The Supreme Court has ruled that litigation funding falls within the definition of ‘claims management services’ which includes ‘the provision of financial services or assistance’ in the Compensation Act 2006. The judges ruled that as the arrangements had been entered into without satisfying conditions for damages-based agreements, they are unenforceable if entered within the UK.
The decision could impact UK litigation funding arrangements where the funders’ interest or return is calculated as a percentage of the Courts award. However, the International Legal Finance Association and Association of Litigation Funders of England and Wales has stressed that the ruling would only impact how legal finance agreements are structured, so that they comply with the regulations.
For instance, Litigation Capital Management (LIT: 87p), an asset manager specialising in funding disputes, structures contracts so that its return is calculated as a rising multiple of invested capital over time. Therefore, its arrangements are unaffected by the Supreme Court’s judgment.
Furthermore, LCM actively manages portfolios of dispute investments across several industries, dispute types, geographies and jurisdictions to diversify the spread of cases. As such, neither existing investments nor LCM’s business model is at risk. In fact, the Supreme Court decision could positively impact its future market share, given the lack of diversity of several of its competitors.
LCM’s results will flag up hidden value
- Positive outcome on another fund investment
- Move to Fair Value Accounting
- Annual dividend per share of 2.25p to be declared
A good example of how LCM’s differentiated approach to rivals is highlighted by yet another positive outcome from its first Global Alternative Returns Fund (Garf).
LCM funded a claim advanced regarding a breach of a bilateral investment treaty and brought under the International Centre For Settlement Of Investment Disputes (ICSID) Convention. An ICSID tribunal has issued an award on jurisdiction, liability, damages and costs in favour of LCM's funded party. The quantum of the award is $76.7mn (£59.2mn) plus interest and costs. As liability and quantum risk has been decided, it significantly de-risks the $4mn investment LCM funded in this dispute to date.
It also means that the group is in line for a hefty profit. That’s because 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.
The board have also decided to transition financial reporting of its investments to Fair Value accounting to put LCM in line with industry peers. The forthcoming 2023 financial results will be presented under the existing cash accounting policy and the newly adopted Fair Value accounting. The implication being that revenue recognition will become less lumpy in future given the high returns LCM makes on its investments. Since June 2010, LCM has delivered an internal rate of return (IRR) of 79 per cent on all completed cases, inclusive of losses. Analysts at house broker Investec note that the change in accounting policy could aid the group to move its domicile to the UK from Australia and in the process attract more interest from UK institutions.
Furthermore, having delivered a record performance in the financial year to 30 June 2023, the board plan to declare a dividend per share of 2.25p when LCM releases results in September, a pay-out that analysts at Investec had not anticipated. The brokerage expects LCM to report 70 per cent higher revenue of A$51.7mn (£27mn) in the 12-month period and increase pre-tax profit by a quarter to A$25.3mn. On this basis, expect earnings per share (EPS) of 16.4c (8.6p). Investec expects EPS to almost double to 30.6c (16p) in the new financial year, implying the shares are rated on a forward price/earnings (PE) ratio of five.
So, LCM is well-funded, delivering positive news flow, has a modest earnings multiple and the forthcoming results will reveal material hidden value. The shares also trade on 1.8 times spot book value under conservative cash accounting – and therefore I re-iterate my buy call (‘Litigation funder LCM makes an eye-watering return’, 19 June 2023). Buy.
RBG investors spooked
- Rosenblatt and Memery Crystal perform in line with expectations
- Convex Capital has a strong pipeline of deals
- Annual cash profit guidance lowered to £10-12mn
- Portfolio of conditional fee and damaged-based arrangements written down to zero
- Dividend suspended to pay down debt
The same cannot be said for RBG (RBGP: 18p), a professional services group that encompasses London’s mid-tier law firms Rosenblatt and Memery Crystal and corporate finance boutique Convex Capital. It has exited all its litigation finance matters, which has come at a cost.
In a pre-close trading update, the group has written down the value of all the remaining conditional fee arrangements (CFA) and damaged-based arrangements (DBA) to zero including the four remaining fully funded LionFish investments (‘Why is RBG one of the lowest rated stocks in London’, 12 July 2023). The total non-cash cash write-off of £13.3mn (14p) includes a £9.3mn investment in a single case that the board now believe will not be successful. Any successful outcome of the other cases will be reported as revenue in the future. The impairment equates to 21 per cent of the group’s last reported net asset value of £61.4mn (64.5p).
Earnings downgrade undermines confidence
It’s not the only news to spook investors. The board has decided to suspend the dividend to accelerate a debt reduction programme and is now guiding shareholders to expect full-year cash profit of £10-12mn rather than the £14.9mn forecast by house broker Singer Capital Markets.
That’s partly because, although the corporate finance boutique, Convex Capital, has a strong pipeline of 18 deals, transactions are taking longer to complete. Singer now expects Convex to deliver £4.5mn of annual revenue, down from £7mn previously forecast and £5.4mn in 2022. The broker also reined in its full-year revenue estimate from £45mn to £40mn for the legal services division. On this basis, Singer now expects both full-year pre-tax profit and EPS to halve to £5.9mn and 4.5p.
Net debt forecasts adjusted
The broker also expects a small rise in year-end net debt from £19.2mn to £20mn, rather than a previously forecast reduction to £15.5mn. This implies a leverage ratio of 2.7 times cash profit (pre-IFRs 16), above the 2.25 times loan covenant.
However, the directors are in talks with the lender and are confident of obtaining a waiver if this scenario plays out. Singer’s cash profit forecast is at the bottom of management’s new range, so if RBG delivers cash profit at the top of the range then the leverage ratio would still be within the loan covenant.
RBG's share price declined 29 per cent following the trading update and the company is now being valued on a current year PE ratio of four, and a miserly three times forecast cash profit to enterprise valuation – 70 per cent rating discounts to peers. I would not sell out at this bombed-out level. Hold.
