Exploit this litigation funder’s miserly rating

The first-half profit numbers from Litigation Capital Management (LIT: 70p), a provider of litigation financing that enables third-parties to pursue and recover funds from legal claims, mask strong momentum across the business.

Following the period end, an Australian class action produced an A$5.8mn gross profit on the A$8.3mn capital LCM invested. Moreover, the group had a successful outcome on a claim against KPMG, the former auditor of Carillion. The A$9.1mn funding of the litigation was financed 75 per cent by LCM’s first Global Alternative Returns Fund (GARF) and 25 per cent by the group. Both the fund and LCM made a gross profit of A$6.3mn, but the group’s return was 2.78 times its capital invested, or three times higher than the fund’s return.

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, thus providing an attractive income stream to complement realisations from its own directly held portfolio. The performance fee on the Carillion case doubled LCM’s profit on the case, highlighting how managing third-party funds can leverage its impressive track record and boost returns for shareholders (IRR of 79 per cent on all completed cases inclusive of losses since June 2010). Factoring in both settlements, pro-forma adjusted operating profit would have been A$6.3mn rather than a loss of A$5.5mn.

Strong pipeline of cases awaiting judgement or award

Furthermore, the first GARF provided liquidation finance to a partner of FRP Advisory (FRP), an additional liquidator of the former Comet Group to cover proceedings issued in the High Court against Darty, a multinational electrical retailer based in France. At the time of its insolvency, Comet was the UK's second-largest electrical retailer with 239 stores and 6,900 employees.

The legal action relates to a transaction that gave preference in Darty's favour prior to Comet entering administration, thus reducing the amounts available for Comet's creditors. Last autumn, the High Court awarded £110mn in the favour of the liquidator. An appeal by Darty will be heard in June or July with final judgment around three months later. The fund has invested around £3.1mn to date in the case, so LCM should be in line for another chunky performance fee.

It’s worth pointing out that LCM’s total assets under management have increased from A$414mn to A$537mn (including commitments in the second GARF) across a well-diversified portfolio of more than 50 investments since June 2022. Chief executive Patrick Moloney highlights the fact that a rising number of cases related to shareholder mis-selling, fraud and competition claims are driving demand for the group’s capital. He also notes an increase in restructuring and insolvency, with online and high-street retailers among the first to suffer in economic downturns.

This augurs well, as does the fact that three directly held investments are awaiting judgment or award, a further three are awaiting final hearings in 2023 and no fewer than eight fund investments are at or close to award, with a further two scheduled for final hearings by the year-end.

Modest valuation

House broker Investec is maintaining pre-tax profit estimates of A$25.3mn (2022/3) and $47.7mn (2023/24), which support EPS of 16.4¢ and 30.6¢. On this basis, the shares are rated on modest forward PE ratios of 7.8 and 4.2, respectively, and prospective price-to-book value ratios of 1.25 and parity.

Admittedly, the share price has moved sideways since the annual results (‘A lowly rated litigation funder’, 20 September 2022), and is slightly below the 77.5p entry point in my 2019 Bargain Shares Portfolio, but the unwarranted low rating and industry demand drivers still point to a positive outcome. Buy.

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