| 2021 | 2022 | ||||||
| Price: | 1.10 | EPS | 0.15 | 0.25 | |||
| Shares Out. (in M): | 116 | P/E | 7.3 | 4.4 | |||
| Market Cap (in $M): | 128 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | 1 | EBIT | 0 | 0 | |||
| TEV (in $M): | 129 | TEV/EBIT | 0 | 0 | |||
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LCM is one of the few publicly-traded litigation funders and reminds me of where Omni Bridgeway was 3-4 years ago. LCM is now seeing a rapid increase in revenues from both its own book and its first fund. A second, larger fund should launch soon. I expect EPS of roughly 20p in the FYE June’22 and 30p in FY23. On a super-conservative quasi-liquidation analysis, LCM could generate £2.87 in cash per share from these two funds and its current book alone, vs a price of £1.10 today … and it would be unusual for a litigation finance stock to trade <2x book.
All amounts in A$ unless indicated. Market cap and EV above in £. EPS is CY
Peers Burford Capital and Omni Bridgeway (fka IMF Bentham) have been discussed quite a bit on this site, esp. Burford, and I encourage you to read those for industry background. LCM was posted by Ares in August 2019, but lots of good stuff has happened since then and it’s time to revisit.
I think lit finance is still in its early innings. The returns on this asset class are impressive, and while I do expect them to compress over time, I think there’ll be good opportunities for a while. The top firms were all founded between the late ‘90s thru 2013. Like we’ve seen in private equity, I expect the early movers to capture the lion’s share of the growth. As Ares put it,
clients rarely speak with more than a few litigation finance firms before making their decision. Engaging in an extra conversation with each new litigation finance provider would generally incur legal costs for the client who would need to pay its own legal counsel to speak with each litigation finance firm to educate the financier about the case. In addition, clients are usually wary about sharing confidential information widely, as this could waive attorney-client privilege.
Some parts of lit finance have become price competitive, like single-case litigation in the UK where clients seek funding out of necessity, or class-action suits in Australia. LCM tries to avoid this via partnerships with law firms where they get a first look at cases, via portfolio funding, and other relationships built over 23 years in the business. Moreover, LCM has stable capital in the form of a nearly net-cash balance sheet and high quality fund investors (large university endowments and family offices w/ experience in lit finance.) Its solid track record also helps: 95.4% win rate over 23 years, 153% ROIC and 78% IRR over the past 10 years (including losses). Notably, these have barely changed from the 5 year return metrics listed in LCM’s 2016 prospectus.
Portfolio deals are only a low-teens% of AUM currently, though this should grow. Unfortunately, Covid-19 made biz dev tough for a while. When LCM merged with Chancery Capital in 2018, it added EMEA to its traditional business in APAC, but it also added Nick Rowles-Davies who was instrumental in originating Burford’s first portfolio deal in 2016. Rowles-Davies was a founder of competitor Vannin Capital, founder of Chancery, and was MD of Burford’s ops outside of the Americas. Ran a lit finance fund at Elliot. He’s one of the thought leaders in this new area of lit finance (and is LCM’s highest paid employee).
Portfolios are sourced from corporations and law firms. They generally have a lower ROIC than single cases, as LCM offers better pricing in exchange for the diversification and exclusivity. LCM doesn’t simply take on all of a corporation's litigation - they do get to pick the cases they want. Target industries are typically high volume, low margin sectors such as construction, aviation and outsourcing where releasing cash that might otherwise be spent on legal fees can boost profits immediately. Despite Burford having grown its portfolio business tremendously since 2016, LCM reports a near-absence of competition for these deals.
LCM no longer competes for class-action litigation in Australia (a crowded field) and avoids the broker-led single cases where funders tend to compete on price. In APAC, LCM is the sole litigation funder recommended to the client in 65%-70% of cases while in the UK, it is closer to 60%. LCM is seeing a lot of growth in its Singapore office. Singapore recently moved to allow lit finance as it wants to be a regional center for dispute resolution. LCM reports that this market is dominated principally by two funders, one of which is LCM.
A fund manager once again
LCM was founded in Australia in 1998 and, like all of the pioneer lit finance firms, focused exclusively on insolvency litigation in the beginning. After about 8-10 years they diversified into commercial disputes. Funding came entirely from outside capital, but given LCM’s small size and (then) limited track record, this capital came with terms not nearly as good as what LCM and its peers are getting today. Thus came the decision to go public on the ASX in December 2016, and a further raise was done when LCM relisted on the AIM in December 2018 to enable LCM to invest its own capital. Given the time-lag between investment and resolution, the modern version of LCM is evident in the financials from FY18 onward.
