Litigation Capital Management settles Australian class action
LCM announced another case win during the month, this time totaling A$132m. While it hasn’t been announced what proportion of the claim LCM will receive, we estimate it to be around ~A$20m. For context, LCM’s revenue for 2022 was A$47m.
LCM is a leading provider of funding for the pursuit and recovery of legal claims. They have an unparalleled track record driven by disciplined project selection and robust risk management. CEO Patrick Moloney, has been a director of the business since 2003 and owns 8.8% of the company.
Disputes finance, also known as litigation funding or third-party funding, is essentially a finance product whereby a funder assumes some or all of the financial risk of a legal claim in exchange for a share of the amount recovered from that proceeding. They essentially cover the claimants legal costs (solicitor fees, barrister fees, independent experts, court fees) and only recover the costs and funding premium if the claim is successful.
Much like a fund manager picking stocks, LCM’s investment managers review hundreds of applications for funding each year and allocate capital to the best investment opportunities — in this situation, legal cases that they believe they are highly likely to win. Over their 24-year history, LCM has invested in 244 separate disputes and only suffered a financial loss on 11.
LCM operates two complementary business models.
The first is direct investments made from LCM’s balance sheet. This invested capital has an 11-yr track record of 163% returns on invested capital. Unlike other listed peers though who do what is called “fair value accounting”, LCM conservatively carry their invested capital at cost until a case is closed.
The 2nd business model is a funds management business. LCM’s stella track record and the uncorrelated nature of this asset class has allowed them to raise money from pension funds, university endowments and family offices. Across two funds, LCM has deployed A$118m and has over A$330m of capital committed.
Since starting the funds management business in 2020, cases are being funded 25% from LCMs balance sheet and 75% from the 3rd party funds. The returns are then split accordingly, but LCM earn additional performance fees as a manager, with extra kickers for IRR’s >20%.
Typically, investments have taken 27 months to reach a resolution. However, because of the backlog in the courts during the pandemic, and the increased size and complexity of LCM’s cases, their portfolio maturity has elongated to 36–42 months. They’ve deployed a lot of capital in the past 2–3 years, with not much to show for it yet. The graph below highlights how the maturity of their portfolio has lengthened.
What this means is that we are starting to see an increased velocity of case wins over the coming 12-months, and with that, cash starting to flow back into the business. The recent announcement is a timely example.
Ordinarily too, you’d think that a longer investment period would decrease your return on capital (because of the time value of money). However, the underlying contractual funding agreements are typically structured with rising multiples over time, so returns are often enhanced as a result of delays.
This is a lumpy cash flow business. It is hard for the market to place a PE multiple on the stock, or for sell side analysts to plug short term earnings expectations into their models (they’ve actually given up). This suits us. We aren’t concerned about the short-term. This business has proven its unique ability to compound its cash flows significantly over long-periods and we expect that to continue.
While this growth is fantastic, we wouldn’t be there if not for sufficient downside protection — our margin of safety.
We take comfort from the fact that LCMs current market cap of A$165m is largely covered by the company’s net asset position.
With the joys of compounding, we believe that Patrick and his team will continue to progress this into a multi-billion dollar asset-management business with a multi-hundred million dollar balance investing alongside.
The information provided in this newsletter is for general information purposes only and does not take into account your personal circumstances. It is not intended to be a substitute for professional advice, so please seek the advice of a licensed financial advisor before making any investment decisions. The author and publisher of this newsletter may hold positions in the stocks mentioned. The author is a representative of Lugarno Partners Pty Ltd AFSL №508934.
