Tony Featherstone speaks to the Slater & Gordon chairman about the company’s acquisition strategy and how boards should respond in market crises.
John Skippen MAICD, had a dream run after becoming chairman of Slater & Gordon in March 2012. Over the next three years, shares in the ASX-listed law firm soared, acquisitions were made, and the market embraced its bold UK expansion strategy.
The 67-year-old, a former finance director of Harvey Norman Holdings, was chairing one of the market’s fast-growing companies.
Then the stakes increased. Slater & Gordon announced in March 2015 it was acquiring Quindell Plc’s professional services division (PSD), a leading UK personal injury law firm, for $1.25 billion and an earn-out fee. The deal would make Slater & Gordon the UK’s top personal injury firm.
Investors flocked to the $890 million equity raising that accompanied the deal and Slater & Gordon seemingly could do no wrong. Its shares doubled over a year in the lead-up to the deal, propelling the former small-cap company into the S&P/ASX 100 index, with a peak $2.7 billion valuation. Investors lauded its management.
Much rode on Slater & Gordon’s success. When it floated on the ASX in May 2007, Slater & Gordon became the world’s first listed law firm. It showed how professional service firms could use equity markets to raise capital and consolidate their industry, and it helped ease painful memories of other listed Australian “consolidators”, notably in accounting and wealth management, that grew too quickly and crashed.
A firm that had fought corporate Australia through high-profile class actions, had historical links with the union movement and the Labor Party, and had been a training ground for prime ministers, now had a foot in the big end of town. Few Australian companies had such global ambition or potential to dominate an offshore market. Then the market momentum stalled. In June, hedge funds questioned Slater & Gordon’s relationship with its auditor, Pitcher Partners, and whether the second-tier accounting firm had sufficient resources to audit a larger, more complex global business.
These funds aggressively upped their bets against Slater & Gordon through short-selling, a sometimes controversial practice that allows investors to profit from anticipating a share price fall. A damning report by a self-interested hedge fund and another by a US investment bank questioned the logic and valuation behind the PSD deal, which had effectively doubled Slater & Gordon’s size.
A selling frenzy ensued when Britain’s Financial Conduct Authority in June announced an investigation into Quindell Plc’s financial accounts, and when Slater & Gordon said it had contacted the Australian Securities and Investments Commission (ASIC) about an accounting error that related to differences between UK and Australian accounting standards and had no effect on its profitability or cash flow.
Slater & Gordon shares more than halved from their 52-week high of $8.07 to $3.50 in days, wiping more than $1 billion off its valuation. More questions were asked about the price paid for PSD, the deal’s due diligence, and Slater & Gordon’s accounting practices in booking revenue from work-in-progress.
For a law firm that trades on attention to detail, the audit error was an embarrassing, albeit relatively minor, mistake. More will be known on the severity of the problem when ASIC releases its findings from an investigation into Slater & Gordon’s accounting practices.
As ASIC looks into Slater & Gordon, some of its shareholders have lodged complaints with the regulator about hedge fund tactics to crush the share price. They claim Slater & Gordon was a victim of market manipulation and “rumourtrage”, false stories being leaked to the media that exaggerated the issues, and even insider trading.
Company Director was aware as the magazine went to press of several Australian fund managers that had lodged formal complaints with ASIC about trading in Slater & Gordon shares.
Supporters of short-selling say the practice aids price discovery, but its many detractors argue it incentivises mischief-makers to leak false information and goes against the spirit of the sharemarket: helping companies raise capital, grow and create long-term wealth.
“In many respects, short-selling is a clear conflict of interest,” says Skippen. “Small investors invest their money with fund managers to invest in companies. Those funds then allocate a portion of that money to hedge funds, which bet against companies and, in some cases, aggressively promote information to drive the price lower. They feed false stories to the media, which sometimes reports them without checking, and these stories make investors nervous and think something is wrong with the company and its financials when there is not.”
