Armstrong Legal acquisition underway and raise is open for AFL holders....

Entitlement Offer

This Entitlement Offer Booklet relates to the Entitlement Offer. Under the Entitlement Offer, Eligible

Shareholders with a registered address in Australia, New Zealand or Singapore are entitled to subscribe

for 1 New Share for every 4 existing fully paid ordinary shares in the Company (Shares) held at 7.00pm

(Sydney time) on Wednesday, 6 March 2024 (Record Date), at the Offer Price of $0.15 per New Share.

The Offer Price represents a discount of:

• 13.79% to the TERP3 of $0.174 per Share; and

• 16.67% to the closing price of $0.18 per Share on 28 February 2024, being the last trading day

prior to the announcement of the Entitlement Offer.

New Shares issued under the Entitlement Offer will rank equally with Existing Shares.

The number of New Shares which you are entitled to subscribe for under the Entitlement Offer is set

out in your personalised Entitlement and Acceptance Form that will accompany this Entitlement Offer

Booklet when it is dispatched to Eligible Shareholders on Monday, 11 March 2024.

Under the Entitlement Offer, Eligible Shareholders that take up their full Entitlement may also apply for

Additional New Shares in excess of their Entitlement at the Offer Price (Shortfall Facility). Additional

New Shares will only be available under the Shortfall Facility to the extent that there are Entitlements

under the Entitlement Offer that are not taken up by Eligible Shareholders. Applications under the

Shortfall Facility will be subject to scale back if Eligible Shareholders apply for more Additional New

Shares than available under the Shortfall Facility (see Section 3.6 of this Entitlement Offer Booklet for

further information). The Directors (and their associates) are not entitled to participate in the Shortfall

Facility.

The Entitlement Offer is non-renounceable and therefore your Entitlements cannot be traded on ASX

or any other exchange, nor can they be privately transferred. This means that Eligible Shareholders

who do not take up their full Entitlement will receive no value for those Entitlements and their percentage

holding in the Company will be reduced.

SUMMARY OF ENTITLEMENT OFFER

Entitlement Offer

Ratio 1 New Share for every 4 Shares held

Offer Price $0.15 per New Share

Size Approximately 19.7 million New Shares

Gross proceeds Approximately $2.95 million

KEY DATES

Event Date

Announcement of the Entitlement Offer Thursday, 29 February 2024

Record Date for Entitlement Offer 7.00pm (Sydney time) on Wednesday,

6 March 2024

Despatch of Entitlement Offer Booklets and Entitlement and

Acceptance Forms to Eligible Shareholders

Entitlement Offer opens

Monday, 11 March 2024

Entitlement Offer closes (Closing Date) 5.00pm (Sydney time) on Thursday, 21

March 2024

Settlement of Entitlement Offer Tuesday, 26 March 2024

Allotment of New Shares (Issue Date) Tuesday, 26 March 2024

New Shares issued under the Entitlement Offer commence

trading on ASX on a normal settlement basis

Wednesday, 27 March 2024

Despatch of holding statements in respect of New Shares

issued under the Entitlement Offer

Thursday, 28 March 2024

HELD (but not on Straw)

Australian Family Lawyers are back on the acquisition hunt, after going through a period of stabilisation and Balance Sheet repair.

That news will likely be met with some trepidation by shareholders given the past experience with previous management. However, the first cab off the rank does look like a bit of a free hit.

ACWE practice in a complementary area of law to AFL, managing will disputes. They are paying $3 million, with an additional potential earnout of $750k based on FY24 and FY25 results. Putting aside the deferred consideration, which I hope they get to pay, let’s say the acquisition is a flop and so they just pony up the $3 million.

The free hit is really in the fact that in addition to the staff of ACWE, AFL are targeting acquiring some $3.7 million of debtors and WIP. At first blush that number looks a little worrying, given the ACWE’s $3.1 million of revenue in FY23. However, AFL have insured themselves with a condition that two years after completion the seller must reimburse AFL for the difference between what is collected and 80% of the balance of WIP and receivables acquired (i.e. circa $3 million). So essentially the bear case is that for $3 million AFL will earn $3 million!

The bull case is a lot more enticing. Let’s assume ACWE continue to make FY23 earnings. In that case AFL would of paid $3.8 million to acquire $0.8 million of annual NPBT (a multiple of 4.75), plus earnt $3.0-3.7 million in cash from the working capital acquired on completion. That is a seriously good deal.

So the deal looks better than previous ones have, but just as importantly the tone from management, the transparency of their disclosures and their actions (e.g. a concurrently announced entitlement offer will be partially – but at $250k, not insignificantly – underwritten by the CEO), give much greater confidence that the adults are in charge and brighter prospects may be ahead for shareholders.

