Hot Stock: IMF Bentham (IMF.ASX)

IMF Bentham Limited is engaged in investigation, management and funding of litigation claims.

Saturday 29th April 2017

Loading the bases

by James Lennon

What’s new?

The key development in recent months has been the release of IMF Bentham’s 1H17 results, which revealed a significant year-on-year improvement in the company’s profitability, with return on equity jumping to 10.4 percent. While this is still sub-optimal relative to our expectations and the company’s track record, it does signify to us that IMF Bentham is starting to benefit from the significant investment in its case portfolio and pipeline over the last year or so.

We expect this earnings trend to continue in 2H17 and into FY18 on the assumption that IMF Bentham’s case portfolio, regional diversification and track record on generating an attractive rate of return on its work in hand remains intact. While management, as is to be expected given uncertainty regarding the timing of any given case outcome, has not provided explicit earnings guidance for 2H17, it is clear from the 1H17 result commentary that IMF Bentham remains in growth mode.

This is evident in the recent launch of IMF Bentham’s first investment vehicle, Bentham IMF, on 13 February 2017. The special purpose vehicle, which will be funded, advised and managed by affiliates of Fortress Credit Advisors LLC, will invest up to US$100 million by way of subscription for Class B stock, with provision for a further US$50 million of Class B stock subject to the joint consent of the Company and Fortress.

As part of the launch, IMF Bentham has committed to invest US$33 million by way of subscription for Class A stock in Bentham IMF Funding Vehicle, with provision to increase this investment to US$50 million subject to the joint consent of IMF Bentham and Fortress. In addition to its special purpose vehicle (that will be used to fund US cases), IMF Bentham has also recently completed Tranche 2 of its secured unlisted notes – Tranche 1 raised A$32 million in April 2016.

As per the recent announcement on the matter, IMF Bentham has backed up its initial debt capital raising with Tranche 2, which raised A$41.18 million. Not unlike Tranche 1, the company intends to use the proceeds from Tranche 2 “for general corporate purposes, including funding its stated growth objectives in Australia, the US and other markets”. In terms of IMF Bentham’s other markets, this now includes Asia following the recent opening of its first Asian office in Singapore.

While the recent expansion in IMF Bentham’s capital base is encouraging from a future potential growth perspective, it should also enable the company to increase its capital efficiency and consequently its return on equity. For instance, it is expected that IMF Bentham’s new funding vehicle will enable better risk management given the larger more diverse case portfolio and reduced need for recourse debt or additional equity.

These are in our view all positive developments, at least from a business model and business volume perspective. However, the missing piece of the puzzle and in our view the million dollar question is whether IMF Bentham can maintain, if not improve, its case success rate. In our view, while the increase in IMF Bentham’s free cash flow in 1H17 is proof that the business model works, recent high profile case losses and an aggressive expansion into new markets are risks worth considering.

That said, we see no reason why IMF Bentham cannot continue to report a multiple on invested capital in line with its 1.6 times (excluding withdrawals) since inception. With industry dynamics still looking favourable (i.e. from a competitive intensity perspective) and IMF Bentham’s risk management processes (i.e. from case selection and investment committee review to case management) still intact, we see no reason to not expect the current success rate to continue.

Outlook

While it remains to be seen what impact the shift in portfolio composition towards the US has on the company’s strike rate and profit margin, there is no question, in our view, that IMF Bentham is now on a firmer footing compared to FY15 and FY16. While the sub-par results in FY15 and FY16 were due primarily to case timings, it did not help that IMF Bentham lost a number of high profile cases, with this having been the catalyst for the diversification into offshore markets.

Price

While IMF Bentham’s earnings multiple for FY17 looks expensive at 18.3 times, this is expected to fall to 5.6 times as earnings recover in FY18, with the yield consequently moving from 2.9 percent to 6.3 percent, respectively. This fundamental view appears to be consistent with stock’s technical set-up, with medium-term momentum favoured to the upside, as evidenced by the bullish moving average crossover that has been in place since June 2016.

Worth buying?

While IMF Bentham’s financial performance has been sub-par over the last few years, we view the recent 1H17 results as a likely inflection point. 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.

James Lennon is a senior analyst at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE

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