LB100: The Second Quartile – The first shall be last…

The City’s mid-tiers defied the critics to achieve market-leading pace through 2015, cementing the gains of recent years. How big an upset can the tortoises deliver?

There are a few simple ideas that define the pecking order in the UK legal industry. The big boys are international, materially larger than the tiers below and two to three times as profitable as their mid-pack cousins.

With globalisation marching onwards and the City leaders having a huge market edge in securing high-end corporate, banking and securities work, it is obvious why the received wisdom in the legal industry for 20 years now has been that the mid-tier is doomed to drift and largely be squeezed out of a changing contest they have little hope of adapting to.

But it seems no-one bothered to tell the City’s resident ‘tortoises’, who have posted not only another confident year of performance in 2014/15, but one in which they have comprehensively outclassed larger London rivals.

Macfarlanes, Stephenson Harwood, Travers Smith, Mishcon de Reya, Osborne Clarke, RPC – take your pick. This loosely defined group has achieved another year of startlingly strong performance, even more impressive given the context of what remains a turbulent and challenging economy. Even firms like Nabarro and Fieldfisher, that have in recent years struggled to find their form, have put in robust showings.

No firm typifies this revival more than Macfarlanes. The firm’s revenue is up 73% in the last five years, following a 14% increase to £159.6m in 2014/15. Such organic growth has unsurprisingly super-charged the 80-partner law firm’s bottom line. Macfarlanes’ profit per equity partner (PEP) at £1.56m is now outpacing every Magic Circle firm barring Slaughter and May, while revenue per lawyer at £464,000 is at the level of elite City institutions.

Macfarlanes senior partner Charles Martin argues this performance comes from clarity in a complex world. ‘It’s a simple business model. Some would say that’s old-fashioned. But not having grown, to some extent, makes us more adaptable.’

‘These maverick independents’

Impressive as Macfarlanes’ Magic Circle-level profitability may be, the fastest growth in the group this year was achieved by Stephenson Harwood, which posted a 20% hike in revenues to £145m, moving the firm up four places to 28th in our table.

The firm cited robust growth in its London, Greater China and Dubai practice, while its commercial litigation, corporate and real estate practices also saw buoyant results. Revenue since 2010 has grown 58%, while PEP at the firm jumped to £746,000 as partners enjoyed a 40% average increase in remuneration, with those at the top of equity taking home £1.16m at year-end compared to just over £800,000 the previous year.

‘We have had a fantastic year,’ says chief executive Sharon White. ‘Commercial litigation was extremely strong. We have a good balance between our contentious and non-contentious work – we are not a corporate-led firm. We are also well balanced geographically. For example, when Europe got hit we had Asia picking up and dusting itself off.’

Osborne Clarke (OC) was another confident performer, with turnover and PEP rising 6% and 7% respectively. It says much about how upwardly-mobile the Bristol-bred firm has become in the last five years that this performance looks sedate by its track record, with revenue having increased 80% in the last five years.

Travers Smith – along with Macfarlanes, the established bellwether firm for transaction-heavy, midweight players – posted another year of confident growth, with revenues up 9% to break the £100m barrier, while PEP closes in on the £1m mark. Aside from keeping tightly focused transactional practices, Travers and Macfarlanes have both moved to balance out their offerings in recent years, with investment in their disputes and regulatory teams.

Meanwhile, after several flat years, Nabarro recorded £126m in turnover – an 8% rise – its largest annual increase since 2008, alongside a 31% jump in PEP to £631,000, constituting a double-digit increase for a third consecutive year.

Senior partner Graham Stedman comments: ‘There’s no doubt the mid-market is in rude health. I’m glad to see we’ve turned in a good result. It comes on the back of hard work we did in the previous two years, trying to attract higher value work and working on cost and margin to put us in that position. People think the market is more buoyant, perhaps not as much as we might have expected. Firms are finding the market hasn’t quite taken off the way they thought it would. The mid-market has to keep working at it.’

