Buy Recommendation 18th APRIL 2019

Stock Ticker

KEYS

Sector

LEGAL

Entry Price

426P

Market Cap

£133.2M

Keystone Law presents a good case for investment

In recent years, there’s been a notable increase in the number of legal services firms choosing to list on AIM. In our view, one of these companies stands head and shoulders above its peers in this emerging mini-sector on London’s junior market. Since going public around 18 months ago, Top 100 ‘challenger’ law firm Keystone Law has consistently smashed growth forecasts and clearly demonstrated there is high demand for its services. This strong momentum looks set to build too, with Keystone well positioned to continue growing its share of the UK legal services market, thought to be worth around £30bn.

Using technology to challenge tradition

Keystone was founded back in 2002, by a group of lawyers who realised that the traditional partnership based law firm business model could be significantly improved upon, with the help of a little modern thinking and some clever technology. They developed a software platform which allows lawyers to work on a self-employed basis and access all the administrative support they need remotely, without any of the traditional overheads.

Through this platform, called ‘Keyed In’, Keystone provides its lawyers essential back-end services including compliance, insurance, marketing, sales, paralegals and even ongoing training. Keyed In allows lawyers to communicate with this central office quickly and easily. It also lets them talk to each other, helping them to take advantage of cross-selling opportunities when they arise. There are no fixed salaries, instead after Keystone collects a fee from its lawyers’ clients, it retains 25% for its services and passes on the remaining 75%

Strong recruitment pipeline

Being one of the very first companies to develop this new business model, Keystone has had a solid early-mover advantage from the off. With the tired UK legal services market seemingly ripe for disruption, the group has been able to secure some big name clients fairly quickly, including Tesco, Nationwide, RBS and the BBC (who, let’s face it, must know a thing or two about choosing a good law firm by now).

The attractive benefits for lawyers have also enabled Keystone to build a very strong recruitment pipeline and an impressive retention rate of around 95%. On the company website, one of the key concepts promoted is ‘flexibility equals productivity’, which seems to be proving popular with its intended audience. Indeed, by offering the ability to plug into the platform, outsource the admin side of things, whilst allowing them to focus on the actual legal work, has proved to be very popular, with plenty of experienced, top-flight lawyers already on the books at Keystone. The number of new lawyers signing up is growing quickly too, rising by 17% last year from 228 to 266.

Building on a healthy balance sheet

Over the past five years (including pre-IPO figures) Keystone’s revenue has delivered an impressive compound annual growth rate of 25%. Healthy profit margins and strong cash generation have helped convert this into an enviable looking, debt free balance sheet. Next month, when the company announces its full-year results for 2018, pre-tax profit is predicted to hit £4.8m. That’s an increase of almost 150% on the 2017 figure. Profit is forecast to continue growing strongly over the next couple of years too and is expected to reach at least £6.1m by 2021. However, with a history of regularly beating guidance, we wouldn’t be surprised to see Keystone exceed this figure significantly.

Given Keystone’s lean fixed cost-base, as the strong recruitment pipeline continues to drive organic growth, overhead costs should become proportionally lower and profit margins should increase. With a £5.31m net cash position, there’s plenty of scope for acquisitive growth too. It’s also worth noting that, unlike many AIM stocks, Keystone offers a confidence-building dividend payment, forecast to be 8.55p this year and rising to 9.65p in 2020.

As Keystone continues to scale up its business, disrupt the sector and become better known, we think it will start to demand more and more attention from investors and the share price should rise accordingly.