AF Legal (Australian Family Lawyers) is a group of practices providing services in the areas of relationship dispute, child support and property settlement etc. This is a rather straightforward and stable industry that will always be needed to the extent family disputes exist.
Applying SQGLP considerations (Size, Quality, Growth, Longevity, Price) to this I can demonstrate the reason I own this business and intend to benefit from long term business appreciation.
Smaller companies relative to their industry (Important to clarify this) allow for what is known in economics as a “Low base effect”. The tendency of a small absolute change from a low initial amount to result in a large percentage change. No better can this be said than a small company that can rapidly gain market share due to a favourable competitive landscape.
AF Legal’s landscape is as suspected, one with no clear distinct/dominant player and a largely diversified network of firms nationally. This is made up of large but generalist firms with Family Law as an ancillary service and smaller specialist firms with 3-10 people employed. This provides a backdrop for the $1.1bn market, allowing AF Legal to attempt to become one if not the only nationally branded Family Law firm.
Due to their DSAS client acquisition model (Digital, Strategy, Acquisition, Sales) the business has heavily streamlined the process of generating leads allowing for cost effective revenue generation and seamless integration on a group-wide basis. This allows for fast and frictionless geographic expansion through lateral hires and acquisitions.
On this note, their differentiated operating model from the typical timesheet driven Biglaw model is attractive to staff that want to come on board. And the cost efficiency allows AF Legal to buy into acquisitions at very low small business valuations and drive both sales and margins once into them. This allows for well above cost-of-capital returns.
Behind this business is Founder Edward Finn, who owns some ~20% of the business and is a strong part of the marketing model currently, leaving operations to COO Grant Dearlove, who has previous experience as the Head of Growth and Markets at ASX listed Shine Corporate (SHJ) for 9 years. During this time Grant diversified service offerings organically contributing 45m worth of new business lines contributing over a third of the group’s revenue. Upon review i believe each member of the management team to be up to the task and are placed uniquely based on their individual strengths.
The clear question is whether growth means reverting or not. My answer is yes eventually, but I'm unsure as to how long it would take. The operating model is stated to be ‘substantive’ in it’s design, making it difficult to replicate in the short term. This gives some time to act on their first mover advantage and give this consolidation an aggressive attempt. Currently, the financials might not look appealing (at least on the bottom line) due to the low Net profit margins, however i believe that due to some fixed and non-recurring costs. This business is set up for extreme short-medium term operating leverage.
Currently the NPAT margin is only 2.7%, however, this includes ASX listing costs, share based payments and head office costs. Without getting into too much detail, i expect that the NPAT margins can move towards their Operating EBITDA margins of 38% adjusted for a 30% tax rate (Currently 26% as they are a base rate entity) leaving a mid 20s profit margin for a business that is trading at roughly 4x trailing sales and 2-3x next year's sales (Inc. Strong Law acquisition and estimated lateral hire contributions) allowing for some re-rating potential or atleast low risk of de-rating.
Couple that with even modest growth and this becomes quite a compelling business at an undemanding valuation. It is just key to keep an eye on the returns they are generating on their capital over time, otherwise I'm a happy holder and look to benefit from many multiples on my investment over time.