In contrast to its own run of potent form, Mishcon looked subdued in 2014/15 for a firm that has grown a trend-busting 146% in five years without a substantive merger. Yet Mishcon still saw the topline move up 12% to £117m, having climbed 18% in 2013/14, though PEP dipped 8% (in context the firm has a high equity/fee-earner leverage and has 76 non-equity partners against 36 full-equity partners).

The firm – renowned for its flair, entrepreneurial culture and distinctive branding – has plenty to keep it busy, having moved to its new London offices in Africa House, Holborn, and with an upcoming conversion to limited liability partnership. The firm also converted to an alternative business structure to allow four senior non-lawyers to join the partnership.

‘As you get bigger – and we’re now one of the bigger London offices rather than an international firm – things take longer to shift. It’s much easier when you’re a £10m business to be robust and nifty, but £100m-plus takes longer to shift,’ says managing partner Kevin Gold. ‘Historically, a three-year plan has been driven by factors or criteria such as revenue or PEP. A longer-term vision is: where do I see myself in ten years’ time? What kind of firm do I want to be? Given the stresses with consolidation or internationalisation and us being these maverick independents, it’s about finding our own place.’

Even Olswang – the one mid-tier player widely regarded to have serious challenges regarding its direction and strategy after deposing its chief executive David Stewart last year – saw revenues grow 8%, though the departure this year of much of its profitable German practice will impact next year.

Driving this band of firms is a firmer UK economy and, in particular, the rebound in the real estate sector, which remains a major business line. Private client, technology and venture capital have also proved to be fruitful areas for this group, tapping into markets that sit uneasily with larger rivals. Such firms have also proved more than able to tap into strong levels of contentious work, even as the Magic Circle and US law firms have increased their investment in the City disputes market.

None of this quite explains the dramatic growth many of these firms have sustained over the last three to five years. But if a consensus emerges, it is that they derive a substantial cultural and financial dividend from the relative lack of size and infrastructure compared to larger beasts. Many of these firms have proved able to reposition since the banking crisis or push through initiatives relatively quickly in a manner impossible for a global giant.

‘We bounced back after the downturn because changes were easy to drive,’ argues Martin. ‘We lost a number of partners. We reshaped a number of practice areas. We abolished all internal communication and focused on generating revenue. We don’t have complexities and the layers of cost that [the Magic Circle] has because of their scale. Our partners focus solely on clients and that is a distinct advantage.’

‘No massive upturn’

Inevitably, given how varied the members of the 26-50 group are, there are firms that neither fit into the mould of the City player nor the current success story.

That is most obvious for practices exposed to the volume insurance and shipping markets, which are both under some strain. Holman Fenwick Willan, a firm that three years ago occupied a place in the top 25, has fallen another three places to 29. With revenues dipping 3% to £139m, PEP fell 15% to £469,000. However, over a five-year period, the firm is still in positive territory, recording growth of 39% on its 2010 numbers.

Ince & Co, which has dropped ten places in the charts since 2013, now sits at 49, with Trowers & Hamlins just making the second quartile at 50, having fallen one place. While Trowers managed a 3% rise in both revenues and PEP, turnover over the last five years has been slowly declining and is currently down by 11%. Ince’s revenues, on the other hand, were down 8% both in 2014/15 and since 2010, but PEP managed to pull up 13% to £275,000, as the firm’s lawyer headcount dropped 9% to 278 lawyers and the number of equity partners fell 8% to 88.

Hill Dickinson, likewise, fell four places to now rank 40, and posted declines in both PEP and revenues, highlighting the continued margin pressure in the volume end of the insurance market. Last year, the firm, along with Ince, made a round of job cuts in a bid to maintain bottom-line growth and decrease firm debt.

Arguably, the only insurance-heavy player to clearly buck this trend was RPC, which achieved a 12% rise in revenue, contributing to a 57% growth rate over the previous five years. RPC, however, has focused recently on diversifying its practice beyond insurance.

Meanwhile, Kennedys, which has been busy boosting its international ties this year, reported flat revenues after enjoying a 10% increase the previous year, but PEP was down 2%, having grown 3% in 2013/14. However, its strategy of a nationwide insurance player is very different to most of the second quartile.