[Held - for my sins...]

A really interesting announcement from AFL this week in relation senior executive changes. In the third shakeup in just seven months Chris McFadden who had jointly been acting as CEO for the past few months, after previously and briefly being the CFO, was formally appointed to the position. That wasn't entirely unexpected but the interesting bit is the outgoing CEO Stace Boardman has been appointed as CFO/COO. Effectively they're swapping roles. I can't recall an example of CEO and CFO of a listed company swapping jobs - I don't know if anyone else can? Bing chat came up with donuts on the topic. Lots of examples of CFOs later going on to become CEOs but not the other way around and never - as far as I know - both at once.

This degree of instability at the top of a business is never welcome but I am pleased with the appointment of Chris to CEO. Not only did he come across from Ashley Services Group last year with a pretty good reputation but the sharing of the role with Grant Dearlove over the past few months didn't sit well. I asked a question in the Strawman meeting about the rationale for keeping Grant, who many thought was a factor in (if not the architect of) their recent poor performance, on in such a senior position. Slightly tactless? Maybe - but it was a genuine question and not meant as a statement. Grant will continue as a Legal Practice Director but not have an operational role in the company going forwards.

Hopefully this latest announcement puts a fullstop on AFL's leadership musical chairs for a while and let's everyone get on with concentrating on the business. AFL's share price is up a whopping 170% off its 12-month low, but that's still barely half its 12-month high - so it's been quite a rollercoaster!

[Held]

Australian Family Lawyers was another holding to give a trading update while I was away. After a long run of bad news shareholders finally had something to be pleased about with news the company had reverted to a profitable result in the usually quieter third quarter.

Revenue decline appears to have abated and there are suggestions that the ultra-tight labour market for lawyers may be opening up. A $340k profit in Q3 may not seem like much but annualised and with a bit of creative accounting to allow for the quieter quarter (probably too soon to be joking about creative accounting with these guys), I can conservatively get to $1.5-2m annual earnings. Relative to the EV of approximately $10m that's a fairly undemanding valuation multiple.

Hidden among the various negative releases from this company have been some encouraging signs that the grown-ups have been put in charge and are righting the ship. The Board has been renewed over the past 12 months and the acquisitional growth strategy has been put on hold. Fund manager and shareholder advocate Peter Johns has joined the board and is regularly buying additional parcels on market. Respected CFO Chris McMadden has come across from Ashley Services (ASH), with an incentive structure better aligned to shareholder interests.

Probably the one bemusing aspect is the board appear to be comfortable continuing without a CEO for the foreseeable future, with responsibilities split between Chris and Grant Dearlove, who continues to be responsible for M&A. That latter responsibility would make shareholders nervous given Grant oversaw the previous shotgun approach to M&A that arguably contributed to them getting into such a mess last year. His dumping of a large portion of his holding at much higher levels also doesn't reflect favourably.

Members will be able to ask about this when Chris McMadden meets with us on Tuesday.

[Holding - nervously]

Australian Family Lawyers today announced the resignation of CEO Stace Boardman. This rarely heralds great news but I suppose on the plus side she will stay on as a consultant until the end of July, which suggests it wasn't a rancorous departure - unlike many of the other transitions in recent times. However, she only took on the role in January last year and presumably didn't do so in the expectation she'd be leaving within 18 months.

Former Executive Chairman and current Legal Practice Director Grant Dearlove and current COO and CFO Chris McFadden will take on the CEO responsibilities in the interim. It looks like Chris is scheduled to meet with us next month so maybe we can get some answers then.

[Held]

Given the past 6-12 months for Australian Family Lawyers expectations from a Company and Trading Update released yesterday were pretty low - Chubby Checker limbo party-style low. And from that perspective the update failed to disappoint. It was pretty sobering reading.

For me there were three major takeaways, all of which were previously evident but were re-affirmed:

1. the underlying business is struggling. The degree to which that is a result of short-term macro vs medium-term prior decision making vs long-term structural industry issues is difficult to be definitive about and shareholders will reach their own conclusions.
2. the previous management were not incentivised to deliver outcomes in the best interests of shareholders and that is reflected in the decisions they took and the transparency of disclosures they made. The fact the HY result will include a substantial provision (effectively a write off) of debtors, that includes some prior to listing, is damning.
3. new management is making a concerted effort to be more transparent and have been making decisions (and overturning previous decisions) in better faith. Whether they're right to cancel the merger with GTC and amend earn out agreements to pay in cash instead of scrip will be borne out over time, but as a long term shareholder those decisions made sense given what we know now. Telegraphing the points in the year shareholders can expect updates and what they will include (e.g. PBT and not adjusted EBITDA) is welcome.

