Litigation funder LCM makes an eye-watering return

Litigation Capital Management (LIT: 82.5p), a provider of litigation financing, has made an eye-watering return on a directly funded arbitration investment.

For good measure, LCM’s first Global Alternative Returns Fund (GARF) invested in the case, too, good news for shareholders as LCM has also earned a A$15.1mn performance fee. LCM 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 internal rate of return (IRR) of 20 per cent, thus providing an attractive income stream to complement realisations from its own directly held portfolio.

LCM and GARF invested A$2.3mn and A6.9mn, respectively, to support the claimant in proceedings relating to a long-running dispute [undisclosed for confidentially reasons] in the London Court of International Arbitration. Following an award in the claimant’s favour, LCM’s direct investment has generated a gross profit of A$14.6mn, or seven times its capital invested. The gross profit more than doubles to A$29.7mn once the performance fee from GARF’s investment is included, or 13 times the capital LCM invested. GARF investors made a 415 per cent gross profit, highlighting how managing third-party funds can leverage the group’s impressive track record and boost returns for shareholders (IRR of 79 per cent on all completed cases inclusive of losses since June 2010). 

In April 2023, LCM almost doubled its gross profit to A$10.4mn on a A$2.1mn litigation investment, a near-500 per cent return on capital invested, after performance fees are included. Specifically, the group and GARF provided funding to a partner of FRP Advisory (FRP) to cover proceedings issued in the High Court against Darty, a multinational electrical retailer based in France, in relation to the collapse of Comet Group.

Modest rating and rerating potential

The profit earned on the latest award as well as three other awards since the start of 2023, including one against KPMG, the former auditor of Carillion, implies the group has posted gross profit of A$53.3mn for the financial year to 30 June 2023, or 103 per cent of house broker Investec’s previous forecast. On this basis, expect pre-tax profit of A$25.3mn and earnings per share (EPS) of 16.4¢, implying the shares are rated on a modest price/earnings (PE) ratio of 9.5 and price-to-book value ratio of 1.4 times.

Moreover, with a raft of directly held and GARF investments awaiting judgment or award supporting expectations of a near doubling of pre-tax profit in the 2023-24 financial year, and the share price on the cusp of breaking out from its base formation, the fundamental and technical drivers are in place for a major re-rating. Indeed, the shares are priced on only 1.2 times 12-month forward book value and on a modest prospective PE ratio of five.

So, although the holding has only produced a modest 6.1 per cent total return (TR) on the entry point in my 2019 Bargain Shares Portfolio, albeit that’s better than the 8.2 per cent negative return on the FTSE Aim All-Share TR index in the same period, the shares continue to rate a buy.

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