Litigation Capital Management (LIT:117p), a provider of litigation financing, has reported record results buoyed by settlements from its directly held portfolio as well as bumper fees earned from third-party funds.

The performance of both the group and the fund interests made for a good read. The third-party funds delivered A$70.2mn (£36.5mn) of post-tax profit and a hefty $24.6mn of performance fees for LCM, which receives 25 per cent of profit on each fund investment over a soft hurdle rate of 8 per cent. The group also earns an outperformance return fee of 35 per cent over an internal rate of return (IRR) of 20 per cent, so providing an attractive income stream to complement realisations from its own directly held portfolio.

Over the past three years, LCM has delivered a cumulative return on invested capital (RoIC) of 208 per cent and internal rate of return (IRR) of 76 per cent, a key reason why outside investors want a slice of the action. Earlier this year, the group’s second Global Alternative Returns Fund (GARF) raised A$291mn of commitments. The outlook for deployment of the capital is increasingly positive.

Strong trading outlook

Chief executive Patrick Maloney predicts a significant rise in the number of appointments of external administrators and liquidators in insolvency, which will translate into increased litigation funding applications in the future. That is of particular benefit to LCM given its long history of funding disputes arising from insolvency and restructuring.

Maloney also highlights a tightening and contraction of the competitive landscape in the litigation finance industry across several markets, including the UK, US and Canada. Having built LCM’s expertise and capacity in the London market, as well as having access to capital through its funds management business, the well-funded group is well-placed to capitalise on tighter industry conditions.

In addition, Maloney pointed out that LCM is “seeing more opportunities in the market and expects to materially achieve commitments in the second fund”. This will position LCM well for launching its third fund, aiming to exploit the high-quality investment opportunities that underpin generations of value and cash to both fund investors and LCM’s shareholders. Furthermore, as the group continues to grow, the operational leverage of the business means that it should deliver even greater profitability and cash generation given that higher activity levels will not need to be matched with proportionate increases in overall costs.

It’s a positive narrative and one well-supported by a raft of successful case settlements in the past year that led to bumper profit for both third-party fund investors and LCM shareholders. It also explains why the board has announced a A$10mn share buyback programme alongside a 2.25p-a-share final dividend, and is planning a fixed-income investor roadshow to attract investors for a London-listed sterling retail bond to take advantage of investment opportunities.

Re-rating set to continue

The news has been well-received with LCM’s share price hitting a 12-month high around 121p post results, up from 87p when I last suggested buying over the summer (‘Litigation funders LCM and RBG digest court ruling, 27 July 2023).

House broker Investec is working on new forecasts to take into account the group’s transition to IFRS-9 fair-value accounting, but analysts had previously forecast a 66 per cent rise in adjusted pre-tax profit of A$47.7mn. Trading on a 12-month trailing price/earnings (PE) ratio of 7.5, offering a 2 per cent dividend yield and an delivering eye-catching return on invested capital, the shares remain a buy.

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