A few weeks ago Shine Corporate – Australia’s second listed law firm – entered voluntary suspension from trading on the ASX pending the outcome of a review of their work in progress (WIP) recoverability.
The outcome of this trading halt was a $17.5m in WIP provision and lower than expected fee to file ratio to the tune of a further $10.5m. This effectively slashed the previous guidance by over 50% to about 26% causing the share price to drop 73.5% to $0.53.
Shine specialises in damages-based litigation where they represent clients who have a claim to personal injury compensation. They operate on a “no win, no fee” model which means they incur expenses up front, with the expectation of receiving a fee once the case is successfully settled.
The WIP is essentially the accumulation of billable hours that the company expects to charge the client once the case settles. In theory, this should give the company better visibility than most companies of future earnings and cash flows based on the expected (and historical) case win rate.
In practice, it is educated guessing.
Essentially, it appears that the expected recovery of fees from WIP has been grossly overstated by the company, leading to a material downgrade by management.
Shine are not the only listed law firm in trouble though, with Slater and Gordon also experiencing a fall from grace after their large UK acquisition did not exactly go to plan. Interestingly, looking back over the last 24 months, Shine’s share price has largely followed the trend of Slater and Gordon despite Shine having nil exposure to the UK market.
Given that Shine had previously continued to reaffirm to the market the strength of its balance sheet and continued financial performance you would be forgiven for observing the above chart and wonder if Shine were becoming unduly cheaper through forces unrelated to their business – namely Slater and Gordon’s demise.
As it turns out, the market may have unknowingly foreshadowed the news from Shine, but no one could have predicted the eerie similarity of two distinct, yet similar businesses.
Being one that doesn’t believe in coincidences, this certainly should raise questions over the sustainability of the listed law firm model, given that so much of the result is dependent of the robustness of the WIP number and the accuracy of the target win ratio – two numbers that are estimated, but in no way set in stone – yet both heavily relied upon for forecasts and company valuation.