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Can the share price of Slater & Gordon Limited ever recover?

Credit: Patrick McKnight

It would be fair to say that there are many more investors who have lost money investing in law firm Slater & Gordon Limited (ASX: SGH) than those that have made a gain – even when you take into account the high number of short sellers who have profited from the downward spiral in the share price.

Many investors who participated in the $890 million capital raising (at an offer price of $6.37) in April to fund the acquisition of the UK law firm Quindell plc must now be scratching their heads and wondering how it all went so wrong.

The shares are again now trading below the float price of $1 on the back of an announcement stating the company was unlikely to meet its earnings guidance for 2016, just three weeks after confirming it was confident of meeting its targets.

The share price has now fallen close to 90% since it reached an all time high of $8.07, just after the capital raising was announced. With more than $2 billion worth of market capitalisation being wiped off since, there are certainly many investors sitting on significant losses.

The problems facing Slater & Gordon have been well publicised but the solutions to many of the issues have yet to be addressed.

The question many investors must now be asking is: “Can the share price of Slater & Gordon ever recover or is this company headed for financial ruin?”

This question becomes harder to answer when it appears the current management team probably can’t even determine where the ship is heading right now and this has been proven by the company’s latest announcement.

Personally, I think there are a number of issues that need to be resolved before I think the share price can make a meaningful recovery:

  • New management team – This process has already started with the appointment of a new Chief Financial Officer (CFO) following the accounting issues identified. The Managing Director position, currently held by Andrew Grech, must now also be in question following the debacle that has been the UK acquisition. He is the person in charge for overseeing the entire business and ultimately responsible for signing off on any acquisition. He, along with the current board of directors, will need to be held accountable for their decisions and a fresh set of eyes may be required to turn this ship around and regain some market credibility.
  • Completion of the ASIC review – The ongoing review by ASIC seems to have been dragged out and a final determination needs to be reached as soon as possible to remove any remaining uncertainties regarding the company’s accounting practices. Despite the appointment of a new auditor (Ernst and Young), the accounting issues will still linger until the review is formally completed.
  • Impairments for the UK acquisition – There is speculation now that Slater & Gordon will need to take a write-down on the value of its Quindell acquistion. The company will undertake an impairment review during the course of the year and investors might expect a significant non-cash impairment that will affect statutory profit. This will hopefully wipe the slate clean and allow a better analysis of the underlying business.
  • Impact of UK reforms – Although the company has stated it is unsure of the potential impact of the proposed UK regulatory reforms, investors are likely to remain cautious until more information is provided. Markets like certainty, and any lingering concerns regarding regulatory change will keep a lid on the share price.
  • Continued Growth in Australia – Slater & Gordon need to produce continued growth in Australia in order to keep what little confidence the market has in the business. If earnings from Australia begin to decline, the share price would likely fall even further.
  • Ability to repay debt – Making large acquisitions has seen the company take on a high level of debt over the last year. According to the latest annual report, long-term borrowings are now more than $716 million. If earnings begin to fall, the ability to repay this debt may come into question and concerns about defaulting on its debt have already contributed to the savage share price decline.

Foolish takeaway

Although the current valuation of Slater & Gordon appears extremely cheap, it is unlikely the share price will make a significant recovery until most of these issues are resolved.

As a current shareholder in the company, I will be holding on to what is left of my investment in the hope that these issues will be resolved, but new investors are advised to avoid this stock until these issues are resolved.

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