In a downturn, business people like to point out, some truths are laid bare. “You only find out who is swimming naked when the tide goes out,” Warren Buffett famously told investors in a 2002 letter. Which is why, after the 2000 dot-com crash, it was the United Kingdom’s elite law firms that were found to be revealing a little too much skin.

This time, it’s different. After madly shedding partners, doubling-down their bets on foreign offices, and tightening their management controls, the global Magic Circle practices– Allen & Overy, Clifford Chance, Freshfields Bruckhaus Deringer, and Linklaters–look a little better-dressed than many of their rivals in the United States. The irony is that the English firms have succeeded by following the lesson of their American peers: They’ve hedged their bets. For U.S. firms, in the past that has meant a healthy dose of litigation and bankruptcy work to balance a corporate shortfall. For the British, the strategy has been geographic: spreading their risk across several continents.

“The U.K. firms have their international investment time behind them and have shown that they can deliver value to their clients around the world,” says Tony Williams, head of London’s Jomati Consultants LLP. “Plus, they’re far better-run than they have ever been.” Williams, a former managing partner at Clifford Chance, can speak from experience.

For the U.K. firms, the international networks are producing more revenue than their massive London offices. In the most recent fiscal year, which is captured in the Global 100 charts (see links below), Allen & Overy for the first time brought in more revenue from its overseas offices than it did from London. (The Global 100 is a joint project of The American Lawyer and Legal Week, a sibling publication.) At Clifford Chance, about $1.56 billion of the firm’s $2.66 billion in revenue came from international offices, with a growing proportion from emerging markets.

Last year 15 percent of Clifford Chance’s revenue came from the growth markets of central and eastern Europe, the Middle East, and Asia, says managing partner David Childs. This year he predicts that proportion will expand to 18-20 percent. “Our offices in these markets are doing very well and will continue to do so this financial year,” he says. The firm has also taken a global approach to reducing its cost base, moving parts of its support functions in IT and accounting to India. This summer Clifford Chance had 110 support workers in New Delhi; by next summer, it is forecast to have more than 300, including a tranche of paralegals.

The British are not strangers to success. In 2001, before the full effects of the dot-com crash hit, six U.K. firms were among the 20 most profitable in The Global 100: Slaughter and May, Herbert Smith, Linklaters, Freshfields, Allen & Overy, and Clifford Chance. By 2002, just three made the grade; by 2004, only Slaughter and May did. The impact of the crash was felt later and deeper by the English practices. They also took a hit in Asia, with the 2003 outbreak of SARS leading to a regionwide slump.

In the first half of the decade, all the leading U.K. firms reported drops in profits per partner (PPP). Their costs were out of control, and their international networks had yet to deliver promised gains in profitability.

Clifford Chance, Linklaters, Freshfields, and Allen & Overy reached their profit nadirs in 2002, 2003, or 2004. Linklaters, for instance, had PPP of $960,378 in 2002, the lowest that year of the Magic Circle; Clifford Chance turned in its own low of $946,000 two years later.

Meanwhile, top U.S. firms pulled ahead, buoyed by their countercyclical practices, which form a higher proportion of their businesses than at their British counterparts. Paul, Weiss, Rifkind, Wharton & Garrison, a U.S.-law-only shop where about half the lawyers are litigators, rose from fifteenth in The Global 100′s profits per partner rankings in 2001 to fifth in 2002, and has not left the top ten since. Firms with leading bankruptcy practices, such as Kirkland & Ellis and Weil, Gotshal & Manges, also made significant gains in profitability. Kirkland increased its PPP from $1.4 million to $1.9 million between 2001 and 2004; Weil’s profits grew from just more than $1 million to $1.5 million. As bankruptcy eased off, Kirkland and Weil pushed ahead with robust litigation and corporate practices.