Slater & Gordon is an important governance case study on several levels. It shows how a board evolves from governing a small enterprise to overseeing a billion-dollar company; how boards ensure proper due diligence of transformative acquisitions; and how directors, in particular the chair, work with longstanding, entrepreneurial chief executive officers (CEOs) who have an outstanding record. It also shows how boards respond in market crises.
In some ways, Skippen’s meteoric governance rise mirrors that of Slater & Gordon. He left Harvey Norman Holdings in 2006 after an 11-year stint to pursue a full-time governance career.
Skippen joined the boards of retail financier FlexiGroup in November 2006 and Super Retail Group in 2008, and remains on both. He also served as a non-executive director of Briscoe Group (NZ) from 2004 to 2011 and Mint Wireless from 2007 to 2008.
Skippen was a good choice for Slater & Gordon’s board when he joined as a non-executive director in 2010. Although he had no experience in law firms, his retail knowledge was an asset for a company rapidly building its brand and using it to expand into other areas, such as family law and conveyancing. His success as an entrepreneur and business owner seemed well-suited to the ambitious Slater & Gordon.
Within two years, Skippen was elected chairman, replacing Anna Booth FAICD, who retired from the board after a distinguished chairmanship to become deputy president of Fair Work Australia.
Skippen has big plans to evolve the Slater & Gordon board, which excels on gender diversity (half of its non-executive directors are women). He wants to add two non-executive directors, making six independent directors. One is likely to have strong UK regulatory experience and possibly be based there. An appointment is expected in the next few months and another in 2016 when the board assesses its needs after the PSD acquisition is implemented.
For now, Skippen’s priority is working with management to calm the market’s nerves, reinforce the potential of the PSD deal, Slater & Gordon’s ability to implement the acquisition, and the reliability of its business model and accounting practices.
He is not a typical chairman. Skippen has owned businesses ranging from graphic design, to car-smash repairs and small accounting firms. The Sydney-based chairman still enjoys picking up the tools for the occasional house renovation and loves nothing more than racing his A900 Toranas around Tasmanian racetracks.
Here is an extract of Skippen’s interview with Company Director:
Company Director (CD): How do you respond to claims that the board has allowed Slater & Gordon to grow too quickly?
John Skippen (JS): I simply don’t agree. Slater & Gordon has built a very strong record in delivering shareholder wealth since it listed on the ASX. Management has done a terrific job implementing a program of acquisitions and growing profits strongly at the same time. Yes, PSD is a big acquisition, but we have demonstrated, over a long period, that we have the bench strength and management strength to pull it off. It’s totally unjustified to argue we have grown too quickly.
CD: What are the broader implications of short-selling for boards?
JS: Slater & Gordon’s experience with short-selling shows just how dangerous the practice has become. The short-sellers can leak all sorts of false information, drive the price lower, profit from it, and get away with it. It’s very hard to fight back. Regulators need to tighten up rules around lending for short-selling; if somebody short-sells stock he or she already owns, fair enough. But borrowing that stock from fund managers, who make a tidy profit from lending it to short-sellers, is an insidious practice that must be reined in.
CD: How did the Slater & Gordon board respond during this crisis?
JS: We responded in two ways. First, the board formed a subcommittee to deal with this issue. I chaired the subcommittee and it reported to the audit and risk committee. We wanted a small subcommittee that worked closely on this issue, rather than lots of people engaging management. The full board was updated daily on this matter and I spoke to Andrew Grech MAICD [Slater & Gordon managing director] once or twice each day, sometimes more. I also met several key shareholders to explain the situation.
The second response was to encourage the executive team not to lose sight of the medium-term goals with PSD and Slater & Gordon generally. The board questioned management about the issues at hand, received very detailed answers, and was satisfied with the response. The executive team has done a great job throughout this issue.
CD: What do you do when the media is being fed information by hedge funds that have an interest in driving the share price lower?
JS: It’s very difficult. Some journalists check information, others do not. Some ran with whatever they were told, others called us for our side of the story. The hard part is, journalists send information and ask the company if it is correct. You may not be able to comment for disclosure reasons, but if you refuse to comment it gives more fuel to their story. The core issue is not so much the media, but the investors who are leaking false rumours to serve their purposes.
