Litigation Capital Management (LIT:65p), a provider of litigation financing which enables third parties to pursue and recover funds from legal claims, launched a US$150m (£118m) third-party fund in March. It’s absolutely flying, having committed 61 per cent of the capital raised across 18 committed projects, and could be fully invested by the year-end. Commercial disputes, class action and arbitration cases account for 73 per cent of the total.
Litigation Capital is investing 25 per cent of the fund’s capital on which it will take its share of profit, receive 25 per cent of profit on each fund investment over a soft hurdle rate of 8 per cent, and earns an outperformance return fee of 35 per cent over an internal rate of return (IRR) of 20 per cent during the fund’s six-year term. That outperformance fee should be achievable as Litigation Capital has only suffered a loss on 11 of the 226 separate investments it has made since being founded, and boasts a cumulative IRR of 78 per cent over the past nine years. Management is highly selective though, committing capital to only 18 of the 522 applications received in the last financial year.
During my results call this morning, chief executive Patrick Maloney outlined plans to launch a much larger second fund (US$300m-US$350m) before the year-end to tap into investor demand for an asset class that is a major beneficiary of the economic downturn (insolvency-related litigation rises sharply during such periods historically), and the changing attitude of corporates in the way they fund litigation. Indeed, even more corporates will now be capital constrained, so will need to seek off balance sheet funding.
Guidance points towards gross profit of A$30m-A$47m in the 2020/21 financial year, a forecast that supports Arden Partners’ forecast 61 per cent increase in pre-tax profit and EPS to A$14.8m and 10c (5.7p), respectively. This assumes seven settled cases, three of which were delayed through the court process due to Covid-19, the only reason why last year’s profits were slightly shy of analysts’ forecasts. This is merely a timing issue. I am not concerned by the absence of a dividend either as the board is still committed to its dividend policy, but is redeploying capital to launch the funds businesses.
The bottom line is that the high returns Litigation Capital makes from its directly-held portfolio is simply not reflected in a price to book value of 1.6 times given litigation investments are held at cash cost. Furthermore, the strong progress on the third-party funds business adds significant weight to the 120p target price. Buy.
Urban Exposure outlines plan for cash returns
Specialist residential development finance provider and asset manager Urban Exposure (UEX:65p) is making stellar progress at winding down its loan portfolio and returning cash to shareholders.
In fact, cash balances have increased from £18.6m to £51m (32p a share) since the end June half-year end, a sum that backs up half of Urban Exposure’s market capitalisation of £102m and accounts for 41 per cent of its net tangible assets of £122.8m (77p a share). The plan is to return £26m back to shareholders through a tender offer in the next two months, but that sum may increase if further loan redemptions occur prior to the announcement of the tender offer.
The board have also issued tighter guidance and now expect the company to return between 72p to 78p a share in total to shareholders, 90 per cent of which will be returned within 12 months. This implies 65p a share of cash receipts within 12 months at the lower end of the range, effectively giving investors a free option on any capital distributions made beyond September 2020 given the share price is also 65p.
It seems a sensible projection to me given that the board have written off all intangible assets to reflect the wind down of the business (£12.4m impairment charge taken in the half-year results), and sliced £3m off loan receivable balances, having assessed the portfolio’s likely realisable value within the time constraints for making the capital returns. The remaining portfolio of loans has a weighted average loan to gross development value of 64 per cent, but this metric does not fully reflect the underlying level of security against the loans, due to the stringent pre-sale requirements Urban Exposure negotiated as part of any development loan agreement.
The progress made by the new board of directors explains why Urban Exposure’s share price has risen from the 55p level after I last suggested buying (‘Bargain shares opportunities’, 29 June 2020), albeit the holding has produced a 6 per cent loss since I initiated coverage in my March 2019 Alpha Report. Nonetheless, with capital now being returned to shareholders, and the loan book being wound down, the risk:reward remains favourable. Buy.
Please note my next column will be published at 12pm on Wednesday, 23 September.
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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.
