A MERGER TOO CLOSE TO CALL

As forecast earlier in the year by Hildebrandt International, Inc. when it reported 58 mergers and acquisitions involving U.S. law firms were completed in 2006, vs. 49 in 2005 and 48 in 2004, law firm merger activity continues in 2007.  The most recent merger announcement was the proposed transaction between Kirkpatrick & Lockhart Preston Gates Ellis (aka K&L Gates) and Dallas-based Hughes & Luce.  K&L Gates, historically labeled a Pittsburgh-based firm, now calls itself an international firm without a headquarters office.

In prior postings where I’ve looked at other announced mergers (Mergers, Metrics, and Other Musings and A Merger Made in . . .?), I’ve discussed LawBall-type analysis as a way to help law firm M&A candidates avoid the “synergy trap” that arises when most companies routinely overestimate the value of synergies they can capture from acquisitions.  As I noted in those earlier postings, 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) into the post-closing firm are critical.  But a LawBall-type analysis 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.

Here, then, is a quick LawBall analysis of the proposed K&L Gates/Hughes & Luce merger.  Using data published in the 2006 AmLaw 200 and the 2007 AmLaw 200 and in the Texas Lawyer’s 2006 and 2007 Firm Finance Surveys, in LawBall format below at the end of the posting (and also included as a *.pdf attachment under Posting Attachments in the right-hand margin) 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 2006 operating results to the new firm’s pro forma.

One twist in the numbers from prior LawBall merger looks – K&L Gates itself is the product of a merger between Kirkpatrick & Lockhart Nicholson Graham and Preston Gates & Ellis announced late in 2006 and effective on January 1, 2007.  So, both the 2005 and 2006 numbers for K&L Gates are pro forma.

This prospective merger is too close to call from a relative financial health or financial direction pre-merger perspective alone.  On the one hand, growth in revenues, return on equity (ROE or profit per partner), and leverage from 2005 to 2006 all favored K&L Gates.  On the other hand, growth in profit, asset turnover (revenues per lawyer), return on assets (ROA or profit per lawyer), and cost per lawyer from 2005 to 2006 all favored Hughes & Luce.  Hughes & Luce’s 2006 margin was significantly better – 38.79% to 25.23% - than K&L Gates’; and, although Hughes & Luce’s 2006 asset turnover ($527,273) actually was lower than K&L Gates ($582,305), the large margin differential resulted in Hughes & Luce’s 2006 ROA ($204,545) also being quite a bit higher than K&L Gates’ ($146,914).  Leverage hugely favored K&L Gates (4.5506 to 2.8085), and this resulted in K&L Gates’ 2006 ROE ($668,539) being higher than Hughes & Luce’s ROE ($574.468).  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, on a post-merger pro forma basis the changes in margin, ROA, and cost per lawyer favored K&L Gates – that is, on a pro forma basis a combined K&L Gates Hughes Luce would’ve performed better in 2006 with respect to margin, ROA, and cost per lawyer than K&L Gates performed alone, while K&L Gates Hughes Luce would’ve performed worse than Hughes & Luce alone in those 3 metrics.  On a post-merger pro forma basis, the changes in asset turnover, leverage, and ROE all favored Hughes & Luce. The future success or failure of this announced merger likely lies with the firms’ post-merger transition and integration plan.