SGH - Slater and Gordon

[skc]

That will lower EBITDA because of changes in WIP but improve OCF as that WIP is liquidated. Call me cynical, but because SGH have guidance that excludes WIP (ie EBITDAW) this won't flow through to that number, but the positive affect on OCF will, to the tune of about $42m at today's fx rate.

The positive side of this is that they do appear to be trying to rein in working capital.

I think the selloff today probably has more to do with the negative OCF forecast in the first period, and the heavier weighting toward the second half.

Been thinking about this a bit more. SGH has now owned QPP/PSD/SGS for 5 months now... so they know a lot better what they actually acquired. The acquisition included 3 major assets...
1. A huge amount of in-progress cases.
2. Existing staff
3. Existing business processes and relationships.

From the AGM update, there are hints that 1 and 3 are severely impaired. The reduction in WIP growth, originally stated growth to 95k cases in FY16 (from 83.5k in FY15), will now be down to ~73k (of which 6k due to Swinton, which was supposed to be immaterial). The reason given is that they will stop taking in cases that occurred over 12 months ago as they have poor resolution rate.

How many cases did SGH actually acquire from QPP (I couldn't find the number)? What is the average age of those cases (I don't think it was disclosed)? Given that QPP has had poor cashflow, you'd think they would have targeted those low hanging fruits quickly, while building up an increasing amount of stale cases. Makes you wonder how representative are those 8000 "due diligence" cases that SGH undertook before the acquisition. Does SGH keep spending cash on hoping they will be resolved? Or should they just bite the bullet and walk away from them (Are they legally allowed to do that)? My guess is there'd be some writedown coming.

Before introduction of the new EBITDAW measures, PSD was supposed to earn GBP 95m in FY16. The change in case intake reduced the number by 20m. So that's a big downgrade regardless of the troubles of their EBITDA definition.

Good thing that they didn't pay anything for the NIHL cases - so at leaset there won't be any writedowns. But my guess is that they are also bleeding there for the same rationale. They have 360 staff working on these and each wants to be paid monthly regardless of case resolution rates. And btw, hearing loss cases are most definitely a lot older than 12 months.

To make matters worse, SGH's own UK business (non-QPP part) is also off to a slow start. It's not possible to tell what proportion of the negative $30-40m cashflow stems from SGS vs SGH UK... but the timing couldn't be much worse. This is particularly worrying because it coincided with regulatory review and recent process changes. It's too early to tell when things will turnaround.

This is a passage from another article. http://www.legalfutures.co.uk/lates...-ex-quindell-business-to-improve-pi-win-rates

Mr Grech said the firm has taken “important strides in charting a clear direction for [SGS], which is markedly different from how it was run by its previous owners”.

He explained: “In multiple areas, we are seeking to reset relationships with counterparties, including insurers, business introducers and suppliers, in line with [our] corporate values.”

This reads to me that everything they acquired in terms of business relationships were unworkable.

Anyhow... the worst part of the AGM address was probably this.

Given the slower than expected start to the year in the UK business and the risk that we may not be able to recover the lost ground by 31 December there is now a likelihood that Group operating cash flow will be negative in the range of A$30-40 million in the first half, with a strong recovery expected in the second half. We are taking a range of actions to mitigate this risk and we are confident that we will achieve our financial year guidance and that we will remain in compliance with our obligations to financiers.

That's a throwaway line that's really highlighting how stretched SGH's cash situation might be. That's not a line that you need to include if you are confident of a turnaround, or that the negative performance is only transient.

So to me there are enough hints in this AGM to suggested that SGH acquired something hairy, yellow, that may or may not smell like a lemon. It will take another period to confirm what fruit it actually is. SGH may be so talented that it may be able to eventually turn it all around. They can write off Asset 1, retain/improve Asset 2 and rebuild Asset 3. But this probably will only happen over the very long term (3+ years) and probably with an unpleasant near-death experience in between.

Let's see how the market judge SGH on Monday after digesting the news over the weekend. Some massive Day 2+ moves after AGMs of late.

 

[galumay]

Been thinking about this a bit more.

Typically detailed analysis, skc.

Quite a bit to absorb and reflect on there!

 

[skc]

Let's see how the market judge SGH on Monday after digesting the news over the weekend. Some massive Day 2+ moves after AGMs of late.

Day 2 = more one way traffic.



Where's the bottom? Still a company with EV $1.4B FWIW.

 

[notting]

I have decided to help them with my marketing business advisory services starting with a new logo;
to better reflect their recent metamorphosis.



In short it continues to be a good one.

