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AFL - AF Legal Group

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Things to like about AFL:
  • Company is small with low traded volume and low institutional coverage (DMX Assets is one institution who holds; coverage here: https://www.dmxam.com.au/files/DMXCP November 2020 Update to Investors.pdf and https://www.dmxam.com.au/files/DMXCP October 2020 Investor update.pdf), therefore it may be operating under the radar.
  • Easy to understand business - Family Law, low lock-up days compared to industry (AFL 79 days vs 176 days of industry average), operate on fixed-fee structure, none of this no-win no-fee rubbish. After a specific number of days (I believe 60), if fees have not been paid, the contracted lawyer will discontinue work until payment is made.
  • Predictable revenues - EBITDA, Operating EBITDA and FCF margins are shown in company announcements. Therefore we can extrapolate profitability of the company for FY21. At approximately $10-12M revenue (my low-high estimate), the company will generate $2.0-2.4M NPAT for FY21, assuming 20% FCF margin. Unaccounting for synergies between front of house and back office, margins could increase anywhere to 20-25%, resulting in $2.5-3.0M NPAT in best case scenario. At $28M MC, expect pricing of 13-15x FCF on FY21 results.
  • AFL is the largest specialised Family Law in Australia, and has the advantage of being the first-mover in Family Law in Aus with no other national players.
  • The company is capital light, as mentioned above, it costs AFL very little to acquire new lawyers via lateral hiring and to outfit new offices. And in return, new lateral hires return $1.8-2.5M over an 18month period (however this occurred in Sydney and Melbourne, so may be lower for other localities including Adelaide, Perth, GC etc).
  • Cash flow generation is predictable with the company being capital light. FY20 cash flows were $1.6M with $1.5M being banked as of 30th June 2020, highlighting the significant cash generating ability and capital lightness of its operations.
  • Owner/founder operated and management have previous experience in growing law firms (Grant Dearlove as acting CFO of AFL, who worked in Shine Lawyers).
  • Strong capital allocation through (1) organic growth, (2) lateral hires and (3) acquisitions will allow for rapid earnings growth and multiple expansion, helping to catalyze a share price re-rating.
  • Goals for FY22 will involve moving into funding services and pre-nuptial agreement type services, expansion into wills and estates and assessment of larger scale acquisitions, all possible as a result of a rapidly-growing, capital-light, highly cash-flow generative company.
 
frugal.rock said:
Vultures...

Your onto a winner, I would say.
Statistics would say they should have an abundance of clients for a good 12 months or so...
Click to expand...
Have a relative in Family Law (= separation and divorce). She has a standard speech
"As your lawyer, I'm $600 an hour; the lawyer on the other side is $600 an hour. The CDs you are fighting over cost $10 each. Work it out; make a decision."
 

AFL to acquire Watts McCray. Has 5 locations across Greater Sydney and the ACT which have historically been AF Legal's strongest growth districts. This acquisition now expands AF Legal into complex large estates and asset distributions.

Watts McCray generates $6M in revenue per year, and AF Legal generated $8M in revenue in the last 12 months. So early estimates for FY22 revenue will be $15M assuming ~30%.

Total consideration is $0.375M upfront in share consideration, and $1.125M in deferred share consideration across 3 annual installments subject to performance conditions.

Acquisition will absorb $1.5M debt facility paid for with existing cash and proceeds from rights entitlement. Therefore this will be completed on a cash free and debt free basis.

$1.5M total consideration for $6M revenue = bought at 0.25x sales.

AF Legal trading at 0.505c, fully diluted, resulting in $36.1M MC. Trading at 2.5x sales without any organic growth for FY22 and that figure does not accurately represent FY22 revenue due to newly founded offices which will take 6-12 months to generate revenue scale, as evidenced by initial Sydney and Melbourne offices.
 
My first read of the announcement it certainly looks like a good fit for the business. Pity they couldn't wait until after the SPP to announce, I was hoping to miximise my allocation, will likely be heavily oversubscribed now!
 
Whether or not it will be a good fit will be seen come reporting time for shareholders, however one for thing for certain is that this will be acquired cheaply. Hopefully there will be similar Rev/EBITDA/FCF margins and will scale well.

I trust Grant, Ed and other management's judgement on the future that they are choosing to go as they are aligned with shareholders in terms of holdings. So a win for shareholders is a win for their own pockets. So far they've done everything right, raising at high multiples and buying acquisitions at low multiples.
 
It will take a bit longer than that to confirm, but based on the published numbers I think we can be reasonably confident.

I am still nervous as I am not a big fan of roll ups generally, and legal ones in particular have been spectacular destroyers of shareholder value. (I still have butt hurt from SHG.)

I will take up my full allocation in the SPP and apply for extra, it still leaves me with a relatively small position, which I feel is appropriate given the very early stage of this business. I dont normally invest in businesses this early on, probabilistically it does't make sense, but I made an exception in AFL's case. Its also in my personal portfolio where I am occasionally prepared to take a bit more risk, rather than the SMSF.
 
From memory, SGH made an absolute shocker of an acquisition in the UK, using borrowed money, and wrote it off as nearly a $1B loss. https://www.smh.com.au/lifestyle/the-undoing-of-slater-and-gordon-20160613-gphmej.html

So far this is very different story. And they have proven that they can suitably manage the roll up of acquisitions - see acquisition of Nita Stratton Funk in June 2019, Walls Bridge in Feb 2019, Strong Law in December 2020. So yes, while I am cautious, SGH is a very different tale, and so far they have been acquiring on very cheap sales multiples using scrip and/or cash, not debt, and are likely buying depressed assets which are inefficiently run; I suspect largely non-digital, lot of paperwork, with unnecessary additional staff. So they buy these companies which are likely being run at low profit margins, remove the trash in the middle, and incorporate a lot of the back-house operations into the AFL way of operations to dramatically increase profit margins and realise the true value of these assets. We will see hopefully how Strong Law performs over the next 6 months, to whether how correct this theory is.