This has probably been my biggest loser in recent years. I'm reminded of the saying that if you're going to panic, it is best to panic early. Although I had concerns about whether the old thesis was broken when this company was trading around 40 cents, I should have been more panicked. C'est la vie.

The question is where to now? It's currently trading on an EV of around $6m. For me it comes down to whether the underlying business can make a cash profit going forwards? If it can it's worth more than $6m - I don't need to open a valuation model to tell me that. If it can't make money it's not worth anything (short of a takeover). The thing is it has made money in the past, when it was a smaller business with fewer economies of scale (how well this industry scales is a fair question but decent management should be able to squeeze some efficiencies out of it). It provides a service that is not going away. It also has some excuses in that it has faced an unprecedented tight labor market and it seems reasonable that a company that relies on a small cohort of the market with specific training and long lead times to gain that expertise would be disproportionately impacted by that. It is somewhat heartening that they've recruited several senior billing positions in the past couple of months but given their history they'll need to show it through actions before they get believed.

Sentiment is rock bottom but I think it can make money and I suspect that looking back in two year's time this will look like the clear buying opportunity. But it's definitely a different thesis than I had a couple of years ago and that does not sit comfortably.

A datapoint for consideration.

I am now booking 12-18 months ahead for family law assessments, and enquiries continue to come in thick and fast. They walk away when they hear the waiting time.

Given I work at the pointy end of family law (see previous straws), this suggests to me the COVID lockdown related rise in separations is making its way through the Courts and the various lawyers are approaching saturation with work.

I wouldn't be surprised to see a bumper half year in revenues with Feb earnings season. No idea what they are doing with costs, so that will be a key metric.

I don't know if the peak has hit yet but given the time from separation to divorce is 17 months, I suspect we're not there yet.

Australian Family lawyers has announced it will buy back up to 10% of shares on issue over the next 12 months. The company had previously indicated an intention to seek out some larger than usual acquisitions and had put in place a $10m debt facility in order to fund this. The announcement of the buyback probably suggests that any targets they had identified are no longer in play.

Reflecting on the most recent reporting season for my portfolio as a whole it was a largely positive one, albeit it's currently a market that punishes laggards much more than it rewards winners. Australian Family Lawyers fell into the former camp with a result I find hard to spin any way other than disappointing.

Management put on a brave face highlighting top line growth of 67% to $18.5m, 'Statutory EBITDA' (an oxymoron if ever one existed) up 170% and Adjusted EBITDA up 63%. But these figures ignored the fact management had disclosed a $22m revenue run rate at the half year result, a significant miss at the EBITDA level and a statutory loss after tax similar to the prior year (after excluding minority interests). The market reacted accordingly punishing the share price in the days and weeks that followed.

There were warning signs. At the half year result management mentioned a temporary quiet period that had since been resolved - something I wouldn't have associated with what I expected to be a defensive business. The lack of any significant update since the half year result also gave pause. After activist shareholders forced management to change their performance targets from being EBITDA growth focused to EBITDA/share focused, I was on the lookout for substantial debt increases and management went some way to obliging by putting in place a new $10m facility in recent months. But as they didn't draw on it, selling on these signals felt like jumping at shadows.

It's not all bad news. The Withnalls acquisition appears to be ahead of plan and is a good early validator of the co-ownership model they will now roll out more broadly (borrowed from Kelly Partners). COVID impacts appear to have been acute in 2H FY22 and should have significantly abated. Management are responding to the significant pressures on keeping staff but appear to be doing so by throwing money at the problem and many of the drivers of that pressure are likely to linger for some time.

So where now? One of the key beliefs I held was that this should be a defensive industry and, if anything, mildly counter-cyclical. That thesis appears to be broken. On the other hand it has fallen a long way - sales multiple is a particularly poor way to value a business like this but to put it in perspective relative to other SM faves it's on about 1x. I'm also conscious that a good mate of mine is a family lawyer and he's a properly loose unit. If he can make his business work how hard can it be?!? On balance it could definitely get worse but I tend to think the balance of probable outcomes is now skewed to the upside and the time to bail is not now. It's definitely not the higher conviction holding it once was though, and I am conscious of the risk of thesis creep. Were I trawling for funds to invest in higher conviction ideas Dr Sell might come a knockin'.

I will give my thoughts on my other major disappointment during the week.

Australian Family Lawyers eeked out a pretty strong half in the past six months growing revenue and EBITDA by over 100%, albeit off a low base and with the benefit of several acquisitions. Pleasingly they did report 20%+ organic growth as well.

Some good stuff:

• $22m annualised revenue run rate
• Result doesn't include Withnalls acquisition (acquired 31 Dec 21), which would of added $1.9m revenue and $0.56m EBITDA, but only $0.24m of NPAT (my estimate) as the non controlling interest would of been removed below EBITDA.
• Further lateral hires/office epansions/acquisitions flagged but as @nerdag points out here in relation to the latter the price paid will need to be watched.

