Bentham IMF: Smoothing Out The Lumps
One listed company that we find interesting is Bentham IMF Limited (ASX:IMF). IMF is a litigation funder that provides the money to mount class actions in return for a share of the proceeds where cases are won or (more usually) settled. Over the years, IMF has developed a reputation for being able to identify and back cases that have a very good chance of success, and for doing so profitably.
There is one big issue that arises in respect to IMF: its cashflows and earnings are very lumpy. A big case can have a significant impact on profits in any one year, and case timing is very unpredictable. IMF has little control over when a case will arise or when it will be concluded, and so earnings numbers swing about quite a lot.
This makes valuation a challenge. Thinking in terms of multiples and growth rates is not much help, and to make any sense of the business you have to be able to think long-term to even out the peaks and troughs. If you take the time to do that though, it seems to us that the investment merits become much clearer.
While the number of large cases that start or complete in any given year is pretty much a random number, the number that will flow through the business over, say, 10 years, can be estimated with more confidence. There will always be stakeholders who are the victims of aggressive behaviour by corporations, and as the dominant Australian litigation funder, IMF will get to look at a large percentage of those cases.
IMF will win some and lose some, but its track record indicates that it has the skill to take on the cases it will win (notwithstanding its recent loss in the Bank of Queensland case). The outcome on any single case may be hard to predict, but the result over many cases is more certain.
At the moment, IMF has a good portfolio of cases up its sleeve, and over the next 3 years those cases should flow through into some healthy earnings numbers. However, 2014 is looking very ordinary.
The stock market tends to be fixated on the short term, so IMF doesn’t get a lot of love in years where its results are weaker. This looks to us like just the sort of opportunity a long-term investor ought to be interested in.
The Montgomery Fund owns shares in IMF.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
nathan stromer
:
The difficulty with IMF is capital management. Management have shown themselves to be mercurial in their attitude to shareholders equity over the last 5 years. First, the management played the options compensation game, resulting in an overhang or “pie shrinking” for existing investors. Next came the convertible notes, or rather (hybrid) equity issue at an expensive 10.25% pa to boot. Then came the old rights issues to raise more equity last year and replace the convertible notes – except this time management decided that “some rights were more equal than other” – i.e. there was an institutional placement about 3 times the size of rights offered to individual investors. You see, IMF needs a constraint inflow of capital to grow its business and normally this can be a great opportunity where the business has some structural strengths and a record of strong (if lumpy) returns. However, this can also be the worst kind of weakness or trap for investors, when shareholder dilution creeps its way in every time.
So, on an important value investing checklist criteria (capital management record) this investment is a fail for me. Isn’t it ironic that the company discloses that its biggest business risk is regulation and competition, but that the biggest risk to investing in it is quiote possibly management themselves?
Of course, I believe IMF is priced reasonably or even inexpensively, and I also believe the prospects are good that future returns will be satisfactory well into the future, but what’s the point if your pie gets nibbled away and there is not a thing you can do about it? Why pay out a 5 or 10 cent dividend if you need the money to grow your litigation book, only to ask back (or force back via a dilutive rights issue) more shareholder funds.
Management could earn my trust if they adjusted their dividend policy and noted the effects of the dilutive capital raising policies of the recent past.
Roger Montgomery
:
Hi Nathan,
There is indeed a need to fund growth and an investor must be willing to accept the method management has devised to achieve this. It may not be everyone’s cup of tea and one needs to ask whether they would be happy to own 100% of the business for ten years before a buying a small piece for ten minutes etc etc…
Adam Novek
:
I was actually doing some research on this the other day so I am glad you posted this article. My view is that if the full year results are a little ordinary, the dividend yield will prevent the share from decreasing by too much. Assumptions here are that total dividends remain between $0.05-$0.10 and the market stays addicted to income generating shares. At the moment orders are slightly weighted to the sell side so continued falls are probable giving a more attractive price. Very risky in terms of share price movements in the short term, but if we can consider this case a one off, then we should be sweet in terms of long term fundamentals. It sounds like based on your research it is a one off…
zoran arnautovic
:
IMF
I would have thought that “choppy” EPS and declining ROE wouldn’t have made
“Montgomery Grade”
Cheers
Roger Montgomery
:
Hi Zoran
Remember that a lumpy 15% is better than a smooth 8%
Bill Bright
:
My head says this may be a good investment but I dislike the legal system where people do not take any responsibility for their own actions and blame everyone except themselves when something such as a dodgy investment turns belly up. Be careful, lift your feet, read the print and live by your actions.