Diversity – the gulf between female lawyers at partner and associate level

‘The insurance market is not one where there is suddenly going to be a massive upturn because of massive amounts of extra activity. We are almost a-recessionary,’ says Kennedys senior partner Nick Thomas. ‘Last year we had the merger with [aviation boutique] Gates and Partners, which brought some revenue in and contributed to the double-digit growth, but also one of the issues we are facing this year is the strength of the pound. We have got a big overseas operation and most of our overseas operations put significant increase on their turnover in local currency, but because the pound is that much stronger we are not seeing it coming through as increases in our global revenue.’

The picture was more muted for the regional and national players in the 25-50 band, who – aside from OC – generally saw less dramatic results, with well-established firms such as Burges Salmon and Mills & Reeve putting in respectable performances.

There were two notable exceptions, with Shoosmiths achieving its best performance for years, with revenues up 11% after a torrid post-2008 period for the firm. Shoosmiths returned to its pre-financial crisis high, breaking the £100m mark in revenues and with PEP jumping 33% to £386,000, as well as posting a five-year revenue increase of 14% after being down 6% between 2009 and 2014.

Claire Rowe, chief executive at Shoosmiths, says: ‘It has been a very good year for the business, in which we have well and truly consolidated our position as a major national UK law firm. We have seen the benefits of the return on a significant amount of investment in the business, investment in people and investment in infrastructure. All of that has contributed to growth in fee income and profit, but equally market share.’

Rowe adds the firm’s corporate and real estate practices increased in activity and generated 22% and 33% respectively in revenues. The UK firm bolstered its national credentials in the summer after taking permanent office space in London’s Tower 42, giving it a ten-office UK network.

The other notable performer from a regional base was Gateley, which saw another year of solid growth to break into the top 50. The firm is, of course, being watched closely to gauge the success of its pioneering public listing this summer on AIM, making it the first UK law firm to publicly float under the Legal Services Act reforms.

In a hurry

While individual variations are substantial, the overall picture for the second quartile illustrates the group performing robustly against the UK market. Average turnover for this group increased 6% from £106m in 2013/14 to £112m this year, while the upper quartile’s average revenue came in at £639m – £11m or 2% less than last year.

While currency movements due to the weak euro, which hit larger firms, and a change in our methodology exaggerate that picture, by any measure, such results turn on their head the accepted notions regarding the prospects for different sections of the market. The bottom half’s average turnover was also down by 5% to £37m from £39m.

It increasingly appears that the 26-50 group is something of an operational sweet spot for the UK legal industry, providing enough scale to compete for lucrative business lines, including in some areas internationally, and with investment in brand and business, while retaining much of the benefits of a smaller operation. They have also evolved into clearly defined but profitable markets that are increasingly being vacated by larger UK firms; such mid-tier players also face less direct competition from US rivals.

If there is an obvious challenge to this group, it is the price of success that creates pressure to internationalise their business, thereby sacrificing many of their natural advantages.

Stephenson Harwood’s White concedes that she is sometimes envious of larger firms: ‘An increasing number of clients are getting bigger and more global, and have sophisticated legal departments, and we can’t always meet the needs of such international clients.’

Such considerations underwrite a continual hum of merger activity, notable in the 2014 tie-up of Wragge & Co and Lawrence Graham, which pushed the combined firm into the top 25, a deal that was followed up by this summer’s surprise union with Canada’s Gowlings. There was also the marriage of Charles Russell and Speechly Bircham (see case study).

But if consolidation will continue to wind its way through the legal market’s mid and lower tiers, the last two years have demonstrated that the firms that hit their stride can go a long way on their own. Quickly. LB

jaishree.kalia@legalease.co.uk

 

Further Reading:

• Case study: Charles Russell Speechlys
• Case study: Osborne Clarke
• Deal machines – the resilience of Macfarlanes, Travers Smith and the mid-tier deal team
• The LB 100 2015 – Through the looking glass