What I don't see:

• Investor briefing? Take the plaudits when you get the chance folks.
• Breakdown of how acquisitions have performed. It does appear AFL has been able to generate synergies but it would be great to see get visibility of that.
• Dividends - it's a little early but pressure will build. This is (or will be) perceived as a defensive, somewhat reliable business that should be generating income (not a super high growth tech play). In 12 months time I think the market will become more insistent.

I'm not convinced this is a forever hold. I don't think it scales particularly well as their research indicates their customers are unlikely to travel more than 10 km to visit a lawyer. So it becomes a roll up model where they can only drive economies of scale so far. Also they're a bit like Invocare in that their customer base is only likely to use them once no matter how well they perform. I'm also a little wary on the defensive nature of the business - I tend to think they're actually a little delayed counter-cyclical. However, for the time being the valuation is pretty compelling so I'll continue to hold until they give me reason not to.

[Held]

Haven't done a deep dive on this company like Noddy's analysis, but I can say that with confidence that there is more than likely to be a big earnings bump for AFL and peers over the next 2-3 years.

As per my previous straw, there's huge demand for family assessments, which are usually done only at the pointy end of family law. My wait list is now over 12 months, compared to this time 2 years ago, which was about three months. Enquiries are still coming thick and fast, and the lawyers all want them done yesterday, because they don't want the open cases on their books whilst plenty of new work is coming through the front door.

Given most work in family law (basically splitting up property and access to kids) never ends up at the pointy end of family assessment, this data point suggests there's a huge backlog of work that AFL will need to get through which will flow through to earnings for at least 2-3 years.

If they continue to acquire peers, you'll need to watch very carefully at price paid.

Disc: Not held

Australian Family Lawyers are scrambling to get away a performance rights resolution before their AGM. This has resulted in an addendum to the notice of their AGM which read "The Addendum has resulted following feedback and discussions from shareholders in relation to the Performance Rights to be issued to the Directors of the Company". I read that as "We've been very naughty boys and got stuck with our hand in the cookie jar."

The marked up amendments to the performance right issue are shown below and are significantly different (both fewer shares and tougher requirements). It's good to see shareholder advocacy in action. The new EBITDA/share targets are roughly in line with my model so it's nice their incentives are aligned with my thesis. Having said that if I start seeing them replace share issues with significant debt to fund growth I'll consider the thesis broken.

[Held]

The Board of AF Legal Group Ltd (ASX: AFL) (Company or AFL) is pleased to announce that it has entered into a binding Heads of Agreement to acquire 51% of Darwin’s leading family law firm Withnalls Lawyers (Withnalls).

The Company will acquire 51% of Withnalls shares or assets for upfront cash consideration of $447,287 and upfront script consideration of $447,287. The transaction is subject to the Company completing its due diligence and finalising transaction documentation. Withnalls recorded over $2.5m in professional fees for the financial period ending 30 June 2021. The acquisition is expected to be highly earnings accretive for the Company.  

***

Another 'cheap' acquisition for AFL. Based on previous acquisitions, the price being paid and the lack of detail with regards to the financials other than revenue, I'm going to suggest they're not currently profitable (which would suggest it's not 'cheap' at all!). As an investor it's really a punt on management they will be able to integrate and drive efficiencies from their various acquisitions. If they can AFL looks like a bargain but it's still an 'if'...

Substantial recent on-market director buying is a good sign though.

Not deemed price sensitive.

[Held on SM and RL]

Australian Family Lawyers today confirmed the acquisition of Watts McCray had completed and gave a trading update.

https://www.asx.com.au/asxpdf/20210616/pdf/44xdzbnvhtsn28.pdf

The market initially thought it was a bit underwhelming falling at the open before deciding around lunchtime that it wasn't so bad after all, ultimately up 6% today.  Not bad, not brilliant was kind of my take too.  The hard work really starts now.  It's a big acquisition for them to swallow with Watts McCray almost being as big AFL prior to the acquisition.  AFL term their valuation as 'undemanding' and from what I think are fairly conservative assumptions it does look that way on a DCF basis.  Having said that the market remembers how some other listed legal firms have fared (looking at you Shine and Slater & Gordon) and so on that basis the discount could be justified.  

One of the differences for me is the segment of the industry they operate in.  Family Law is not cyclical, in fact it's arguably slightly counter cyclical.  It's also a highly fragmented segment and the big players aren't incentivised to compete aggressively with them.  So we'll see how they go but there's plenty of room for them to grow organically.  Much will depend on how effectively they can integrate acquisitions and eventually build a brand that has its own value in the market.

[Held]