Perhaps they should grow into merger and acquisition solicitation, more creative they will have a plethora of first hand experience will generate further self employment for vertical integration, won't help those staffing costs but they could add the 7-Eleven model to help with that- it's all good.

 

[Rainman]

... Let's see how the market judge SGH on Monday after digesting the news over the weekend. Some massive Day 2+ moves after AGMs of late.

You can say that again! Down 20% today after dropping more than 20% on Friday.

 

[Rainman]

... The funny thing is that this is actually a pretty simple business. John gets hit by Joe, has $x in medical fees and missed work, threatens to sue Joe's insurer, insurer pays up, before it goes near a courtroom. ...

But occasionally a matter will go to court, particularly a matter involving a few hundred thousand dollars or more.

I haven't read SGH's financial reports but how does it account for a matter that it wins at first instance in FY1, then loses on appeal in FY2 (in which it would have to pay the other side's costs) and then loses again after appealing that appeal in FY3 (again, paying the other side's costs)? If the other side appeals a decision which SGH's client won at first instance, does SGH make provision in its reporting for the possibility that it may have to pay the costs of losing an appeal?

There is then the long drawn-out process of costs assessment should one or the other party dispute a party's claim for costs.

In short: the amount that SGH thinks it might have earned on any one matter would often remain uncertain for a considerable period of time after a matter has settled or been the subject of a court judgment. This feature of SGH's business requires very conservative accounting, in my view.

 

[Valued]

But occasionally a matter will go to court, particularly a matter involving a few hundred thousand dollars or more.

I haven't read SGH's financial reports but how does it account for a matter that it wins at first instance in FY1, then loses on appeal in FY2 (in which it would have to pay the other side's costs) and then loses again after appealing that appeal in FY3 (again, paying the other side's costs)? If the other side appeals a decision which SGH's client won at first instance, does SGH make provision in its reporting for the possibility that it may have to pay the costs of losing an appeal?

There is then the long drawn-out process of costs assessment should one or the other party dispute a party's claim for costs.

In short: the amount that SGH thinks it might have earned on any one matter would often remain uncertain for a considerable period of time after a matter has settled or been the subject of a court judgment. This feature of SGH's business requires very conservative accounting, in my view.

Law firms don't pay costs to the other side out of their own pockets, it's the client's liability. Why do you think they pay costs? Did they say that anywhere? That's not how it works in Australia, but I suppose that could be the case in the UK, especially if they bought a litigation funder? A company like IMF Bentham becomes liable for costs because it is a litigation funder, not a law firm, and they have to engage a firm.

If they lose the case though it means a lot of time was spent on the case and there was no reward, so the loss is the employee wages that went to not producing any income.

 

[Rainman]

Law firms don't pay costs to the other side out of their own pockets, it's the client's liability.

True. I should have put that better.

What I meant was: when an SGH client succeeds at first instance and is awarded an amount of damages plus his/her legal costs on an ordinary or on an indemnity basis, I presume that SGH will recognise those costs (once they have been quantified) as revenue in the financial year in which they are awarded. However, how does SGH deal with a situation where the party ordered to pay damages and costs successfully appeals? Now the costs that SGH has previously recognised as revenue will have to be reversed. Does it make allowance for that possibility at the time that costs/revenue is recognised?

Also, while I understand that the legality of the practice varies from jurisdiction to jurisdiction, some plaintiff law firms agree to indemnify their clients for any costs that they are ordered to pay following unsuccessful litigation. This practice often occurs where the law firm has advised a client to reject a settlement offer and to press on to trial and the client then fails at trial. It is a practice that is permissible and increasingly common in the UK: Sibthorpe and Morris v London Borough of Southwark [2011] EWCA Civ 25 (see also http://www.internationallawoffice.c...o-indemnify-clients-against-costs-liabilities).

Does SGH disclose when and where its UK practices enter into these sorts of costs indemnity arrangements?

 

[McLovin]

Been thinking about this a bit more. SGH has now owned QPP/PSD/SGS for 5 months now... so they know a lot better what they actually acquired. The acquisition included 3 major assets...
1. A huge amount of in-progress cases.
2. Existing staff
3. Existing business processes and relationships.

From the AGM update, there are hints that 1 and 3 are severely impaired. The reduction in WIP growth, originally stated growth to 95k cases in FY16 (from 83.5k in FY15), will now be down to ~73k (of which 6k due to Swinton, which was supposed to be immaterial). The reason given is that they will stop taking in cases that occurred over 12 months ago as they have poor resolution rate.