CD: Moving to other issues, what made you transition into governance?
JS: Harvey Norman had a majority holding in Rebel Sport and an investment in Briscoe Group. I knew both businesses well. When I left Harvey Norman, several people called and asked if I was interested in board roles. I’d noticed over the years that many directors had never run companies and experienced the trials and tribulations of doing so. Having run businesses of my own, and having been a chief financial officer for many years, I thought I could add something to boards.
CD: Your other main current governance roles are for retailers. How did you come to join the Slater & Gordon board?
JS: I was in discussions with Egon Zehnder [the executive and board search firm] about another role and the Slater & Gordon directorship came up. It was bit left-field for me, but I was very impressed with the then chairman, Anna Booth, Andrew Grech and the managing director of the firm’s UK and Europe operations, Ken Fowlie MAICD. I saw the potential for Slater & Gordon to use its strong retail brand recognition to expand into other markets, here and offshore, and felt my retailing experience was a good fit for the business.
CD: What are the main challenges of governing a fast-growth enterprise?
JS: When a company is making lots of acquisitions, the board must ensure there are very clear processes and delegation of authority. Slater & Gordon has an excellent acquisitions team and tremendous experience over a long period in acquiring firms. But the board is not constrained in any way in getting independent advice on an acquisition if it chooses to.
CD: The PSD acquisition was a transformational deal. How did the board assess that deal and how it would monitor the implementation of the acquisition?
JS: Slater & Gordon first went to the UK in 2012, so we already had a good understanding of that market. PSD was a complex deal, simply due to its size and the nature of its cases. We strongly believe the best people to assess the value of work in progress are the people who do the work each day, so we had more than 70 of our solicitors go through PSD’s files as part of the due-diligence process. We also had Ernst & Young, Greenhill & Co [an independent global investment bank] and CitiGroup advising us.
Andrew Grech, Ken Fowlie and Kirsten Morrison [Slater & Gordon’s group general counsel] were in the UK for several months doing due diligence, in addition to the firm’s M&A team. We had at least five board meetings about the PSD deal and I spoke to Andrew every day or two for an update on its progress. It was the most rigorous due diligence I have seen.
CD: How does the board test and challenge management when approving large deals?
JS: A key difference between the PSD deal and our other acquisitions, apart from its size, was the valuation. Management was prepared to pay a higher multiple for PSD because it meant we were doing the equivalent of 20 to 30 transactions in the UK in one deal. The board had to be convinced about the valuation and after careful consideration it approved the deal.
Another board consideration was integration. Slater & Gordon decided to keep PSD as a separate operational unit, and Ken Fowlie relocated to the UK. The CEO of our UK operations, Cath Evans, and Neil Kinsella, the firm’s head of general law UK, were already there and doing a great job. The board was satisfied that several of the firm’s top people were on the ground in the UK, leading the implementation.
CD: What are key things you look for when approving large acquisitions?
JS: In addition to valuation, I think about key-person risk and regulatory or compliance risks. The risk of legislative change is always on the horizon. Regulatory changes in the UK in 2012, which made it harder for small law firms to process lots of personal injury claims, worked in our favour. It led to many smaller UK firms disappearing and the personal injury market following the Australian experience, where it’s all about scale.
People sometimes underestimate or don’t understand regulatory risk in new markets. Every country has its approval process, which varies across industry, and it’s easy to overlook how much damage can be done from legislative change.
CD: What makes a good merger?
JS: It starts with the firm having very strong advisers that the executive team and board trust. That was certainly the case with the PSD transaction. It’s important that the board has access to corporate advisers for independent advice, as we had with Greenhills. Apart from one small leak in the UK, from within PSD, the deal was kept under wraps until it was announced.
The second part is having the right people who can implement the deal at the right time. It is one thing buying a business, and another having people that the board and executive team trust to make the deal work for shareholders. My experience at Harvey Norman showed the benefits of being able to “export” key people from Australia into offshore operations.
