THIS IS AN UNEDITED TRANSCRIPT
AK: Eureka now brings you Andrew Grech who’s the CEO of Slater and Gordon and, as you know, Slater and Gordon has had a terrible time lately; its shares have crashed from above $6 to below $3, a tremendous amount of short selling going on and a lot of reputational damage, you would think, from investigations by regulators in both the UK and in Australia. I’m a shareholder of Slater and Gordon. I’ve been there for a while, so obviously I’ve paid much more than the current share price. I bought some more at $3 and I’m probably going to buy some more as it’s continued to fall. But the declaration of interest, I’m a shareholder of Slater and Gordon.
Okay, Andrew, thanks for joining us.
AG: It’s great to be here.
AK: Now, Andrew, before we get into the details of what’s happened, I just wonder whether, in a big picture sense, the problem is that you possibly moved too early on Quindell and, you know, if you’d have waited, you not only would have got it cheaper but you would have, in a sense, bypassed a lot of the regulatory issues that have since come up.
AG: Yeah. Well, I think a number of investors have raised… and commentators have raised that concern. We think we made the right decision in moving on various business assets when we did. You know, to give you some insight in to that, I guess what we were concerned about was that waiting would cause us to let the assets become impaired by time and that was something that we were concerned about because, as you can imagine, there are a number of people in the business that we wanted to keep within the business and we wanted to keep the customers of the business satisfied by the service that was being provided. And so, whilst I accept that in the end these questions or judgements, the judgement we made at the time was that it was in the best interests of Slater and Gordon to get the assets in the state which allowed us to optimise value and that’s what we’re trying to do.
AK: Because obviously the consequence has been that you’ve been horrendously attacked by short sellers.
AG: Yeah, absolutely. There’s no doubt that there are many in the short selling community that believe that we’ve made a fundamental error of judgement in terms of the quality of the business assets we acquired and in the way that we’ve executed on the transaction. It probably won’t surprise you to know that we disagree with that view, but it’s a view that we can really only disprove by performance. And so what we’re concentrating our efforts on is the performance that we hope and believe will bring about dispelling the views of those in the short selling community that are, I think as you put it, you know, fairly aggressively attacking Slater and Gordon shares.
AK: I like that short selling community. That’s good.
AG: No, I’m doing my best to as kind and as generous as I can possibly can. Look, I don’t think just, you know, to address the obvious, I actually don’t think that it’s in the interests of Slater and Gordon’s shareholders for management to become distracted by trying to counter every proposition that’s put by short sellers and to focus on them as the problem. The problem is that we need to prove that we’ve made a good decision, not a bad one, and, as I said, you know, the only way we can really do that realistically is by performance. So we’re not running away from that. You know, we’re all here working hard every day trying to do just that and keep ourselves, despite all of the things going on, you know, more broadly, you know, with ASIC, you know, with the investigations that are going on, the inter-Quindell PLC in the UK and of course to the share price there’s been a fair destruction of value in share price terms. That’s not something any of us are happy about, all we can really do to affect that or to improve that position is deliver the performance and so that’s what we’re going to concentrate on.
AK: But do you accept that you haven’t really properly explained what you’re doing with the UK acquisition and how it fits in and what’s good about it because, I’ll tell you what, that’s what it seems to me. I don’t think you’ve properly explained it.
AG: Well look, obviously when commentators have of short stature say that, one can only reflect and see how we can communicate better with the market. We’ve really done our best to communicate the strategic rationale for the acquisition in terms of its place in allowing us to secure a dominance of the personal injuries claimant market in the UK. And I think it needs to be remembered that we only entered the UK market in April 2012 and post this acquisition we’ll have about, you know, 12 per cent share of the UK personal injuries claimant market and that is a very important position for us to hold, given that the nearest competitor will be at about half or just over half that market share in size. And so that gives us an ability to continue to consolidate a market in which we believe the forces for consolidation, as they were in Australia at the period we went from, you know, five per cent, six per cent market share to 25 per cent market share, you know, there are some very strong parallels. So, you know, we’ve held investor information sessions which I’m afraid were kind of slightly overshadowed by information and press about Quindell’s accounts and so forth. So I think it has been… I certainly agree that it’s been very difficult for us to get clean air and to tell the story in an environment where people can focus on the strategic goals that we’re trying to achieve through this acquisition. I certainly agree with that proposition. And we’ll take on board the need to redouble our efforts and keep the communication better and improve it.