How many cases did SGH actually acquire from QPP (I couldn't find the number)? What is the average age of those cases (I don't think it was disclosed)? Given that QPP has had poor cashflow, you'd think they would have targeted those low hanging fruits quickly, while building up an increasing amount of stale cases. Makes you wonder how representative are those 8000 "due diligence" cases that SGH undertook before the acquisition. Does SGH keep spending cash on hoping they will be resolved? Or should they just bite the bullet and walk away from them (Are they legally allowed to do that)? My guess is there'd be some writedown coming.

I think what is happening under the bonnet is that SGH thought they could get increase case resolution speed, how I don't know. That's turned out to be harder than they imagined and so they've had to dial back taking on new cases and go for "easier" cases with quicker resolution. SGS when it was Quindell was taking on ~80k cases/year but only closing ~40k. Obviously that puts a huge strain on working capital, and I wonder if SGH has woken up to the fact that while the cases they have may be strong, they don't have the balance sheet to fund them for x number of months/years. I'm not sure the cases are impaired as much as "delayed". Maybe I'm being too glass half full. Regarding point 3, I think that appears to be the case.

This leads into this...

That's a throwaway line that's really highlighting how stretched SGH's cash situation might be.

The pitfalls of being a public company: Every insurer knows what SGH's position is. What's the effect on claims settlement? The second half recovery will be truly epic. Negative OCF in the first half of $30-$40m, but sticking to FY OCF of $205m. I'm happy to watch from the sideline.

 

[McLovin]

It would be hard to exclude cases unless it was very clear. All firms will have a questionnaire to start off with. Some clients because of their injuries or background won't be able to read/write or understand the form. The questions have to be very basic and just ask things like the date of the injury and what happened. A computer won't be able to say whether there is a case or not, they would be screened by a person. In terms of excluding a case based on questions, I don't see how you could do that. You could have a question like "When did the injury occur?" and if it was over statutory limitation the firm could reject it but they could lose work because sometimes the limitation can be extended and you can still settle out of time cases. There are also exceptions such as being under a legal disability and then clients won't know what constitutes a legal disability without legal advice. If they are excluded because the automated process tells them they were not under a legal disability when they were then the firm could potentially be exposed to liability. Examples of a legal disability are being a minor, being in prison or not being of sound mind.

The only way to know if someone has a case is to get a medico-legal report. The client is made to pay for it. The firm has to collect information from the client and send a letter of instruction to a doctor. If it is a complex case the letter of instruction may take some time and possibly involve instructing a barrister. They would have precedents for the simple cases like the standard motor vehicle accidents. This means the firm has to put in a couple of hours of work at this stage.

As an alternative to an automated process, most firms would just have a 15 minute consultation that is free with the client where they work out pretty quickly if there is any chance at all. If it sounds like a terrible case that is too risky they will not take it unless the client agrees to pay the hourly rate and put money in trust, i.e. they will take the case but not no win no fee.

An automated process would mean people who want to have that face to face consultation or at least a consultation over the phone would go to a firm that offers that. You are correct in that there are many firms, including just general firms, who will take on speculative personal injuries matters. The rewards are quite high and often involve minimal work since 95% of the cases settle. Therefore, if the big firms lose that personal touch they will likely find people will tend to go to the solicitor who will give them the time of day. Personal injuries firms are more in the listening business then the legal business. Clients want to be listened to. They want someone to hear their story and their problems. Some of those tend to be quite relevant though. A person going on for 30 minutes about how they can't pat their cat called fluffy after the accident because they can't bend down may seem irrelevant but actually that's something they can't do anymore and if it had that much of an effect on them that they can talk about it for 30 minutes that's evidence that goes to the effect the injury had on their life and could increase damages.

Thanks for the overview, valued.

 

[skc]

I think what is happening under the bonnet is that SGH thought they could get increase case resolution speed, how I don't know. That's turned out to be harder than they imagined and so they've had to dial back taking on new cases and go for "easier" cases with quicker resolution. SGS when it was Quindell was taking on ~80k cases/year but only closing ~40k. Obviously that puts a huge strain on working capital, and I wonder if SGH has woken up to the fact that while the cases they have may be strong, they don't have the balance sheet to fund them for x number of months/years. I'm not sure the cases are impaired as much as "delayed". Maybe I'm being too glass half full. Regarding point 3, I think that appears to be the case.

The inventory doesn't spoil... according to the Andrew Grech. In theory that's true. It's just hard to trust the inventory quality coming from Quindell.