Slater & Gordon couldn’t ask for a better person than Ken Fowlie to ensure PSD is “Slater and Gordonised” as quickly as possible, and report back to the board on the implementation’s progress. When the board knows the person leading the implementation, and has great faith in that person, it makes things a lot easier.
Strong internal succession planning is also part of this process: the board needs to know that when a key person moves overseas, somebody is ready to step into his or her role and ensure a seamless transition.
CD: The PSD deal, for a time, propelled Slater & Gordon into the ASX 100 index. What are the main governance challenges when an organisation quickly moves from dealing with mostly small-cap fund managers to being a top-100 company?
JS: You have to take along your current shareholders as the organisation grows, and think about how you communicate with new ones. You also have think about analysts, local or international, who might be covering the stock for the first time and ensure they have sufficient understanding of the firm and its industry.
CD: Andrew Grech joined the firm in 1994 and became its managing director in 2000. Is there a different dynamic in the chair/CEO relationship when an organisation has such a long-serving CEO?
JS: In some cases, it could be. I have seen CEOs over the years who do not consult anyone and see boards as an unwanted intrusion. Andrew Grech is the polar opposite of that. He is extremely down to earth, has a consultative style with other executives and the board, and is very well respected within the firm and in the investment community. He is one of the best CEOs I have worked with and is like a sponge with advice from the board.
Also, the fact that the core Slater & Gordon executive team has significant long-term equity in the firm, and are substantial shareholders, ensures everybody is pulling in the same direction and that there are no egos in the room.
CD: How do you see the law industry evolving in the next 10 years?
JS: Key trends are more paralegals being used, fewer lawyers, more technology, and big firms getting bigger, to achieve economies of scale. I expect more legal markets, here and overseas, will open up through regulatory change. There are lots of opportunities for Slater & Gordon.
CD: Slater & Gordon has a long history with the trade union movement and some of its lawyers have gone on to have successful political careers in Labor or the Greens. Now that it is a billion-dollar company, is there a risk of still being seen as aligned with one party?
JS: The firm’s alignment with the Labor Party or the trade-union movement has always been overstated. Every issue or case the company represents is judged on its merits and we take a bipartisan approach. A lower percentage of our work comes from unions these days.
CD: Your directorships of Super Retail and FlexiGroup, and your retail background give you a bird’s eye view of that sector. Is the economy as weak as commentators suggest?
JS: It depends on how exposed the retailer is to housing and where it operates. Those whose sales are influenced by housing in New South Wales and Victoria are doing okay. Those who rely on the resource states of Queensland and Western Australia are probably struggling.
My concern is that in the long term, so much money is being sucked out of the retail sector to fund more expensive or larger houses, or pay non-performing taxes such as stamp duties.
CD: Why don’t we see more entrepreneurs join boards of large listed companies?
JS: It’s a good question. Lots of entrepreneurs see boards as something that slows companies down and big companies see entrepreneurs as too free-thinking for boards. I found that having started and run businesses, with my own capital, was a terrific training ground for boards. Entrepreneurs are typically a lot more focused on strategy and growth, but the best ones are also risk averse and proactive at looking at what can go wrong in deals.
CD: What do you like most about being on boards?
JS: The variety and an ability to contribute to interesting businesses and help guide talented executive teams. It’s very rewarding when you have a strong board discussion that the executive team takes in and uses to help grow the business, and when you see young managers rise up the ranks and take on senior leadership roles.
CD: Will we see you on more boards in coming years?
JS: Possibly. I like governance and enjoy chairing Slater & Gordon. As chairman, you have to ensure all directors are fully informed and on the same page. You have to make an effort to talk to directors at least a few times in between each board meeting. I like dealing with people.
CD: How do you relax away from work?
JS: I love sport. I snow and water ski, am an avid tennis player, and still love my car racing. I own a few race cars in Tasmania that a couple of young guys manage for me and love nothing more than racing them around the track. I still enjoy using my hands to repair cars or fix houses. With three children and three grandchildren, life is pretty busy.
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