Why the Slater & Gordon Limited share price is getting slammed today

Credit: Patrick McKnight

Shares in tort law firm Slater & Gordon Limited (ASX: SGH) have plunged 7.6 per cent to 42.5 cents this afternoon, despite the company releasing no specific news to the market.

The stock more than doubled in value from 29 cents to more than 60 cents last week after the law firm revealed it had agreed a debt restructure deal with some of its creditors including National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC).

The stock is largely traded by speculators currently and the recent selling pressure is probably the result of short-term traders booking profits after last week’s large price rises.

The deal agreed last week gave the law firm’s creditors the option of taking a cash payment or warrants in the firm in exchange for agreeing to the debt restructure.

Where a creditor accepts warrants (shares that will vest at a future date) the maximum they can obtain is up to 15% of any uplift in the market value of Slater & Gordon for 30 days from the effective date of the amendment (presumably) at April 30 2016.

This effectively provides the lenders some insurance in the form of the option to take warrants over cash with the limit capped at 15% of the issued shares in the company where the uplift in market value is “very substantial”.

The fact that the law firm has been able to buy more time is good news, although the real issue is whether or not it’s able to reverse its disastrous cash outflows of $83 million posted in the first half of the financial year.

That will come largely down to whether the firm can convert the work in progress on its balance sheet into cash earnings over the six months ending June 30 2016 and beyond.

Management has been consistent in its expectations that cash flows would be heavily skewed to the second half of the financial year as it resolved multiple delays and operational problems associated with its newly-acquired UK legal services businesses.

This morning shares sell for just 42 cents, which puts the company on an enterprise value of around $920 million given net debt stood at $741.4 million at the end of 2016. This means it’s going to have to deliver on expectations for large cash flows in FY17 and beyond if it is to justify that valuation.

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Motley Fool contributor Tom Richardson owns shares of Slater & Gordon Limited.

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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