The pitfalls of being a public company: Every insurer knows what SGH's position is. What's the effect on claims settlement? The second half recovery will be truly epic. Negative OCF in the first half of $30-$40m, but sticking to FY OCF of $205m. I'm happy to watch from the sideline.

It's clear that nobody expect them to be able to meet guidance. By mid Feb they should adjust their guidance. If they so much meet the negative $30-40m in H1 and guide to a $100m OCF for the full year, they'd probably get a nice bounce.

 

[Ves]

Still running really hard to the downside, and the volume is still well above average. Wonder if there have been a few whispers from the banks re the covenants? If they were forced to raise capital, how much could they raise (see: bruised reputation) and what is the likely discount (pretty big IMO)?

ASIC is the other wild card.

Or maybe it's just the market having a panic or the evil shorters running wild.

 

[McLovin]

Still running really hard to the downside, and the volume is still well above average. Wonder if there have been a few whispers from the banks re the covenants? If they were forced to raise capital, how much could they raise (see: bruised reputation) and what is the likely discount (pretty big IMO)?

ASIC is the other wild card.

Or maybe it's just the market having a panic or the evil shorters running wild.

This is where this cognitive dissonance that I have with SGH comes in. These guys do shareholder class actions. Having such a high, as to almost be unbelievable, turnaround forecast in the second half is surely very strong grounds for a class action if they miss that milestone in a big way, which the market seems to be suggesting is inevitable. The AGM was an opportune time to say things are going slower and adjust down their OCF forecast at least. I just can't imagine a bunch of lawyers being that dumb.

Here's their BBG case...

Billabong is an Australian surf wear, accessories and action sports apparel company, founded in 1973. Its products are licensed and distributed in more than 100 countries.

The claim against the company relates to Billabong’s announcement to the market on 19 December 2011 that, contrary to prior earnings guidance given on 18 February 2011 and 19 August 2011, it no longer expected strong underlying growth in earnings before interest, tax, depreciation and amortisation (EBITDA) for the financial year ending 30 June 2012 (FY12) and, further, that the company now expected its EBITDA performance for the first half of FY12 (1H12) to be 20-26% below its 1H11 performance.

In response to the announcement on 19 December 2011, Billabong’s share price fell from $3.64 immediately prior to the disclosure to $1.77 on 20 December 2011, a fall of about 51%.

https://www.slatergordon.com.au/class-actions/current-class-actions/billabong-shareholder

 

[VSntchr]

And if things couldn't get any worse for SGH, an announcement from the UK government that they are looking into increasing the small claims court max payout. Industry legislative risk has now been brought to the mix after what has largely been company specific risk smashing the stock.

A bit of a left-field jab, but perhaps explains a bit of todays re-acceleration in the selling.

 

[skc]

And if things couldn't get any worse for SGH, an announcement from the UK government that they are looking into increasing the small claims court max payout. Industry legislative risk has now been brought to the mix after what has largely been company specific risk smashing the stock.

A bit of a left-field jab, but perhaps explains a bit of todays re-acceleration in the selling.

I wish I red that overnight... would have been a year maker!

They can kiss their UK business goodnight me thinks.

 

[Ves]

Wow, another 30% fall. SGH were obviously a bit slow in releasing that announcement, but a few of the early sellers appear to be following the news.

Surely it's now being priced for a massive capital restructure by the market?

 

[Ves]

This is where this cognitive dissonance that I have with SGH comes in. These guys do shareholder class actions. Having such a high, as to almost be unbelievable, turnaround forecast in the second half is surely very strong grounds for a class action if they miss that milestone in a big way, which the market seems to be suggesting is inevitable. The AGM was an opportune time to say things are going slower and adjust down their OCF forecast at least. I just can't imagine a bunch of lawyers being that dumb.

That's amazing. The BBG case is almost a perfect fit (in more ways than one) if it plays out like most people think it will.

This is quickly becoming the binary situation that you earlier predicted. It's way too hard to figure out how it plays out for me, and the fact that the underlying business, is far from excellent, means I'm just happy to watch.

 

[VSntchr]

I wish I red that overnight... would have been a year maker!

They can kiss their UK business goodnight me thinks.

Oh mate! Looks like it could have been a year maker from the re-open!

 

[VSntchr]

In my somewhat limited experience watching the market trade I don't think I've ever seen the depth move as fast as what SGH is doing right now...

 

[McLovin]

I wish I red that overnight... would have been a year maker!

They can kiss their UK business goodnight me thinks.

Yes. I would say so. But they're only proposals at this stage. The Tories are probably on the side of the insurers so I imagine they'll be trying their hardest to get this through.