A MERGER MADE IN . . .?

In Mergers, Metrics, and Other Musings, I noted that Hildebrandt International, Inc. had reported 58 mergers and acquisitions involving U.S. law firms were completed in 2006, vs. 49 in 2005 and 48 in 2004, and the company expected “to see merger activity continue at an active pace” in 2007.  I also mentioned a McKinsey & Company article in which the authors said, “[I]t is typically not the buyer but the seller who captures most of the shareholder value created,” and believed this result is due to the fact that “Most companies routinely overestimate the value of synergies they can capture from acquisitions.”

In discussing a way for law firm M&A candidates to avoid the “synergy trap,” I noted further,

Right away one thing comes to mind – LawBall-type analysis, including a pro-forma of the post-closing firm, to facilitate the “due diligence” review.  Certainly, numbers aren’t the entire story to a successful M&A transaction; the transition and integration of the people, technology, and processes (including the typical law firm hot spots – culture and management) in the post-closing firm are critical.  But LawBall analysis, as with financial operating performance, can lead one to ask critical questions that facilitate a deeper understanding of the strengths and weakness of both the pre- and the post-merger businesses.

I then used 2 examples to illustrate: the merger of Kirkpatrick & Lockhart Nicholson Graham and Preston Gates & Ellis, a merger announced in late 2006 and effective on January 1, 2007 creating K&L Gates, using The American Lawyer’s 2006 (2005 operating results) AmLaw 200; and the announced but subsequently called off merger between Dewey Ballantine and Orrick Herrington & Sutcliffe, using the 2006 AmLaw 200 and the 1997 AmLaw 100.

I thought it might be interesting, with release last week of the 2007 AmLaw 200 (2006 operating results), to take a look at the 2005 and 2006 individual firm operating results and a 2006 pro forma for the recently announced (and pending) merger between Texas (Dallas and Houston)-based Locke Liddell & Sapp and Chicago-based Lord, Bissell & Brook, with the new firm apparently to be named Locke Lord Bissell & Liddell.  Using data published in the 2006 AmLaw 200 and the 2007 AmLaw 200, below in LawBall format are:

• The 2005 and 2006 individual financial operating results for both firms.
• The annual compounded growth rates from 2005 to 2006 for both firms.
• A 2006 pro forma for the new firm.
• A comparison of each firm’s actual 2006 operating results to the pro forma.

Revenues, profits, asset turnover (revenues per lawyer), return on equity (ROE or profit per partner), return on assets (ROA or profit per lawyer), and cost per lawyer growth from 2005 to 2006 all favored Locke Liddell.  Profit, ROE, and ROA for Locke Liddell all grew significantly, while the same metrics declined for Lord Bissell.  Locke Liddell’s margin improved from 31.25% to 35.59%; Lord Bissell’s margin fell from 37.62% to 32.80%.  Cost per lawyer declined for Locke Liddell, while cost per lawyer grew for Lord Bissell.  Only in the metric of financial leverage did Lord Bissell improve while Locke Liddell declined; but Locke Liddell’s financial leverage in 2006 still remained higher than Lord Bissell’s.  This 1-year snapshot is interesting – but as I’ve said before, I’d like to see the panoramic view (a 5-year comparison) before I reached any significant conclusions about the relative financial health or direction of the 2 firms pre-merger.

Not surprisingly, after looking at the 2005 and 2006 individual firm financial operating metrics, the pro forma post-merger changes in margin, asset turnover, financial leverage, ROE, and ROA all favor Lord Bissell – that is, on a pro forma basis Locke Lord would’ve performed better in 2006 than Lord Bissell performed alone, while Locke Lord would’ve performed worse than Locke Liddell alone.  Only does pro forma post-merger cost per lawyer favor Locke Liddell.

Was this kind of analysis used before the agreement to merge was reached?  If not, would it have changed anyone’s opinion if it were used?  As a member of either firm I would’ve wanted to see this analysis long before I voted so I could ask the financial questions that this analysis poses and get comfortable with the answers and the transition/integration plan.  Obviously, we don’t know what, if any, post-merger operating changes are planned by the new firm.  Taking a cue from the McKinsey article, though, I hope the firms simply aren’t assuming  “synergies” will overcome the financial operating differences.  It’ll be interesting so see how things progress from this point to and beyond the merger – and only time will tell whether this merger will prove to be one made in heaven - or hatched in hell.