Last week it was announced that Australia's largest listed law firm Slater & Gordon Limited (ASX: SGH) is to spend around $1.2 billion on the professional services division of UK business Quindell Plc assuming the deal is approved by relevant parties.
The giant deal will potentially see Slater & Gordon nearly double its market value, while the entitlement offer to raise $890 million of the funds required will probably be bigger than most of this year's standalone IPOs on the ASX.
The law firm's meteoric growth has been based on an acquisitive growth strategy in the United Kingdom, although the latest deal is its boldest yet and certainly puts Slater & Gordon higher up the risk curve as an investment opportunity, with an additional $375 million of underwritten bank debt required to fund the purchase.
Retail shareholders are being asked to take up a 2:3 renounceable entitlement offer, which will effectively add 66% to their current holding in the group.
The group's most recent half-year results showed a net profit of $33.7 million, with a cash flow from operations of $26.5 million representing 78.6% of the net profit. In the prior corresponding half-year period cash flow was 91.6% of a net profit of $21 million.
As a fast-growing personal injury (PI) business the group's accounting practices will come under scrutiny, with the posting of accruals part and parcel of operating in a world of PI claims that have notoriously long time periods to settlement (if any).
Indeed, I have personal experience of directly managing (and occasionally winning!) personal injury claims in the UK on a pro-bono basis of legal representation for individual clients from a variety of backgrounds. Time periods of 12-24 months are common until settlement and the chances of success far from guaranteed.
If liability is disputed the stakes are raised and cases can end up in court and rumble on far longer, with total compensation awarded or costs incurred (if any) unknown until a final settlement is agreed or a court order enacted.
The complexity around the posting of accruals is self-evident and Slater and Gordon's acquisition target has been a prime target of short sellers itself over allegations of improper accruals, cash flows and profit posting related to its professional services division (PSD).
Slater & Gordon says it has conducted extensive due diligence on Quindell's PSD and is 100% satisfied any issues are not material and the purchase price around 6.9x earnings is reasonable given the opportunity.
Investors in the renounceable entitlement offer will need faith in the soundness of Slater & Gordon's business model, due diligence and judgment in taking the plunge on Quindell's PSD.
At an offer price of $6.37 the stock is available at a substantial discount to the trading price ($7.85) and 15.6% discount to the theoretical ex-rights price based on the group's March 27 closing price of $7.55.
Although not over-enthusiastic about the acquisition, I'm happy to give management the benefit of the doubt and take up the offer (and some extra risk), while expecting the price to be volatile as events take their course.
Other legal eagles on the ASX include rival PI operator Shine Corporate Ltd (ASX: SHJ) and class action funder IMF Bentham Ltd (ASX: IMF), although there may be much better prospects out there if you're looking for income and growth…