Like its peers Burford and Omni Bridgeway, which got into the fund business in 2016 and 2017, respectively, LCM launched its first fund in 1H20 (ended June’20) with its US$150M Global Alternatives Returns (GAR) fund. Investors include two US university endowments, a global I-bank, a Swiss fund manager specializing in lit finance, and a large family office.
(Note: currencies get confusing with this name: LCM reports in A$, trades in £, raises funds quoted in US$, and also just borrowed 50M in US$)
GAR terms:
LCM usually sees litigation resolved within 24 to 36 months, with an average of 27 months. Cases that are settled early, often including insolvency litigation, can sometimes end in less than a year. Cases that stretch to 5 years are rare. Out of 44 cases in LCM’s current book, the oldest two are about 46 and 52 months. Note that Covid-19 often added 6 months due to court closings and other delays.
In less than 1.5 years, GAR is already 77% committed. So despite the 6-year life of GAR, most of the eventual proceeds will likely have been returned in the first 3 years. I expect that LCM will by then have a 3rd fund in which existing investors can invest some/all of the proceeds they’ll receive from the first fund.
LCM is now working on the first close of its second fund (no name yet), which will include both of the two cornerstone investors who took down US$100M of the first fund. This could be announced any day now, and should happen by the end of CY2021. The first close will likely be $180-200M in size, with the second close reaching the full US$300M.
A younger Omni in some ways
A Covid-recovery play (for long-term investors)
LCM describes litigation finance as being countercyclical. I think it would be more accurate to say it’s uncorrelated, except that recessions create a higher volume of gross claim value (the damages plaintiffs are seeking), but that higher earnings for lit finance firms are unlikely to line up with lower earnings in the rest of the economy. The reason is the typical lag between the cause of action, filing of a lawsuit, and eventual resolution. Moreover, with Covid, we’ve seen gov’t imposed moratoriums on insolvencies. Management said last month that it expects a wave of insolvency litigation to be filed in the next 6-12 months. On the 1H21 call in March they stated,
it's been our experience in the past, having funded through the global financial crisis in the back end of the Asian credit crisis, that those applications will continue for very many years thereafter until the limitation period sort of expires. So you've got a good 6-year flow once that starts of insolvency and restructuring-related disputes, which
will require funding.
Other stuff to expect
Now that LCM is running more AUM, mgmt expects to take on some larger and more complex cases, both of which are likely to increase the average months to completion from the current 27 to perhaps 36. Defendants obviously fight harder over larger sums of money. Moreover, mgmt has been candid that they expect this to compress returns somewhat, which I take to mean largely the IRR% metric. Longer cases typically have lower IRRs. I’m not terribly concerned about ROIC, as the fee structure charged to plaintiffs typically ratchets up in the event that litigation stretches beyond the 27 month mark.
Like Omni Bridgeway, LCM uses IFRS 15 and carries its investments at cost (Burford marks up its cases upon reaching certain milestones, as does Manolete, which is exclusively an insolvency player). So earnings have been very lumpy, and given the growth plus the typical 27 month litigation period, the company screens horribly. That should change soon given my earnings forecast.
Earnings will continue to be lumpy but less so as AUM grows. The company’s own book plus its fund are both highly diversified across cases, litigation types, and geography. There are no mammoth-sized outlier cases as you find with Burford or Omni.
Earnings will grow strongly. In each half-year, a large case could slip from one period to the next. But over time they'll grow. Consider that LCM will likely collect around 2.35x from past investments. The amounts were 3.5, 4.7, 7.2, 14.6, 28.0, 52.0, 88.0 millions in FYs ending June of 2015 thru 2021 (includes 10.7 and 39.5 millions of outside capital in FY20-21).
Valuation
I could make the current £1.10 share price look super cheap by slapping a multiple on 30p of ‘22E EPS. But given that LCM’s first fund is only 1.5 years old, and I want to be really conservative here, I’d rather not capitalize LCM’s burgeoning fund management business into infinity.
And I don’t think I need to do that to highlight the value here. Let’s instead suppose that LCM launches its second fund on identical terms, and then see how much cash its 100%-owned book and both funds would turn into after one-round of investment.
Assumptions:
Using this math, I wind up with £2.87 in cash per share, comprised of 30p from Fund 1 fees, 57p from Fund 2 fees, and £2.00 from LCM’s own book plus 25% co-investment in the funds. Now it’s true that IRR might compress, and also that the total fund size might not get invested, but there’s nothing in here for further reinvestment, additional funds … no growth whatsoever. A near 3x on that alone is pretty good I think.
First close of second, larger fund any day now
Past investments hit the income statement - much of the current book is pretty ripe
Tsunami of insolvency litigation as gov't moratoriums expire (in Australia for example)
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