DWF IPO: Are these AIM law firms better value?

by Andrew Hore from interactive investor |

DWF just listed its shares in London, but a handful of law firms already on AIM are worth a closer look.

DWF just listed its shares in London, but a handful of law firms already on AIM are worth a closer look.

DWF (LSE:DWF) is the first law firm to gain a premium listing on the London Stock Exchange, but there are plenty of rivals on AIM - some of which offer better value and higher yields. 

The UK Legal Services Act 2007 launched the alternative business structure for law firms, which enabled them to become limited liability companies, and the first firms took up this structure in 2012 - so it is still relatively new. 

There are estimated to be more than 600 of these companies. These new vehicles are more suited to longer-term investment in the firm than a partnership where the partners take out most of the profit each year. The quoted ones are able to issue shares and raise finance to become consolidators of the sector. 

DWF is larger than its AIM rivals but they have built up track records and have successful acquisition policies. The sector tends to grow faster than GDP and most of the market is dominated by around 40 firms, but there are consolidation opportunities in the mid-market, where the AIM law firms fit in.

DWF raised £75 million at 122p a share but £22 million went on expenses. The DWF share price ended the week at 125.15p, valuing the company at £375 million.

DWF financial performance

DWF operates from 27 offices in the UK and internationally. DWF is ranked 23rd among the top UK legal firms, according to The Lawyer. The business is split into four divisions: commercial services, including business restructuring and tax, personal injury and motor insurance, connected services, including loss adjusting and claims management, and international operations in Europe, Asia and Australia.

In the year to April 2018, pro forma revenues were £236.5 million and pro forma pre-tax profit was £14.8 million - adjusted for the members' remuneration and profit shares. Pro forma net debt is £20.7 million and pro forma net assets are £58.3 million. 

DWF's pro-forma post-tax profit was £12 million in the year to April 2018, even adjusting for the cash being raised, the historic multiple is above 20.

The stated policy is to pay up to 70% of post-tax profit in dividends. That suggests a potential yield of between 2% and 3%, depending on profit growth.

In the six months to October 2018, like-for-like revenues improved from £112.7 million to £133.4 million, although the latest reported revenues were £157.1 million, because it includes £23.8 million of recoverable expenses following the IFRS15 accounting regulation changes.

The underlying interim pre-tax profit improved from £19.8 million to £28.1 million, but although this indicates growth, it is not adjusted for the members' remuneration and profit shares.

In the short-term, further selling by existing shareholders should not be a problem but it could hamper the share price in the longer-term.

One-fifth of each DWF-employed individual’s shareholding will be released from lock-up after the announcement of results for the year to April 2020 and 10% for each of the next four full-year results announcements, plus an additional 10% each year depending on performance. 

AIM law firms

The AIM-quoted law firms are all growing both profits and dividends - some more rapidly than others. The ratings vary with some trading on single figure prospective multiples, while Keystone Law is more highly rated than DWF.  

There are companies, such as NAHL (LSE:NAH), which have set up their own law businesses, but the focus is the pure law firms. 

Gateley (GTLY)

Gateley (LSE:GTLY) was the second law firm to gain approval to change to a corporate structure and the first to float in London nearly four years ago. Gateley's main areas of business are property, employee pensions and benefits, banking and financial services, business services and corporate.

Property generates two-fifths of revenues and nearly one-half of the group profit contribution. The next most profitable area is banking and financial services.

There has been a combination of organic and acquisitive growth and Gateley has an excellent track record of at least meeting broker expectations. The 2015 placing price was 95p and 21.86p a share has already been paid in dividends. 

The latest interim figures show a one-fifth improvement in revenues to £46.4 million – including organic growth of 10% - and a 19% rise in pre-tax profit to £5 million. Net debt was £8.2 million at the end of October 2018 and without further acquisitions debt would decline. However, the pipeline of potential acquisitions is stronger than it has ever been according to management.

Given Gateley's record since joining AIM a prospective multiple appears too low, even if the rate of growth is more modest than some of its peers.

The forecast yield of 5.2% is a further attraction. Gateley offers a combination of a steady business with a good income. 

Gordon Dadds (GOR)

Gordon Dadds (LSE:GOR) completed the acquisition of international law firm Ince UK, for up to £27.3 million over four years, at the end of 2018 and the combined business will trade as Ince Gordon Dadds. This is an immediately earnings enhancing deal with the main boost coming in the year to March 2020. There are duplicate costs that can be eliminated, and Gordon Dadds has already moved into Ince's London office.