AK: And do you think you’ve also maybe suffered some reputational risk or potential reputational risk because of a lot of the controversies as surrounded sort of investigations by regulators in the UK and in Australia and, you know, your business depends so much on your reputation?
AG: Look, I think that’s something we are very concerned about and of course you’ve hit the nail on the head. What I can tell you about that is that it certainly has not hit new client numbers or new client enquiry numbers in either Australia or in the UK in terms of the Slater and Gordon Lawyers brands. I think it’s very important to remember that whilst Quindell has got… attracted a lot of very negative, and I might say some of it justifiable, media attention and criticism because of its governance failings, that hasn’t really impacted upon Slater and Gordon’s brand at a consumer facing level, remembering that Quindell is not a consumer facing brand; it acquired clients through a number of sub-brands. It is true to say that there’s a very small proportion of the business that we acquired in the UK that relies in part for a new client delivery from insurers and insurance brokers – that is, institutional clients – and it would be naïve just for me to suggest that those institutional clients were not concerned by the investigations in to Quindell, but we’ve been able to manage a very open dialogue with them. So far we’ve only lost, you know, one of those institutional clients and whilst we’re not happy about that, the reasons for them leaving our arrangement were more to do with their internal desire to insource some of the work that we were doing for them. Now, I won’t say that the noise about Quindell was irrelevant to them making that decision, but I don’t think it was the dominant reason they moved. I think perhaps even, you know, more instructively, clients are obviously keen and reputation amongst clients is something we prize very highly because, as you correctly observed, our most important asset or at least one of our most important assets, but so too is our relationship with our staff. And I’m very happy to tell you that we really haven’t suffered any increase in attrition rates, any difficulty recruiting new staff. I think once we were able to explain to staff, and we’ve had to do that obviously. We’ve had to double our efforts in the staff communication stakes. Once we were able to explain to staff what’s going on and what it means in terms of our objectives and perhaps more to the point what it doesn’t mean, I think it’s been more than anything else a galvanising set of events. I think Slater and Gordon has always been a place where people don’t mind fighting with their backs up against the wall and I think it’s certainly true to say that in the context of what’s in the public domain, we feel as though our backs are up against a wall. And so our job is to stay really, really focussed on what we’re here to do and we’re going to continue to do that.
AK: Well, perhaps we can just take a step back and perhaps you could explain for us a couple of things. One is how the acquisition in the UK came up. Was it something you were looking for or was it opportunistic in the sense that it was offered to you and you thought right, we’ll go for that? And exactly how it increases your market share. How does it fit in to your business?
AG: Yeah, sure. So the UK business started with the acquisition of a firm called Russell Jones & Walker in April 2012 and then after that we acquired a number of smaller law firms, getting ourselves to the stage where at about the time we started looking at Quindell, we were about in equal first place in terms of market share with the largest comparable firm, a firm called Irwin Mitchell in the UK. The difference between Australia and the UK market is in the UK market there are a number of intermediaries that sit in between clients and law firms called claims management companies. And whilst we wanted to and have been focussing on establishing the Slater and Gordon brand, so we can have a direct business to consumer channel for new business generation in the UK, we also came to understand over the first couple of years in the UK that whilst changes to the law were restricting and limiting the business models of claims management companies, they were going to consolidate as law firms were and were a channel of new business generation that we really had to have an answer for if we wanted to get in to the dominant position that I think we’ve been able to get in to in Australia. And so we started looking at options to do that, including doing due diligence on a number of claims management company businesses. When we first came to the… It was, you know, about this time Quindell was becoming a higher profile in the UK market, sort of 13 and 14, and we certainly had them on our radar, but in a sense we’ve used them as a competitor rather than as a potential acquisition target at that time. And then in late, very late 2014 we were approached by one of the former vendors, a gentleman who would solve his business in to Quindell and who approached us on the basis that he thought that the then senior management, Rob Terry who left under a fair cloud, it’s a bit fair to say, weren’t really operating the business in a way that he and other people had solved their businesses in to Quindell thought gave them the best chance of their businesses achieving their full potential. And so we really started looking at the business assets with a view to limiting our due diligence to the legal services business. So Quindell had put together a number of businesses, but the primary businesses were actually law firms like Slater and Gordon and the various other businesses that had been acquired in the UK who did claimant personal injuries work. So I