This morning IPH Limited (ASX: IPH) as the holding company for a collection of patent law firms including Spruson & Ferguson reported a net profit of $19.7 million on revenues of $101.2 million for the six-month period ending December 31 2017. The profit and revenue were down 11% and up 9% respectively on the prior corresponding half.
In response the stock has shed 20% to $4.13 in morning trade.
IPH will pay an interim dividend of 11.5 cents per share on earnings per share of 12.4 cents, which means it is paying out almost all of its underlying profits to maintain a modestly high dividend yield. The earnings per share were down 9.5% in a result the group blamed on increased investment in data and analytics software among other factors.
Another factor the group attributed the weak result to was an appreciating U.S. dollar over the reporting period which was no secret, but failed to prevent investors bidding the stock up around 20% before it handed back all of those gains today.
The company also reporting that a December 2017 revaluation gain it flagged and booked in December 2017 also meant this comparable half's numbers look weaker.
In total the impact of the revaluation gain (plus its subsequent reversal in January 2017) and FX movements "negatively impacted" this half's results by $3.1 million.
More important is the operating performances of the businesses which were mixed with Australian operations' like-for-like earnings down 5%, while its Asian operations grew revenue and EBITDA 4% and 3% respectively.
The group now has drawn debt of US$26 million mainly used to fund its recent acquisition of New Zealand law firm AJ Park. Cash on balance sheet stands at $18.3 million.
As such IPH has been growing revenues partly as a result of its acquisition strategy, but with debt growing and earnings falling it needs to be careful it doesn't end up a textbook case of a mismanaged roll-up strategy.
Once again IPH suggested the slowdown was a symptom of a relative decline in business across the board for patent law practitioners after a surge of business in FY 2016 (and prior) as a result of The America Invents Act (AIA) that caused a once-in-a-generation surge in patent applications.
No surprise then that the business choose this purple patch of patent applications to list on the stock exchange and obtain maximum value for the inside owners of the business.
Foolish takeaway
Given the group's average track record since it went public, lack of a competitive advantage, and relatively low barriers to entry in the patent law field I still don't see much to like about it as a long-term investment option.
The impact of the AIA and blaming of the half's profit fall on the reversal of the revaluation gain also suggesting to me that this business may be run more for the current and former insiders than today's shareholders.
Ninety-nine percent of successful law firms operate privately in partnership and have done for centuries as this allows them to attract and retain the top fee-earning talent in exchange for a profit sharing agreement remuneration model.
For example a smart lawyer looking to get ahead will work long hours to deadlines at a law firm partly in the knowledge that one day they can make partnership and share in a firm's profits. If that incentive is removed as profits are shared by shareholders a firm may struggle to attract the best lawyers and a worse outcome is that those lawyers' interests are not as well aligned to the firm's profit-making interests.
As such I'm unconvinced that a law firm required to share virtually all its profits (as IPH does) with shareholders is a sound business model vis-a-vis the requirement to deliver sustainable growth when the fee-earning employees are your key asset.
For a business posting falling earnings the annualised price to earnings around 16.5x based on a $4.13 share price is not particularly attractive in my mind. However if it can deliver on its growth plans the stock may offer reasonable total returns to today's investors.