There is a group back office function that can absorb the back office requirements of acquisitions as they are made and this helps to cut costs. 
Gordon Dadds has made six acquisitions since reversing into AIM-quoted shell Work Group in August 2017, but Ince is the largest by far. Even before joining AIM, Gordon Dadds was acquisitive. The pace of acquisitions makes comparisons more difficult. Revenues and profit are growing rapidly, but how much of the growth is going to be organic is difficult to assess.

Investors appear not to be confident in the forecasts, at the moment, and this is probably due to the level of acquisitive growth plus Ince's poor performance prior to acquisition. If Gordon Dadds can achieve the earnings growth that is anticipated, then the shares look cheap, and the yield is set to be the best in the sector next year.

Keystone Law (KEY)

Keystone Law (LSE:KEYS) has a different strategy to the other quoted law firms. The group is effectively a hub for individual, self-employed lawyers, which operate from their own offices. The lawyers focus on legal services to individuals and small businesses and bring a client base with them.

Keystone's London office provides IT, insurance, compliance, marketing, training and admin services. Keystone handles the finances of the lawyer and retains 25% of the income to cover the back office support, while paying the other 75% to the individual. 

In 2017-18, there were 21 applicants each month that wanted to join Keystone and after a vetting process 28% of them joined the group. There is a 5% annual churn of lawyers and that is mainly due to retirement. The average age is 50 years old and the average annual billings are £150,000.

This is a low risk model with plenty of scope for growth in margin through further expansion, particularly as it is obviously popular enough to attract a regular flow of new applicants. Keystone claims to be the sixth fastest growing law firm in the top 100.

Keystone is the most highly rated of the AIM law firms and it appears fully valued with the share price having nearly trebled since it floated 16 months ago. 

Knights Group Holdings (KGH)

Knights Group Holdings (LSE:KGH) has made four acquisitions in less than nine months since joining AIM. Knights offers corporate and commercial law services for businesses and is focused on secondary markets outside of London.

Recent acquisitions have strengthened Knights' position in Oxford and Leicester. These purchases have used up the cash raised in the flotation, although the business is cash generative.

In the six months to October 2018, Knights reported a 37% increase in revenues to £23.9 million while organic growth was 10%. Underlying pre-tax profit doubled to £4.4 million. Trading continues to be strong and there will be more integration benefits from acquisitions.

Knights is in the top 30 best AIM performers so far this year and it is the second highest rated AIM-quoted legal firm with the lowest yield. The prospective multiple is set to fall rapidly, although it will still be higher than its peers other than Keystone. The share price has already had a good run. 

Rosenblatt (RBGP)

Rosenblatt Group (LSE:RBGP) is a litigation-focused law firm and the thinking behind the flotation was to raise money to provide finance to fund the working capital for cases. Litigation is more risky than legal work generating more regular income and cash can take a long time to come through in some cases.

Rosenblatt plans to take on teams of lawyers or make acquisitions. The 2018 figures will be published on 30 April and the company has confirmed that they will be in line with forecast pre-tax profit of £4.6 million. The dividend will be 2.8p a share, which is 12% higher than originally forecast. 

Forecasts could be boosted by the success of contingent-based legal cases. The share price has been drifting downwards after initially going to a premium to the 95p a share flotation price last May. Rosenblatt is the only one of the AIM law firms that is trading at a discount to its placing price.

So far, the trading strategy appears to be working well and the rating suggests that there is still caution about the quality and reliability of earnings. If Rosenblatt can show that the rewards of the strategy are what it expects them to be then the shares could be re-rated. 


AIM law firms                      
Company   Share price (p) Year end 2019 2020 2019 2020 2019 2020 2019 2020
        EPS (p) EPS (p) Dividend (p) Dividend (p) PE PE Yield (%) Yield (%)
Gateley GTLY 152 April 12.7 13.7 7.9 8.5 12 11.1 5.2 5.6
Gordon Dadds GOR 131 March 13.4 20.8 6 9 9.8 6.3 4.6 6.9
Keystone Law KEYS 450 January 12.2 14.3 8.9 10.3 36.9 31.5 1.9 2.3
Knights Group KGH 287 April 10.9 16.5 1.8 3.3 26.3 17.4 0.6 1.1
Rosenblatt RBGP 86.5 December 7.5 7.9 3.7 4 11.5 10.9 4.3 4.6

Source: interactive investor

Andrew Hore is a freelance contributor and not a direct employee of interactive investor.

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