Slater & Gordon Limited’s biggest mistake

Credit: Patrick McKnight

The share price of entrepreneurial law firm Slater & Gordon Limited (ASX: SGH) has fallen off a cliff in November, although in early 2015 few analysts or journalists were paying much attention to the tort law operator’s attempts to make its biggest UK acquisition yet.

The lawyers were eyeing up a big new move into the fast track road traffic accident space via the $1.3 billion acquisition of the claims management business of a UK business known as Quindell Plc.

And why not as any risk of regulatory reform in this area had effectively been shot down by the British Ministry of Justice in late 2013, while the only political party likely to seek reform in this area was considered to have no virtually chance of forming a majority government in the May 2015 general election.

Hence the chances of renewed legislative reform must also have been considered extremely low. In fact in March 2015 the odds of a Conservative party election victory were up to 7/1 and at the end of March 2015 Slater & Gordon’s management announced they were to make a $1.3 billion offer for a claims management business whose main line of business was clearly in the sights of Conservative party legislators.

A calculated gamble that backfired, after the Conservative party won a majority in one of the biggest shocks in UK election history in May 2015 and wasted no time in announcing the radical proposed reforms to compensation culture just 6 months later in November 2015.

The rest is history as Slater & Gordon’s share price has lost up to 90% of its value without a single profit downgrade.

Notably, proposed reforms to Small Claims limits and rights to general damages have been shot down before in the UK, and there remains the prospect that they could at least be watered down once again.

Either way, Slater & Gordon then remains a high-risk bet, with the earnings potential of its $1.3 billion UK acquisition now under real threat. It has though reiterated earnings guidance for financial year 2016 of EBITDAW of around $205 million.

As a through-the-cycle legal services business short-term earnings forecasts should be reasonably accurate, unlike say a miner like Rio Tinto Limited (ASX: RIO) that is impacted by volatile commodity prices, or a retailer like Dick Smith Holdings Ltd (ASX: DSH) that is subject to seasonal factors like Christmas demand.

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Motley Fool contributor Tom Richardson owns shares of Slater & Gordon Limited. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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