know that for a lot of people because Quindell has promoted itself as a technology company and has presented itself in a very complex way, that seems to be at odds with our strategy, but actually when you go underneath and analyse the core businesses that were underneath Quindell, at their heart the key driver of that business was a law firm that had its providence in a law firm called Silverbeck Rymer which had a 15 year, 20 year history in the UK. So I think what we were interested in was looking at a business that had built a very strong processing capacity in the motor vehicle accident area which drives something like 90 per cent of all claims. That 90 per cent of all claims in the United Kingdom are motor vehicle accident claims and the vast majority of those are very low impact cases that require an enormous processing capacity. Because we’d been orientating the Slater and Gordon Lawyers business in the UK towards the higher value, more complex work, it was actually very important for us to be able to build that very high processing capacity in order to compete in that space which we wanted to do. So in a nutshell what this allowed us to do was to in one step get access to the processing capability to do that high volume, low value work more profitably, but it also allowed us to penetrate two channels of business generation that the Slater and Gordon brand would have difficulty penetrating in the UK; firstly, the claims management company channel of new business generation and secondly, the channel of new business generation which is getting work from insurance companies, claims brokers and vehicle manufacturers or sellers because those companies all run programmes to use outsourced services to do what’s called first notification of loss, which I’m happy to explain, you know, what that means.
AK: Okay. Well, in your due diligence did you identify that there were questionable behaviours going on at Quindell?
AG: We certainly identified and called out very clearly when we raised the capital that we didn’t accept the assumptions upon which their accounting statements had been completed and we called that out very clearly. Essentially, you know, they had taken a very aggressive approach to revenue recognition which we didn’t agree with and secondly, they had taken a very aggressive approach to the recognition of expenses. Effectively what they were doing was amortising the expense of acquiring clients across the whole life of the client matter which might be one year or two years rather than recognising it as the expenses are incurred, which is the way that we’ve done it. And so when we valued the business, we valued it based upon the accounting assumptions and principles that we apply in our standing businesses and we also looked at the underlying client work and the quality of the underlying client work and I have to say that whilst a lot of ink has been spilled about their accounting practices, which others have now reported on, including the new board and restated their accounts very, very substantially, in terms of the quality of the client work, we did very extensive due diligence. We had some 70 of our own lawyers poring over 8000, 9000 files over the due diligence period and we came to the conclusion actually that in terms of the service levels, the clients, in terms of the quality of outcomes they were achieving for clients, it was work of a very good standard, which could be improved upon like all practices can be improved upon and, in fact, the fact that it could be improved upon was one of the reasons that we were interested in it because we saw an opportunity to buy a business that we could improve and add value to by adding our expertise in running legal services businesses.
AK: So are you saying that you did not pay for the way that they were valuing or that they were recognising…
AG: No. We did a valuation based upon the future earnings that could be generated from the business assets we acquired, not on the basis of a sort of the sum of the parts. I mean I know, for example, that some of the hedge funds and, in fact, one of the analysts from Bank of America Merrill Lynch, you know, have been asserting that we paid too much for the business and the evidence that we paid too much for the business is when you look at what Quindell paid to the various businesses when it acquired them, it only adds up to £224 million, I think the number is from memory, and we paid substantially more than that, £637 million for the assets. Now, you know, that’s of course a legitimate point of view. The question is, is it the right way to assess value? Well, we would say not because we would say that the way that you assess the value of a business as a going concern is to value the earnings that that business can generate. And we did our own work on that in conjunction with Ernst & Young, Citigroup advisers and Greenhill who were also advising on the deal. So we did a lot of due diligence to try and get comfort that we would be able to generate the earnings which underpin our valuation from the acquisition of these business assets. Now, there’s no doubt and we’ve made clear that there is a lot for us to do in order to get to the earnings number that we’ve called out and we’re working on that every day very earnestly. We’ve put clear guidance out there in the market in terms of what we expect these business assets to deliver and at the moment, at least, we believe that that’s achievable and that’s what we’re striving towards, but you know in our, I guess, respectful view of the other commentators, the way to best judge that is by the performance, not to pre-empt it. Now, of course people are entitled to have their views in the meantime and clearly they do.
AK: Can you explain what exactly ASIC is investigating with you in Australia?
