Law versus Covid-19: what’s the verdict?

In terms of the handful of publicly listed players, we are yet to get a full picture of how well (or badly) they have navigated the turmoil. But by piecing together a first quarter update from DWF (DWF) and the full year numbers from Keystone Law (KEYS), investors might be able to get a measure of what to expect.

Setting the bar

Keystone saw its revenue increase by 7 per cent year-on-year in the six months to 31 July, to £24.5m. This was entirely organic growth, as unlike peers such as Knights (KGH) and Gateley (GTLY), Keystone doesn’t use acquisitions to drive momentum. Instead, it relies on the continued recruitment of senior lawyers – so-called ‘principals’ – who bring clients with them. This is the cornerstone of its capital-light, platform business model – the group contracts a network of self-employed lawyers who work from their own base and connect to the central office using proprietary software. Keystone added 27 new principals in the first half, bringing the total to 347.

With its lawyers already working remotely as standard, the group had the ideal set-up for lockdown and was able to maintain operational capacity at 100 per cent. “I don’t think there were many other law firms that would have managed to achieve that,” says chief executive James Knight.

But the pandemic did see revenue per principal decline by 8 per cent. New instructions from clients dropped by 30 per cent in the first six weeks of lockdown, with the property, family law and private client divisions being particularly hard hit. Ongoing work from existing cases meant that the fall in overall activity was limited to 20 per cent, however, and new instructions have now recovered to roughly pre-pandemic levels in most practice areas.

That tracks with what we recently heard from DWF (DWF), which reported a steady improvement in activity since the end of April. “People talk about a ‘V-shaped’ recovery and when you look at our numbers you see exactly that,” says DWF’s chief operating officer Matthew Doughty. While underlying adjusted pre-tax profit plunged by almost a third to £14m in the year to 30 April, it more than tripled year-on-year in the first quarter of the current financial year. Mr Doughty notes that the insurance division has been particularly busy: “Our claims handling business is seeing large volumes of business interruption claims that we’re starting to help insurers to manage. We expect that will drive through to litigation in due course.”

Keystone also saw its profit dip in the first half. This came as junior lawyers employed by the central office were not used as much to assist on cases and investment in new central office space pushed up overheads. Adjusted pre-tax profit shrank by almost a fifth year-on-year to £2.2m. Still, robust cash generation meant the group ended the half with £6.9m of net cash (excluding lease liabilities), up from £4.4m at the January year-end. Having not declared a final dividend last year, Keystone is paying two interim dividends of 3.3p per share.  

Rise of the virtual law firm?

Before Covid-19 arrived on the scene, Keystone was somewhat of an outlier in terms of its remote working practices. On the whole, the legal profession has been resistant to the idea of abandoning the office. But with lockdown forcing law firms to work remotely, some have found the process more agreeable than anticipated and these arrangements could stick around post-pandemic. Linklaters – which is one of the ‘Magic Circle’ law firms – announced last month that its lawyers will be able to spend up to half their time working outside of the office on a permanent basis.

But if more conventional law firms switch to a hybrid office model, will Keystone lose its edge and ability to attract new recruits? Tom Callan, analyst at Investec, doesn’t think so. He points out that remote working is just one element of Keystone’s appeal to lawyers – the other being what he calls a “keep what you earn advantage”.  Rather than fixed remuneration, Keystone pays its lawyers 60-75 per cent of case fees and only once it has received payment from clients. “There’s still no firm inside the top 200 that offers that,” says Mr Callan. “Keystone is the only one and it is doing it at a scale that nobody else can touch.”

Navigating an economic downturn

As well as the hurdle of Covid-19, law firms are also now staring down a recession. Interestingly for investors, because this is a relatively new sector – Gateley was the first to make its public debut back in 2015 – we are in somewhat unchartered territory as to how the listed law firms’ share prices will perform.

Activity in certain legal practice areas – such as property, commercial and corporate – depends on business confidence so there are likely to be fewer transactions during an economic downturn. But some defensiveness comes from counter-cyclical services such as litigation, dispute resolution and restructuring. For DWF, “the mix of type of work changes,” says Mr Doughty. “But overall, we don’t tend to see volumes decline.” The hedging effect is not completely seamless as things like M&A deals often wrap up and bring in cash fairly quickly, while litigation work can take much longer to complete.  

Insolvency is one area where things are expected to step up. A wave of such Covid-19-induced events has been prevented thus far by government support measures such as the ‘Coronavirus job retention scheme’ (CJRS) and the ‘Corporate Insolvency and Governance Act’. But these efforts may well end up just delaying the inevitable – there could be an upsurge of corporate distress later in the autumn when the CJRS comes to an end and the economic toll of the pandemic bites. Trade credit insurer Atradius is forecasting that insolvencies will grow by 27 per cent this year.