One beneficiary of the Royal Commission

Anthony Aboud

IMF Bentham (ASX :IMF) operates in the litigation funding industry. It is the second largest firm of its type in the world and has arguably the highest quality service offering globally.

Litigation funding is pretty mature in Australia, and you could argue that - perhaps aside from everyday Australians - the industry is one of the few beneficiaries of the current Royal Commission into banking and financial services.

Globally this is a burgeoning industry. It is a very small, but growing, part of the funding mix for US legal practices and there are plenty of parallel opportunities for businesses in this space including international mediation and insolvencies.

The key to this industry is having a strong balance sheet, diverse case mix and having a skilled investment team which picks and chooses the right cases to fund. This is easier said than done and IMF has an excellent 18-year track record.

I have followed IMF for more than ten years now, and I have always found the uncorrelated 70% internal rate of return (IRR) that litigation funding could generate an attractive proposition.

But on the flip side, I always wanted to wait until the company lost a few big cases before investing, as I always thought that would be the best entry point at which to buy the shares. This happened late in 2015 when there was a perfect storm of Slater & Gordon unwinding (a firm in the same industry, but completely different businesses) and IMF losing money on some high profile cases. This is where we started buying shares in IMF.

How we value the business

These sorts of businesses are usually missed by the market because they do not have steady earnings, the accounting is a little complex and, up until recently, there was very little brokerage coverage of the company. But we've always been firm believers that if you have a solid investment thesis and you do the work - even if you have to wait a decade - you can often be rewarded.

IMF is a very difficult company to value given the historic volatility of earnings, however we believe the best lead indicator to earnings is the amount of capital the company invests in cases (usually with a three-year lag).

This figure has increased three-fold in the past three years from $50 million p.a. on average (between 2010 - 2015) to $160 million in FY18.

By our figures, we estimate that if the company were to generate similar IRRs on these investments - it may well generate around 50 cents per share EPS by 2022. On a 12 times multiple, this leads to a valuation of around $6.00/share - which is double the current share price today.

Of course, with any company we buy there are always going to be business risks to take into account - and for a firm like IMF, the main risk we see is that the investment team changes its investment style and the IRR falls materially from its current level of around 70% IRR.

But in the absence of this occurring, we believe that IMF today represents a good opportunity. We are excited about the strong market position the firm has in the industry, the healthy barriers of entry for new entrants into the industry and the exponential growth in demand for litigation funding.

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Chris Titley

Great read

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Brett Davies

Thanks for the report and assessment. IMF have been diversifying both in terms of geography (US expansion, Canada, Europe and Asia offices) and also in the types of cases they fund. Additionally they are increasing the quantity of cases. I expect that should help with the exposure to any adverse case results where the impact will be a much smaller percentage impact. IMF have in the last days raised additional capital ($90m) at $2.80 which in total will dilute shareholding around 17% but provide funding for future endeavours. It does seem like a difficult business to value as they have several types of funds to pay for cases and they each have different parameters of cost and expected return. I think if the company were able to provide investors with a better understanding of potential returns there would be more interest in the stock. Obviously its all a bit unpredictable as it depends on case results but as the scale of the business grows I would hope it becomes clearer.

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