I think its quite a compelling investment. AFL can expand very cheaply and very rapidly, as shown so far through new offices and lateral hires. Profit margins so far are good and if they can be maintained or increased, then it increases the FCF coming through the bottom dollar. You have the founder of the company being heavily involved and well-aligned to the success of the company, and even stepped aside to let someone more experienced in the legal sector expansion to take the helm. With this acquisition, AFL is now the largest, by revenue, legal firm on the ASX too. There is a lot to like, and this is one of the few microcaps on the ASX that has real potential to vastly outperform the market.
 
Maybe, but caution is wise. Its trading on stupid multiples now, it needs to continue the growth uninterrupted and execute everything very well. Any business involved in roll ups is high risk, and as a result position sizing is critical.

(its not the largest revenue law firm on the ASX by a long way!)

Your narrative is compelling, but the proof will be in the pudding - and thats still in the oven.

As I said, I have enough conviction to hold a small speculative position, because there is potential.

Seriously, there are plenty of ASX microcaps with the potential to vastly outperform the market, unfortunately potential is an unrealised outcome, we always have to remember there are many possible paths and many don't follow the narrative.

I hope for both our sakes your optimistic narrative turns out to be warranted!
 
I really don't understand how this is on a stupid multiple and I believe you're being blinded by price/earnings ratio. AFL is $26M EV therefore LTM EV/EBITDA is 8x, assuming a 50% EBITDA profit margin as per their normal operations, the NTM EV/EBITDA is 3.5x. LTM P/S is 4x, while yes this isn't considered cheap, this is not out crazily of the question for a company growing organically at like 30%+ pa, and NTM P/S is closer to 2.2x.

RE largest law firm, apologies I have omitted 'family law'. Which yes, they are the largest listed family law firm on the ASX.

If this is currently being valued at 4x P/S, what is the correct evaluation next year when they report in excess of $15M revenue due to ramping revenues up from all new lateral hires and office openings, plus acquisitions? $60M MC/~73M SOI diluted = 82c

There are many people on other forums who I have discussed this with, who also see this value.
 
EBITDA is bull**** earnings at the best of times, AFL are particularly egregious in this case, they have 3 different types of EBITDA in their reports and it ends up being a proxy for revenue because they remove so many fixed costs, read the notes and footnotes carefully and you will see what i mean.

They are the only listed family law firm, so thats meaningless.

P/S is a pure stonk metric & even more meaningless than EBITDA.

If you know what companies are reporting next year, then I am not sure what you are doing bothering posting on forums!

The world is full of people who mistake narratives for value, or have insufficient understanding of financial reporting to be able to calculate a range of value. A consensus about a business is a red flag for me, not a confirmation.

Despite all that, I think there is a reasonable chance that AFL can make the business plan work, but if you dont understand and account for the risks involved in roll up models you will burn a lot of capital learning. Its not a given, and the downside is significant.

The reality is the business is far to young to assess its true value and potential. We cant look thru meaningful ROIC or ROIIC metrics to understand how the roll up model is performing and whether capital allocation is prudent. This really matters in finding great businesses. As said, I am prepared to risk a small amount of capital to have a toe in the water incase they do execute and it becomes what I would consider a long term investible business. I repeat, I hope your narrative & optimism plays put for both our sakes - and then you can say you told me so!
 
AFL announced today that the Watts McCray acquisition is finalised and that the business is tracking inline with their expectations, given that the results for FY2021 have been largely telegraphed, subject to any hidden surprises, my sense is it will be probably 6 to 12 months before a clearer picture emerges of the value of the business and whether it can execute the narrative while controlling the costs and avoiding poor capital allocation decisions. Happy to continue holding at this stage.
 
I see AFL have acquired another small family law practice in Melbourne, deal done with cash, some hurdle payments to come. Wont be a big impact but it all helps if they can continue to get the scale advantages and the execution is on point.
 
Correction - Its not an all cash deal, its 50% cash, 50% shares, shares will be issued under the less than 15% rules.
 
AFL released FY 2021 results today and the market didn't like them, a massive reversal of last half's profitability and a big loss for the full year.

I have had a bit of a chat to a couple of fellow investors and I think they are right in pointing out that while the results are worse than the company had suggested from guidance, there are some mitigating factors.

The two acquisitions in the half have impacted negatively on earnings - the costs have all flowed through but any revenue has been slow to come in, there were some staffing issues as well at the start of H2 that didnt help with the expenses and the previous 2 quarters cash flow had been particularly strong and the cycle of working capital caught up this time and detracted from the operating cash flow.

I think the promotional management style hasn't helped, they failed to flag the likely downturn and then chose to ignore it in the AR & investor presentation, instead focussing on bull**** earnings. It probably would have been prudent to outline to shareholders why EBIT, NPAT & FCF were so negatively impacted and why in the particular circumstances they weren't necessarily a good indicator of the financial health of the business.

I was considering getting out based on the annual report, but I have decided to hang in there and see if they can deliver some earning power from the acquisitions and some organic growth to improve the financials.

 
More red flags for me with AFL today, released an announcement of acquisition of Darwin firm, Withnalls. Its a 51% ownership deal which smacks of KPG - and is a structure I particularly dislike for the opaque accounting and financials it creates. It also looks expensive for a tiny office with 3 lawyers. Again, a microcap announcing a deal with no meaningful financial metrics, so we have no idea if the business is even profitable.

My conviction is dropping and it wont take much for me to exit this one.
 
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