and basis
Core revenue mix	PI 75%; non-PI 25%	p.2; excludes project litigation
Brand awareness	60% nationally; 83% in Melbourne	p.2, 2004 survey
Client acquisition	About 30,000 calls a year; about 80% of clients willing to recommend	p.3
Per-case economics	Legal fee 15,000; internal litigation cost 10,500; disbursements 2,250	Exhibit 5; amounts in A$
Per-case duration and historical success rate	Usually 6–24 months; recent PI case success rate 95%	p.3; historically screened cases, not a guarantee for new cases
Per-case peak funding	3 × 4,250 = 12,750; pre-tax profit 4,500 if successful	Exhibit 5
Per-case NPV	Win 1,407.88; lose −8,940.30; expected value at 95% probability 890.47	Excel Exhibit 5A; WACC 11%, 6 months per period; original DCF tax timing
Per-case sensitivity	Extending each period to 9 months cuts successful-case NPV to 701.18; break-even success rate about 86.39%	Calculated by changing inputs to Exhibit 5A; all else equal
Historical and projected profit	2006 total revenue 44.372, EBIT 7.901; 2008 forecast revenue 65.421, EBIT 15.830	Exhibit 3; A$ millions; 2008 excludes future acquisitions
Historical / projected EBIT margin	7.901÷44.372=17.81%; 15.830÷65.421=24.20%	Derived from Exhibit 3; not a historically proven stable 24%
Last four acquisitions	Consideration 9.3; expected 2008 revenue contribution >8.0	p.4; historical deals, not the model's future deals
Model's future acquisitions	10 a year in 2009–2011; purchase price / revenue 1.2x	Exhibit 8; Excel D44:F44
Model's core assumptions	Organic growth 10% to 2015, 3% from 2016; EBIT margin 24%; tax rate 30%	Excel Financial Valuation Model
Model's working capital	NWC / revenue 30%; PI / revenue 75%; WIP / PI revenue 100%	Same as above; NWC excludes the separately listed WIP
Use of IPO proceeds	Total 35.0 = existing shareholders 17.3 + offer costs 2.3 + net debt reduction 15.4	Exhibit 6; A$ millions
New vs. existing shares	New 17.7; existing shares sold 17.3; total shares after offer 107.78	Derived from Exhibit 7 and the change in share count before and after the offer; millions of shares
Equity and debt	Offer price 1.00; net debt after offer 5.4; equity value at offer 107.78	p.5; Exhibits 6–7
EV implied by offer	107.78 + 5.4 = 113.18	A$ millions; text gives approximately 113
Base-case DCF	EV 151.028; equity 145.628; 1.3512 per share	Excel B53, B55, B57
Terminal value	Terminal value at end-2016 320.428; its present value 125.263, 82.94% of EV	Excel K48, K50; calculated here
Incremental value of acquisitions	No further acquisitions: EV 144.203, 1.2878 per share; base case adds EV 6.825	Only annual acquisition amount G6 changed from 10 to 0
Cash gap	2009–2011 FCF total −21.637; cumulative from 2008 through 2011 −16.426	Excel C47:F47; operating and investing cash flow basis, before interest and dividends
Valuation downside	EBIT 20%: 0.9606/share; organic growth 5%: 1.0931/share; combined downside: 0.9028/share	Combined downside = EBIT 22%, organic growth 5%, acquisition multiple 1.5x
Price gap and margin of safety	1.3512÷1−1=35.12%; 1−1÷1.3512=25.99%	The first is the valuation gap relative to the offer price, the second is the price's discount to valuation; neither is a guaranteed return

Key People

Person / organisation	Role	Decision rights, interests and pressures
Gloria Rosen / Freemantle Emerging Leaders Fund	Fictional fund manager in the case; manages an A$100 million fund	Decides on subscription and position size; faces fear of missing out on a hot IPO but remains accountable for investment value
Andrew Grech	S&G Managing Director	Leads growth and the listing; needs capital, and also needs to maintain a professional services organisation's ability to execute
Vendor Shareholders	Original shareholders who funded earlier growth	Get partial liquidity in the IPO; still hold about 48.8% after the offer, subject to a five-year staged escrow release
VCR employee shareholders	Participants in the employee share plan	About 11.6% after the offer; equity helps retention but cannot replace professional culture and professional identity
Anna Booth and the board	Chair and directors; the board includes three lawyers	Handle conflicts between capital, strategy and professional duties; protect the independence of professional judgement
Clients, courts and regulators	Those owed professional duties, and external constraints	The interests of courts and clients may require the firm to sacrifice short-term profit; shareholders must accept this order
Austock Securities / public-market investors	Offer intermediary and providers of new capital	The intermediary wants the deal done; new shareholders care about returns, information quality, liquidity and conflicts of interest

Core Tensions

1. A model value of about A$1.35 per share, versus dependence on long-term assumptions. The A$1 offer price is attractive, but terminal value makes up about 83%; a 24% margin cannot be treated as a law of nature.
2. Growth opportunity, versus growth consuming cash first. More cases and more acquisitions both bring WIP and working-capital needs; projected cash flow is negative throughout 2009–2011.
3. Expanding a professional services platform, versus rising integration difficulty. Brand and processes can be replicated; lawyers' judgement, local relationships and culture do not necessarily replicate in proportion.
4. Liquidity for shareholders, versus growth capital for the firm. Not all of the A$35 million raised goes into the company; the use of funds has to be examined item by item.
5. Outside capital's return requirements, versus courts/clients coming first. This constraint must be reflected in decision rights, incentives and disclosure, not just in the words of the prospectus.