The Age of Consolidation

October 21, 2015

OUR CITY SAN DIEGO

By Laira Martin

SAN DIEGO – The nation’s largest firms once flooded into San Diego, but changes in the market mean more consolidation than growth in recent years.

When Mike Whitton started practicing law in his hometown more than 20 years ago, San Diego was a tight-knit legal market wedded to the area’s healthy but homog­ enous economy of defense contractors, real estate developers and entrepreneurs.

But the area’s  legal  community has seen tremendous growth since then, and Whitton,  now the managing partner of the San Diego office ofTroutman Sanders LLP, hardly recognizes the market.

“It’· changed,”  he said. “There  were a handful of signature firms in town that everybody knew. It was easier to be known in the market. Now, there are many firms in town and many more lawyers.”

Whitton’s firm is typical of the evolution. He  joined Miller, Boyko &  Bell, a small boutique practice, in 1994. It merged with a Washington, D.C.-based firm to become Ross, Dixon  &  Bell in  2000. Troutman Sanders, an Atlanta-based firm with more than 600 attorneys, took over the practice in 2009.

Troutman Sanders continues to grow in San Diego. But it is now the exception to the rule, as several of the largest firms have closed their  San  Diego  offices in  recent years.

It is part of a nationwide trend in which the biggest firms are m rging. The first half of 2015 saw the most lllergers ever, 48 total, according to Altman Wei! MergerLine, which  has  been  tracking  mergers  since 2008 Five more have occurred since the second half of the year began. And when growth is occurring, it is not domestic.

“The largest U.S.  law firms  are look­ ing outside of the U.S. for opportunities to grow,” said Ward Bower, a principal of Altman Wei!. “As they shake off the last effects of the recession, they are ready to make big deals again.”

In 2009, Peter  Kalis,  chairman and global managing  partner  of  K&L Gates, the  nation’s eighth largest firm, told The American Lawyer magazine it never closed an office and didn’t plan to start then.

As of 2013,  the San Diego office is no more.

Goodwin Procter also closed its San Diego office in 2013. In 2011, McDermott Will & Emory moved its San Diego staff to Irvine. Covington & Burling also closed its doors here after only seven years, moving 15 attor­ neys to a newly formed office in Los Angeles. Sughrue Mion, an intellectual property firm, abandoned its La Jolla office.

Three years ago, Larry Watanabe, a legal recruiter based in  Rancho Santa Fe and a founding partner  of  Watanabe & Nason, LLC, foresaw consolidation as the coming trend, but never did he think it would be so swift and so vast.

“Consolidation has  occurred  far more quickly than I originally anticipated,” he said. When Watanabe moved to San Diego 20 years ago, the tech boom -particularly in life sciences and biotechnology – inspired optimism  among  big  firms. That growth increased legal needs, especially in intellectual property litigation and patent work, which could sustain  high  billing rates. The city was also becoming home to one of the few business dusters in the country focused on renewable and dean technology, supported by research from University of California San Diego.

The number  of  branch offices of the nation’s 250 largest firms grew from nine in 1986 to 35 in 2006. The number of lawyers at those firms grew at an even greater pace – from 283 to 1,344. It was all part of a world­ wide trend  that  saw the  largest law firms grow -primarily through mergers -from revenues of $7 billion in 1986 to $71 billion in 2006.

With its growing tech market and high profits, San Diego was one of the prized loca­ tins during this heyday. In 2006, it ranked 14th in the world with $872,610 in profit per partner.

But that was the high-water mark. Since 2006, law firm revenues have been flat. And for the firms that  have seen some growth, expenses have outpaced revenue.That’s led to a drop in the number of national law firm branch offices here. It’s now closer to 25, Watanabe estimates.

While the economy is partly to blame, the decline started  two years before the reces­ sion. Clients began to move away from the high hourly rates to lower-priced firms, in­ house legal departments, contract attorneys and  legal process outsourcers. A  decrease in clients, paired with little to no  positive change in the tech industry and exorbitant overhead costs have made it harder to justify branch offices in San Diego, especially with a legal hub like Los Angeles so close by. Compounding the  problem,  some  big firms started providing volume discounts to retain market share. But, that left other firms struggling, most notably Luce, Forward, Hamilton & Scripps in San Diego.

“In order for survival, it was necessary for them to merge,” Watanabe said. “The firm’s profits were not sustainable to maintain and keep their rainmakers.”

Luce Forward had been San Diego’s largest firm since 1873 and had been strongly tied to the real estate market. That had helped it grow into one of the nation’s largest firms, with seven offices throughout California and one in New York City at its peak. But when the market went south, it did not have the practice breadth to weather the storm.

Its revenue dropps4· to $83.5  million in 2011 -its lowest point since 2000. That led to key departures, and it finally merged into McKenna, Long & Aldridge in March of2012.

McKenna Long has since been consoli­dated into Dentons, the largest law firm in the world, with approximately 6,600 attor­neys.

The primary problem is that there is not enough work in San Diego to warrant the high billing rates that national practices desire. Watanabe said that while tech and life sciences could once support those rates, national firms must seek global work from outside the  region  to  sustain San Diego branch offices.

“Law firms are finding that it is really not necessary to be in San Diego County to really warrant the existence of all major national and  international  firms  that are  already here,” Watanabe said. “The consolidation is going to come at the hands of the major law firms.  Billing rates that are between $800 to $1,000 an hour are just not necessary in San Diego.”

Some partners  are  leaving larger firms for ·smaller firms, where  billing  rates are lower. Watanabe helped facilitate Troutman Sanders’ acquisition of the intellectual prop­ erty team, led by David Devernoe, from Gordon  & Rees, one of San Diego’s bigger law firms.

Meanwhile, boutique law firms that sur­ vived the large-firm growth period may actu­ ally be in a better position to thrive locally, given their lower number of billable hours.

As for Whitton, success in  the future depends on balancing local work with global work and paring down superfluous expendi­ tures.

“There was a paradigm shift in law firms,” Whitton  said. “There were fundamental changes in how they approached their busi­ ness. No  question,  firms had to  do some downsizing, but well-managed firms then are even better managed now.”

 

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