The dotcom crash favoured the US members of the Global 100 over UK rivals. But, finds Richard Lloyd, the roles look now to be reversed
In a downturn, business people like to point out, some truths are laid bare. “You only find out who is swimming naked when the tide goes out,” Warren Buffett famously told investors in a 2002 letter. Which is why, after the 2000 dotcom crash, it was the City’s elite that were found to be revealing a little too much skin.
This time, it is different. After madly shedding partners, doubling-down their bets on foreign offices and tightening their management controls, the big four magic circle firms — Allen & Overy (A&O), Clifford Chance (CC), Freshfields Bruckhaus Deringer and Linklaters — look a little better-dressed than many of their rivals in the US. The irony is that the English law firms have succeeded by following the lesson of their American peers: they have hedged their bets. For US law firms, in the past that has meant a healthy dose of litigation and bankruptcy work to balance a corporate shortfall. For UK law firms, the strategy has been geographic: spreading their risk across several continents.
“The UK law firms have their international investment time behind them and have shown that they can deliver value to their clients around the world,” says Tony Williams, head of Jomati Consultants. “Plus, they are far better run than they have ever been.” Williams, a former managing partner at CC, can speak from experience.
For the UK firms, the international networks are producing more revenue than their massive London offices. In the most recent fiscal year, which is captured in the Global 100 charts, A&O for the first time brought in more revenue from its overseas offices than it did from London. (The Global 100 is a joint project of Legal Week and The American Lawyer.) At CC, about $1.56bn (£903m) of the firm’s $2.66bn (£1.5bn) in revenue came from international offices, with a growing proportion from emerging markets.
Last year 15% of CC’s revenue came from the growth markets of central and eastern Europe, the Middle East and Asia, says managing partner David Childs. This year he predicts that proportion will expand to 18%-20%. “Our offices in these markets are doing very well and will continue to do so this financial year,” he says. CC has also taken a global approach to reducing its cost base, moving parts of its support functions in IT and accounting to India. This summer CC had 110 support workers in New Delhi; by next summer, it is forecast to have more than 300.
Of course, London’s legal elite are not strangers to success. In 2001, before the full effects of the dotcom crash hit, six UK firms were among the 20 most profitable in The Global 100: Slaughter and May, Herbert Smith, Linklaters, Freshfields, A&O and CC. By 2002, just three made the grade; by 2004, only Slaughters did. The impact of the crash was felt later and deeper by the English practices. They also took a hit in Asia, with the 2003 outbreak of SARS leading to a region-wide slump.
In the first half of the decade, all the leading UK law firms reported drops in profits per equity partner (PEP). Their costs were out of control, and their international networks had yet to deliver promised gains in profitability.
CC, Linklaters, Freshfields and A&O reached their profit nadirs in 2002, 2003 or 2004. Linklaters, for instance, had PEP of $960,378 (£556,000) in 2002, the lowest that year of the magic circle; CC turned in its own low of $946,000 (£548,000) two years later.
Meanwhile, top US law firms pulled ahead, buoyed by their countercyclical practices, which form a higher proportion of their businesses than at their British counterparts. Paul Weiss Rifkind Wharton & Garrison, a US-law-only shop where about half the lawyers are litigators, rose from 15th in The Global 100’s profits per partner rankings in 2001 to fifth in 2002, and has not left the top 10 since. Law firms with leading bankruptcy practices, such as Kirkland & Ellis and Weil Gotshal & Manges, also made significant gains in profitability. Kirkland increased its PEP from $1.4m (£810,000) to $1.9m (£1.1m) between 2001 and 2004; Weil’s profits grew from just more than $1m (£579,000) to $1.5m (£868,000). As bankruptcy eased off, Kirkland and Weil pushed ahead with robust litigation and corporate practices.
Thanks to the less litigious climate in the UK, the leading London firms have never had the same hedge. London litigation header Herbert Smith makes the largest proportion of its revenues from litigation. In the year ended 30 April, the practice contributed around 36% of Herbert Smith’s $844.5m (£489m) in revenue. Linklaters’ commercial practice, which includes litigation as well as other areas, such as real estate and intellectual property, contributes about 23% to the firm’s revenues. The rest comes from its corporate and finance practices. A&O’s litigation group contributed just 9% to the firm’s top line.
What is not clear yet is the extent to which the US firms’ larger countercyclical practices will protect their profit growth. There are some signs that bankruptcy work is starting to increase — in July the Automated Access to Court Electronic Records reported that the number of bankruptcy filings in the US had surged by 57%, compared with July 2007. But the market is yet to see the large-scale restructuring mandates that were so profitable in the last downturn.
The Citigroup 2008 half-year survey paints a particularly gloomy picture of the US market. A banker to the majority of Am Law 200 practices, Citi reveals that average profitability is down across the board in the US, particularly among the top-tier practices. Citi’s survey of 165 law firms from The Am Law 100 and the Second Hundred, as well as some smaller firms, reported that profits per equity partner dropped 9.1% on average in the first half. For the most profitable practices, the fall was as high as 11.7%.
In the UK the prognosis is bleak but not quite as bad. “We have had a better first three months than I would have expected, but it will be a very good performance to post a material increase in PEP,” said Herbert Smith managing partner David Willis. CC’s Childs says that a good performance this financial year will be growth of more than 10% in the emerging markets and 5% in London, the US, and the Eurozone.
Structurally, the top UK firms are different now than they were at the beginning of the decade. London’s leaders have become more efficient and have improved their profitability with the zeal of a Wall Street stalwart. Freshfields now has roughly the same number of equity partners — 400 — that it had in 2001 (it recently cut the numbers from a high of 521 in 2006) but has more than doubled its revenue in the same period. (Fee income stood at $937.5m (£543m) in 2001, compared with $2.358bn (£1.37bn) today. CC now has fewer equity partners than it did in 2001 — 395 today compared with 448 — and roughly the same number of lawyers, but has added more than $1bn (£579m) to its top line.
“My view is that the downturn could be very different this time for law firms,” said Mike Francies (pictured), head of Weil Gotshal’s London arm. “The UK firms now have widespread international networks that are very successful, but the downside for them is that they still have a huge number of mouths to feed in London.”
In other words, for all its overseas growth, the magic circle is still overweighted toward London — and London, too, is feeling the effects of the downturn. CC has the largest office in London, with around 1,000 qualified lawyers, while New York’s largest firm, Skadden Arps Slate Meagher & Flom, has 845 in New York, according to research from The National Law Journal in 2007.
Entering this downturn, the UK firms are in their strongest position since the 1990s. In the short term, they look more resilient than many of their US counterparts. A sustained slide in the pound will take some of the gloss off their numbers, but the continued strength of the euro provides some compensation. And there is greater risk in emerging markets. Russia’s recent conflict with Georgia and subsequent posturing against the West, for instance, led to an 18% fall in Moscow’s stock exchange — evidence that gains in some emerging markets are at the mercy of political power games as well as business strategies.
The US firms have not seen a marked increase in litigation and bankruptcy work, but the smart money suggests that it is only a matter of time before they do. Those with larger, established international networks, such as White & Case, are better placed. Further, there will continue to be a demand for the most elite US corporate firms, such as Cravath Swaine & Moore and Wachtell Lipton Rosen & Katz.
It will not be until next year’s Global 100 rankings that we see just how far the tide has gone out for the legal market. For many firms — both British and American — it will not be a pretty sight.
This article first appeared in the The American Lawyer, Legal Week's US sister title.
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