AG: Look, as you would appreciate, Alan, I’m sure with your experience, it wouldn’t be appropriate for me to go in to the detail of our discussions with ASIC. What’s unusual about the situation we’re in with ASIC is that it’s in the public domain at all. And I mean I’m sure you would know that the surveillance unit of ASIC looks at 60 to 80 companies at least every year and have a conversation with those companies about various accounting treatments. Their audit and insurance group which is the bit within surveillance is doing that all the time. The only difference here is that it’s the fact that they’re having those discussions with us is in the public domain. So that’s the first thing to say. But the second thing to say is that some of the things that ASIC has been discussing with us, and obviously we’ve been cooperating fully with them, as you would expect us to, are things that really are now already in the public domain because some of the things are things we’ve talked about when we released our results, like, for example, the reclassification of the work in progress assets on our balance sheet from current in to current and non-current. And so whilst that doesn’t have any impact on the value of those work in progress assets, we thought it was an important opportunity to respond to some of the concerns in the market about all of the work in progress assets being in current, which had been the way that we’d typically dealt with those, I must say with the endorsement of ASIC when we listed in 2007 because we haven’t changed our treatment of that since 2007 and that was certainly one of the issues that we discussed with ASIC when our prospectus was released in 2007 when we initially raised capital. So I’m sure you would know as well as I do that, like most things in life, the attitudes and views of the accounting profession in terms of the interpretation of the accounting standards evolves and changes over time, as it should, and so that’s one… that view has evolved over time. Equally, the other significant change we announced which was not discussed with ASIC which was more something that came out of the audit process was a change in the treatment of acquisitions under the Business Combinations rule and, again, it doesn’t have any P and L, cash… I beg your pardon, cash impact. These are more accounting changes which require you now, as we are informed by the auditors that the audit profession has really come to a view that wherever consideration for the purchase of a business is in part related to the future employment or continuing employment relationship of principles for that business, even though you’re paying the market salaries for their labour, you’ve still got to recognise that component of the consideration as remuneration or, at least in our case, payments to vendors because most of these people are non-employees, they’re members of a limited liability partnership. And so that’s an interpretation of the Business Combinations rule, frankly, that we weren’t expecting and was somewhat of a surprise to us, but nevertheless…
AK: So what’s been the impact of that?
AG: So it doesn’t have any cash impact, but there was an increase… we had to restate profit in FY 2014 and in FY ’15 and that actually increases profit from memory via… to a degree. And effectively what it does is it moves what you’ve paid for the acquisitions from investing cash flows in to operating cash flows. So it doesn’t have any net impact, you’re still paying what you paid. You’re still getting the business that you paid for, it’s really just about the accounting treatment of the payments that you’ve made.
AK: But I mean it’s not a very good look at all to have it… As you say, it’s out there in the public domain that ASIC is investigating or reviewing your accounting practices. That doesn’t look good at all.
AG: Well, I agree with you. It doesn’t look good and, you know, it’s, as I said to you, very unusual. In fact, ASIC tell me that they’ve never been in a position before where discussions of this kind have been in the public domain.
AK: How did that happen, do you know?
AG: Well, the lawyer in me is going to come out now, Alan, because I have to be very, very careful in what I say. I can certainly say to you that no one at Slater and Gordon revealed that in the public domain. I’m informed by ASIC that no one at ASIC informed the market of that. It’s been brought to our attention that a number of the hedge funds that have short selling interest in the stock were reporting their concerns to ASIC and it’s possible that one of those hedge funds reported that fact to the media. And so that’s probably how it got in to the public domain, but to be frank with you, I’ve no evidence one way or the other.
AK: Well, it was a massive win for whichever hedge fund got that information because they would have cleaned up.
AG: I’m sure that the short sellers have and are making a tidy profit from events over the last several months and, you know, I share the pain of all of our shareholders in that. I guess the only thing I can do as a shareholder is not sell my shares which of course I’m not doing, but what other shareholders do will of course depend upon their own position and their level of confidence about the future of the business overall. I think the key point we’ve been trying to make and I think the result itself demonstrates is that the underlying business is actually performing in line with guidance, so it’s not as though the underlying business or any of the underlying business fundamentals changed; they continue to be strong and improving and that’s why we believe Slater and Gordon is and will continue to be a sound investment for our shareholders. Of course, you know, all shareholders are subject to the kind of crisis of confidence that being constantly in the media in a negative sense creates and it’s… you know, I agree with you that it is not a good look and it’s something that we’re trying to work to remedy, but all we can do is continue to work with ASIC and get through that process, which we hope to do in the next few weeks, and then of course deliver the results in line with the guidance that we’re given.
