A Case for Bulls
Litigation Financier, IMF Bentham (ASX:IMF) has finished the year in the middle of its 5-year transformation towards a “fund manager” business model where it will manage third party capital in its Special Purpose Vehicle funds. Naturally, the transformation will show some “growing pains” while the legacy business model reflects the historical issues of lumpy returns. Nevertheless, we are pleased with the company’s progress so far and maintain our BUY rating.
What’s New?
In our previous coverage of the company back in July (FAT-AUS-883) we looked at the company’s various case updates from its domestic Australian and International (largely US) investments. The updates were positive and indicate that the company was well placed to benefit from its new round of funding using the Special Purpose Vehicle (SPV) model where it can expand its case exposure to other regions.
Since then, the company has announced a couple of salient updates with the first (i) being the long awaited FY18 results which will be the primary focus of this update and followed by (ii) an update on the CEO’s employment terms and remuneration package.
In a filing dated 07 September 2018, the company announced that Mr Andrew Saker, CEO and Managing Director, has changed his employment terms to better align his interests with the shareholders.
Mr Saker will no longer participate in the company’s short-term incentive plan (cash bonus) at year-end but will receive a bonus after a 3-year performance period. That aside, Mr Saker will also no longer have a fixed term employment with the company but will now be subject to a “rolling contract” where he may be terminated on a 6-month notice if his performance isn’t up to par. Finally, the company will also update his retirement package but is subject to shareholder approval in the upcoming shareholder meeting this 21 November.
With that out of the way, we now look at the company’s results for the year:
FY18 Results Review
As a reminder to Members, the company’s business model involves investing in class action lawsuits against companies which can take several years to bear fruit and this will naturally lead to lumpy revenues and earnings with periods of lower than average cash inflows as the company waits for some cases to be resolved. According to management, the average length of cases is 2.6 years and the average return on invested capital is 1.5 times, including lost cases.
That said, we believe that IMF Bentham (ASX:IMF) can be viewed akin to a traditional value investing fund where the fund’s short-term performance can underperform the market as the investment ‘picks’ take time to payoff. Thus, the best way to treat the company is based on a longer-term view and with its track record of success, we remain confident in its potential.
This year was more of an “investing” period for the company with the recent launches of the SPV. Management then did some “housekeeping” by consolidating some cases in the different funds; a case in point is the company transferring the majority of its US investment portfolio to the Bentham IMF 1 US Fund while also deploying capital to Asia and European cases.
Source: 23 August 2018 Company Presentation
With a greater degree of “investing” activity in the year and fewer case resolutions, Net Revenues (Net Income from Cases) for the period were down 37.0% year-on-year to $71.2 million. This lower year-on-year result was nevertheless in-line with our expectations as the company has provided steady progress updates on case performances.
Source: 23 August 2018 Company Presentation
On the cost side, Litigation Expenses for the year were up 8% year-on-year at circa $54.7 million. This largely reflects the court dismissal of the USA Fund Case 003 arbitration claim (in the form of a cashless write-down) worth circa $4.036 million. There was also the “Confidential Hong Kong Matter” which, though favourable, had a significantly lower margin.
There were multiple cases that are still ongoing (Wivenhoe among others) as well as increased hiring activity in the Investment Team due to the SPV funds. However, management focussed on overheard at the corporate and branch level.
These upticks in expenses were already factored into our expectations, and covered in our previous review (FAT-AUS-859).
Overall, IMF Bentham (ASX:IMF) ended FY18 with a net loss of $7.8 million compared to last year’s profit of $15.4 million. Again, we note that such a variation in results (lower ROIC or lost cases) is to be expected for IMF Bentham but the fact is that this period had a fewer number of total cases resolved and exacerbated results this time around.
In our view, this provides further validation of management’s longer-term plan (five-year business transformation plan) to diversify the investment portfolio away from idiosyncratic case risks.
Outlook
Going forward, we believe the company is well placed having already set up operations in Asia and Canada while the recent footprint expansion back into Europe will broaden the case exposure for the group.
We also like the new SPV funding model the company is using as it will transition the company from managing its own balance sheet to also manage third party capital, generating additional revenue while simultaneously reducing risks.
Source: 23 August 2018 Company Presentation
This also rides the new secular trend of Litigation Financing – which originated in Australia – which is becoming increasingly mainstream and a legitimate Alternative Asset class.
Turning to the charts, and on the daily, resistance sighted at the 50-day moving average (red line) followed by the February intra-month low of $2.73 (horizontal blue line) have been reclaimed. A move to the February high of $3.33 is the next focal point.
With reference to the monthly chart, prices have closed (on a monthly-basis) above the 78.6% Fibonacci retracement of $2.15. This is a positive and have seen a move back above support at $2.48. From here an initial target of $2.91, being the 127.2% Fibonacci extension, has also been taken. The 161.8% Fibonacci extension of $3.45 is the next focal point of resistance. The long-term uptrend remains firmly intact, and will likely dictate the broader direction of IMF Bentham.
Summary
IMF Bentham’s result this time around highlighted the issues of its legacy business model which runs the risk of lumpy returns while cases are still ongoing. Nevertheless, we are pleased with the company’s progress so far and look forward to the completed transition towards a “fund manager” business model.
Over the longer term, we continue to have a positive investment stance on IMF Bentham (ASX:IMF). This is based on our expectation that the breadth and depth of the company’s case portfolio and funding capability, in combination with its longer-term track record on case outcomes, provide a solid platform from which to generate attractive future returns for shareholders.
Accordingly, IMF Bentham (ASX:IMF) will remain firmly held in the Fat Prophets portfolio. For Members with no current exposure to IMF Bentham, we rate the company’s shares as a buy.
