Peak Australia?

 

For the past three years, Australia has been one of the hottest destinations for international law firms. Earlier this month, Pittsburgh-based K&L Gates became the latest firm to break into the market with the announcement of a merger deal with Australia's Middletons. The last 18 months have also seen the firm now known as Herbert Smith Freehills, Ashurst, Clifford Chance, Squire Sanders, and others either merge with Australian firms or launch their own offices Down Under. 

 

But now the boom in cross-border investment, mainly in the resources and energy sectors, that drew those firms is slowing down, raising the prospect that all the new arrivals will be fighting for shares of a shrinking pie.

 

"I would be very surprised there is enough resources work for people," says Darryl McDonough, the Brisbane-based managing partner of Clayton Utz, one of Australia’s largest firms not to have pursued a merger or tie-up with an international partner. “I suspect this [slowdown] will continue into 2013. Even if activity returns, it will certainly not be at the level of the past number of good years."

 

The slower growth in China over the past year has been a major reason for concern. The increasing trade between Australia and Asia's rising economic superpower has been the chief rationale cited by international firm for their expansions in Australia. A quarter of Australia’s exports go to China; iron ore alone comprises 60 percent of those exports and coal accounts for much of the rest. Lower demand in China has predictably led to lower prices for both resources.

 

In August, Anglo-Australian mining giant BHP Billiton announced it was postponing or scaling back projects in the country worth around $50 billion. Along with general economic conditions, the company also cited Australia’s rising labor costs and the strong Aussie dollar in explaining its actions. 

 

Rising costs are also clouding prospects for the heretofore red-hot Australian liquefied natural gas (LNG) sector. International investors have poured almost $200 billion into mainly offshore LNG projects in Australia, but concerns are now rising that potential U.S. exports of LNG produced via hydraulic fracturing, or fracking, may render the Aussie projects uneconomical. Ann Pickard, the Australia chair for Royal Dutch Shell Plc., recently warned that U.S. and Canadian LNG could end up being 20 percent cheaper for Asian customers than that from Australia.

 

Adrian Tembel, managing partner at Sydney-based Thomsons Lawyers, says most firms in the country recognize the Australian economy is cooling. "I think it is accepted wisdom amongst ourselves that energy and resources deals will dissipate, continuing into 2013," he says.

 

Some firms in Australia have already taken action in the face of economic weakness. Clayton Utz this month made approximately 20 employees redundant, less than half of whom are lawyers, according to a spokesperson. "We have for some time been reviewing our structure in response to client and market requirements and best practice and more recently in light of the depressed economic climate in Australia," the firm said in a statement. DLA Piper, which last year entered into a full merger with its Australian alliance firm DLA Phillips Fox, also confirmed that it has laid off some of its staff.

 

For many years, most international firms wrote off the idea of expansion in Australia, noting that the country of 22 million people was already well served by several large domestic firms. 

 

But that has changed dramatically in recent years. U.K. firms Ashurst and Herbert Smith respectively merged with leading Australian firms Blake Dawson and Freehills. Mallesons Stephen Jaques joined up with Chinese firm King & Wood, and the former Allens Arthur Robinson entered into an alliance with Linklaters. Norton Rose kicked off the recent wave with its 2010 merger with Deacons Australia. 

 

On top of those big mergers, Clifford Chance entered into a double tie-up with boutique firms Chang Pistilli & Simmons in Sydney and Cochrane Lishman Carson Luscombe in Perth. Allen & Overy laterally recruited a large group of partners from Clayton Utz and Freehills. Squire Sanders launched in Australia last year by bringing aboard most of the lawyers in the Perth office of Minter Ellison.

 

Most of those firms say they remain confident that they have made the right move, with some pointing out that the level of investment in the Australian mining sector remains high. Indeed, the Australian Bureau of Statistics says it expects 2012 to end with $119 billion of capital investment in mining projects, out of some $181.5 billion in investments across sector.

 

Many point out that the intertwining of the Australian economy with China and other expanding Asian countries will carry on. Though there may be hiccups, few doubt that China will continue to expand in the long term, a trajectory which can only benefit Australia.

 

"People know that the Australian economy is still a much better place to do business than the other parts of the world today," says Jason Ricketts, Australia managing partner for Herbert Smith Freehills.*

 

In the meantime, he says the firm has found increased activity in some sectors has balanced out a slowdown in others. He notes that his firm has been busy with outbound telecommunications deals. Earlier this year, Freehills advised Sydney-based television program guide provider Austar United Communications on its $2 billion acquisition by local rival Foxtel.

 

K&L Gates Asia managing partner David Tang says the firm is in it for the long haul, and wanted to move forward with a merger partner that was a perfect fit. He notes that, despite the slowdown, international firms are still worried about being left behind in a rapidly consolidating market.

 

Tang thinks other Asian economies will make up for any drop in demand from China. "Yes, the mining cycle is there, but demand for energy and resources can also come from Japan and Singapore," he says. "These needs don’t go away overnight."

 

The K&L Gates partner also says his firm expect to represent many U.S. clients eyeing investments in Australia across industries.

 

But Tembel says firms counting on cross-border deals outside of mining and resources haven’t paid attention to Australia’s economic history.

 

"The Australian economy has always been unsuccessful in exporting value-added products like technology and brands, so international firms are not going to pick up outbound work from those," he says. "The only outbound and inbound work will be exclusively energy and mining work, which is highly cyclical."

 

In Tembel’s view, international firms’ interest in Australia is quite puzzling. “The upside is really quite limited,” he says, adding that his firm has turned down discussions with several foreign firms. “We don’t see the comparative advantage [of Australian lawyers in Asia] and from their point of view, what is the point of adding Australia when we have no track record of trading in Western Europe or in the U.S.?”*

 

Even if the Australian economy avoids a sharp downturn, the larger number of competing law firms–and their relatively large size–could present problems.

 

“I don’t think the size of the pie has shrunk, just that it has been sliced up into more pieces," says Robert Chu, the Melbourne-based Australia practice head for Sullivan & Cromwell. "If you take a large substantial pie and cut it up into small slices, whether that is significant enough to justify a large practice for any single firm, that becomes the question."

 

Sullivan & Cromwell, which opened in Australia in 1983, has just a dozen lawyers in Melbourne and Sydney, mainly advising Australian companies on U.S. capital markets issues. Chu says the firm has no plans to follow the new entrants in pushing into local practice.

 

"We have no plans to practice Australian law, and are going to continue to focus on what we do best," he says. Some other earlier entrants among U.S. firms, like Skadden, Arps, Slate, Meagher & Flom and Sidley Austin, have taken a similar approach. 

 

Tembel thinks many of the new entrants are likely in for a rude awakening. "Slow resources practice may mean they are overexposed to local domestic work," he says. "That is when the major downsizing will take place."