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Keystone's flexible offering ahead of the curve

The business model of the legal disruptor has enabled it to operate smoothly despite wider disruption
Keystone's flexible offering ahead of the curve
  • Gross margin suffers through falling utilisation 
  • Improved cash generation and conversion 

A capital-light business model in which fee earners work remotely, but are connected to a central support network via proprietary software. Sounds like an ideal set-up given the events of the last 12-months or so. Yet that is the default position for Keystone Law (KEYS), an industry disruptor that has delivered a 4 per cent increase in adjusted earnings for FY2021, despite softening client demand during the first half of its fiscal year.

The initial contraction in demand brought about by the pandemic resulted in lower utilisation rates for centrally employed fee earners. This fed through to an 80-basis points fall in the gross margin to 25.9 per cent. Ironically, the fall in utilisation was also due to the success of Keystone’s Pod concept. Management warned that the “circumstances which historically would have resulted in exceedingly high utilisation of the employed juniors are now less likely to occur”.

That was the only real drawback in a year that has probably served to highlight the benefits of Keystone’s business structure to lawyers. The “freedom, flexibility and autonomy” mantra clearly has an appeal judging by the number of lawyers who have come on board. Despite wider commercial disruption, the number of qualified applicants increased 6 per cent to 253, while the number of lawyers accepted jumped 25 per cent to 70.

The efficiency of the group’s capital management has been apparent throughout the pandemic. Payments to the group’s lawyers are not made until the relevant client invoices are cleared, thereby underpinning cash conversion. Cash generated from operations increased by 35 per cent to £6.6m, while the operating cash conversion rate stands at 100 per cent.

The legal sub-sector could be about to get a little more crowded, as it has been reported that both Mishcon de Reya and Sheffield-based legal services provider, Irwin Mitchell, are exploring the possibility of initial public offerings on the London bourse. Irwin Mitchell has also told its lawyers and staff that they can decide where and when they work – within reason presumably. The pandemic is precipitating changes in working patterns across the board, but you could argue that Keystone was well ahead of the field.

Increased volumes and a return to face-to-face meetings beckon as the lockdown provisions are eased, but shareholders can be satisfied with the group’s performance throughout a troubled year. Liberum has upgraded its target price from 615p to 800p, and is guiding to EPS of 17.4p, rising to 19.6p in FY2023. We share the broker’s confidence. Buy.

Last IC view: Buy, 429p, 28 Apr 2020

KEYSTONE LAW (KEYS)  
ORD PRICE:669pMARKET VALUE:£ 209m
TOUCH:660-690p12-MONTH HIGH:680pLOW: 410p
DIVIDEND YIELD:2.6%PE RATIO:48
NET ASSET VALUE:53p*NET CASH:£5.8m
Year to 31 JanTurnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
2017**25.61.203.50na
201831.61.936.000.80
201942.74.7512.29.00
2020 49.65.2313.33.20 †
202155.05.4113.817.2
% change+11+3+4+438
Ex-div:10 Jun   
Payment:09 Jul   
*Includes £6.1m of intangible assets or 19.5p a share. ** Pre-IPO. † No final dividend declared for FY2020 and excludes 8p special dividend.