AK: So when do you think that that will be completed and will its completion be announced?
AG: Yes. So ASIC, as again I’m sure you know, Alan, from your own experience, ASIC do not offer positive assurances, they don’t provide advisory opinions. The process will be that they will write to us and simply tell us that their inquiries are closed in relation to the matters that they’re inquiring in to and then we will release a statement to the ASX simply reciting that fact. And we will then hopefully put the whole period behind us and move on with the real business of continuing to grow and improve the business, which is something that I’d like to think we’ve had up until now a reputation for doing, over a long period of time, pretty successfully.
AK: How much of the halving or more of the share price do you think is due to the ASIC review and how much to what went on in the UK?
AG: Oh look, Alan, I’ll leave it for others to speculate. I really don’t know. I honestly couldn’t tell you. I mean I think it’s… I think to your earlier point, I think it’s all part of the creation of pretty negative news flow and so I guess the thing that I take some solace from is that it will only have a permanent, long term effect if it’s true and we don’t believe it to be true. We believe that the acquisition we’ve made is a sound one strategically. We’ve never hidden from the fact that it’s a long term, not a short term, ambition that we have and therefore we expect, as you are when you’re building a market leader in any new market, for there to be ups and downs and this is certainly one of the downs, but you know we’ll just keep struggling along and continuing to try and make the case for why this deal makes strong strategic sense and makes sense for us, our business more broadly.
AK: It’s possible that you won’t be through all this entirely until next August, isn’t it?
AG: Oh yeah, absolutely. I mean I think… You know, I’d like to think that, you know, we have a reasonable half year and we can tell the story about why it is that the indicators for better performance are there. You know, I think that we’ll start to see some recovery then. But sure, I mean there’s no escaping the fact that we are playing a long game and, you know, not all of our shareholders either can afford to or have the appetite to play a long game and that’s understandable. You know, that’s perfectly within their rights. But our job, our charter is to run the business for long term, sustainable returns and that’s what we’ll continue to do.
AK: So just briefly on the underlying… the core business of yours, particularly in Australia, I think the key metric is win rate. What is the win rate now and what are you saying it’s going to be this time next year, say?
AG: So remember that the Australian Slater and Gordon Lawyers business is now quite a diverse business and so the bit you’re talking about where win rates are most relevant is really in relation to personal injuries litigation practice and the win rates are overall are 70 per cent plus and continue to improve year on year. In some categories of work, you know, they’re 90 per cent, 95 per cent plus. Because obviously I include in that 70 per cent plus cases that are terminated at a very early stage because it’s sometimes necessary to do some initial investigation work before you know whether the case has reasonable prospects for success or not. So, you know, overall the success rates, the probability of success in Australia, and I might say in the UK personal injuries law business as well, that is the Slater and Gordon Lawyers business, is strong to improving. And so, again, that’s one of the really fundamental things about our business that rightly we and people outside the business look at. It’s one of the best indicators of whether the business is being well-managed, whether the risk is being managed well on the ground and I think all the signs are that that’s the case.
AK: And what about your other businesses in Australia?
AG: Well, you know, one of the really heartening things about the results this year was that the general law practice which encompasses family law, conveyancing, criminal law, you know, commercial litigation, you know, a whole range of areas of law, pretty much anything anyone experiences throughout their life, we can manage now at a really competent level with specialist people at their fingertips. And this is really the first year where it’s made a strongly positive contribution, so I think, you know, the margins were about halfway towards our target margins of 10 per cent to 12 per cent to 15 per cent and what that tells us is that the investments we’re making in that sector are sound investments that will pay off for us and our investors over the next couple of years. So we’re really delighted with the progress we’re making in Australia and in the UK in the general law areas. There’s obviously a lot more to do there. They’re markets that are two to three times the size of the Australian personal injuries law market and growing at about two to three times the rate of the personal injuries law market and so they’re areas where we think we can continue to grow organically in the medium to long term.
AK: We’ll have to leave it there, Andrew. Thanks very much.
AG: No worries. Thanks for your time.