Thanks to a less litigious climate in the U.K., the leading London firms have never had the same hedge. Among British firms, Herbert Smith-home to one of the premier litigation practices in London-makes the largest proportion of its revenues from litigation. In the year ended April 30, the practice contributed around 36 percent of Herbert Smith’s $844.5 million in revenue. Linklaters’s commercial practice, which includes litigation as well as other areas, such as real estate and intellectual property, contributes about 23 percent to the firm’s revenues (the rest comes from its corporate and finance practices). Allen & Overy’s litigation group contributed just 9 percent to the firm’s top line.

What is not clear yet is the extent to which the U.S. firms’ larger countercyclical practices will protect their profit growth. There are some signs that bankruptcy work is starting to increase-in July the Automated Access to Court Electronic Records reported that the number of bankruptcy filings in the U.S. had surged by 57 percent, compared with July 2007. But the market is yet to see the large-scale restructuring mandates that were so profitable in the last downturn.

The Citigroup 2008 half-year survey paints a particularly gloomy picture of the U.S. market. A banker to the majority of Am Law 200 practices, Citi reveals that average profitability is down across the board in the U.S., particularly among the top-tier practices. Citi’s survey of 165 firms from The Am Law 100 and the Second Hundred, as well as some smaller firms, reported that profits per equity partner dropped 9.1 percent on average in the first half. For the most profitable practices, the fall was as high as 11.7 percent.

In the U.K. the prognosis is bleak but not quite as bad. “We’ve had a better first three months than I would have expected, but it will be a very good performance to post a material increase in PPP,” says Herbert Smith managing partner David Willis. Clifford Chance’s Childs says that a good performance this financial year will be growth of more than 10 percent in the emerging markets and 5 percent in London, the U.S., and the Eurozone (nations that have adopted the euro as their sole currency).

Structurally, the top U.K. firms are very different now than they were at the beginning of the decade. The English firms have become more efficient and have improved their profitability with the zeal of a Wall Street stalwart. Freshfields now has roughly the same number of equity partners-400-that it had in 2001 (it recently cut the numbers from a high of 521 in 2006) but has more than doubled its revenue in the same period (it stood at $937.5 million in 2001, compared with $2.358 billion today). Clifford Chance now has fewer equity partners than it did in 2001-395 today compared with 448-and roughly the same number of lawyers, but has added more than $1 billion to its top line.

“My view is that the downturn could be very different this time for law firms,” says Mike Francies, head of Weil, Gotshal‘s London office. “The U.K. firms now have widespread international networks that are very successful, but the downside for them is that they still have a huge number of mouths to feed in London.” In other words, for all its overseas growth, the Magic Circle is still overweighted toward London–and London, too, is feeling the effects of the downturn. Clifford Chance has the largest office in London, with around 1,000 qualified attorneys, while New York’s largest firm, Skadden, Arps, Slate, Meagher & Flom, has 845 attorneys in New York, according to The National Law Journal‘s 2007 NLJ 250. ( The National Law Journal is a sibling publication of The American Lawyer.)

Entering this downturn, the U.K firms are in their strongest position since the nineties. In the short term, they look more resilient than many of their U.S. counterparts. A sustained slide in the pound will take some of the gloss off their numbers, but the continued strength of the euro provides some compensation. And there is greater risk in emerging markets. Russia’s recent conflict with Georgia and subsequent posturing against the West, for instance, led to an 18 percent fall in Moscow’s stock exchange-evidence that gains in some emerging markets are at the mercy of political power games as well as business strategies.

The U.S. firms have not seen a marked increase in litigation and bankruptcy work, but the smart money suggests that it’s only a matter of time before they do. Those with larger, established international networks, such as White & Case, are better placed. Further, there will continue to be a demand for the most elite U.S. corporate firms, such as Cravath, Swaine & Moore and Wachtell, Lipton, Rosen & Katz.

It won’t be until next year’s Am Law 100 and Global 100 rankings that we see just how far the tide has gone out for the legal market. For many firms–both British and American–it won’t be a pretty sight. Ladies and gentlemen, hold on to your bathing suits.

The Charts