- Assets under management (AuM) rise a third to A$336m
- Annual adjusted operating profit increases 47 per cent to A$16.4m on 3 per cent lower revenue of A$37m
- A single case in New Zealand produces 300 per cent return on invested capital
- US$150m third-party fund now has 88 per cent commitments and follow-on US$300m fund to launch shortly with first close before year-end
Litigation Capital Management (LIT:94p), a provider of litigation financing that enables third-parties to pursue and recover funds from legal claims, has successfully navigated the Covid-19 pandemic and looks set to deliver bumper returns for shareholders in the coming years.
Despite the pandemic causing disruptions to the court and arbitration process, and in progressing due diligence on applications, Litigation Capital still made investment commitments of A$109m having assessed 572 applications (10 per cent rise year on year) in the 12 months to 30 June 2021, albeit that was down from A$147m in the prior year. Given the group’s impressive track record – only 11 financial losses from 237 investments in the past decade and cumulative return on invested capital (ROIC) of 153 per cent – it’s no surprise to see the third-party fund Litigation Capital launched in December 2019 now 88 per cent fully invested (including projects in due diligence). This helped lift AuM by a third to A$336m.
A follow-on US$300m fund is currently being marketed with first close imminent and has the support of the first fund’s cornerstone investors. Litigation Capital’s impressive portfolio internal rate of return (IRR) of 78 per cent explains why investors continue to back the investment manager. Litigation Capital receives 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 IRR of 20 per cent, thus providing an attractive income stream to complement realisations from its directly held portfolio.
Litigation Capital’s legal eagles’ ability to cherry-pick the right cases to back was for all to see in the latest financial results; one case involving a long-running partnership dispute in New Zealand produced two-thirds of the group’s annual revenue and an eye-watering 300 per cent return on the A$6.2m Litigation Capital invested over a 30-month period. Moreover, with 18 of the 44 cases in the directly held portfolio now 25 months or longer in duration – the 10-year average project length is 27 months – there are real prospects of settlements accelerating in the coming years.
|Simon Thompson's 2019 Bargain Shares portfolio performance|
|Company name||TIDM||Opening offer price 01.02.19||Bid price 21.09.21 or exit price (see notes)||Dividends||Percentage change|
|TMT Investments (note one)||TMT||250¢||1,090¢||20¢||722.6%|
|Futura Medical (note two)||FUM||14.85p||34p||0p||129.0%|
|Litigation Capital Management||LIT||77.5p||92p||0.71p||19.6%|
|Mercia Asset Management (note three)||MERC||29.57p||27.5p||0p||-7.0%|
|Jersey Oil & Gas||JOG||205p||138p||0p||-32.7%|
|FTSE All-Share Total Return index||6,852||7,980||16.5%|
|FTSE AIM All-Share Total Return index||1,023||1,452||41.9%|
Note 1: Simon advised taking profits on TMT Investments at 580c a share to bank 140 per cent gain including dividend of 20c ('Takeovers, tender offers and taking profits', 9 September 2019), and subsequently advised buying back the shares at 318c ('On the hunt for recovery buys', 6 July 2020).
Note 2: Simon advised taking profits on Futura Medical at 34p a share on Monday, 14 October 2019 ('Bargain Shares: golden opportunities', 14 October 2019). The selling price is used in the performance table. Current share price 40p.
Note 3: Simon advised selling Mercia Asset Management at 27.5p a share on Monday, 9 December 2019 ('Taking stock and profits', 9 December 2019). The selling price is used in the performance table.
Source: London Stock Exchange opening offer prices at 8am on Friday, 1 February 2019 and latest bid prices or when Simon advised exiting the holding.
Indeed, since the financial year-end Litigation Capital has generated revenue of A$5.6m and profit of A$4m from a court settlement in Australia. This judgment has been obtained 22 months following the commencement of funding and although it is subject to appeal, the structure of the funding means that Litigation Capital’s return will ratchet up from this point even though the investment risk is now relatively low.
Taking account of likely gains from other cases that are expected to settle in the 12 months to 30 June 2022, analysts at Investec Securities expect both annual pre-tax profits and earnings per share (EPS) to more than double to A$37.7m and 23.8c (12.7p) on revenue of A$57.1m. The range of analyst estimates is quite wide – Arden Partners is pencilling in pre-tax profit of A$29m and Canaccord Genuity forecasts middle of the range A$32.3m – the disparity is explained by the anticipated timing of realisations and the fact that projects are held at cost in the balance sheet, so gains are only realised on case settlements. This also means that LCM’s historic price-to-book value of 2.2 times materially understates the value held on its balance sheet given the group’s high returns on invested capital.
Importantly, the business is well-funded to continue to back new projects – net debt was negligible at the year-end with Litigation Capital holding gross cash of A$49.7m and having access to a further US$20m of funding on a four-year credit facility. Bearing this in mind, the directors report that almost half of corporates report a “significant increase in dispute volumes over the past year, with a consequential impact on resourcing that will lead to an inexorable rise in the consideration and use of disputes financing”.
They also expect that the “pandemic is likely to produce more traditional corporate and commercial disputes as the traditional areas of disputes such as construction and shipping, already hit by the early effects of the pandemic, will be joined by an increase in aviation, retail, hospitality, leisure and infrastructure related litigation”.
Moreover, the “financial uncertainty in the coming year is likely to give rise to an inevitable increase in insolvency related disputes”. That’s important as disputes have historically increased in uncertain financial times, thus underlining the countercyclical and counter recessionary nature of disputes financing. Litigation Capital is ideally placed to benefit.
The shares have drifted since I upgraded my target price to 150p over the summer after my original 140p target was achieved (‘Backing litigation funding winners’, 13 July 2021). However, trading on a forward price/earnings ratio of 8 using the average of the three broker estimates, and priced on a modest price-to-book value, the risk is heavily skewed to the upside. Strong buy.
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