Litigation Cap. Regulatory News (LIT)

17 March 2020

Litigation Capital Management Limited

("LCM", "the Company" or "the Group")

Interim results for the six months ended 31 December 2019

Litigation Capital Management Limited (AIM:LIT), a leading international provider of disputes financing solutions, announces its interim results for the six months ended 31 December 2019 ("HY20").

Highlights

· Delivering sustained growth across a diversified portfolio by investment activity and geography

· First close of a new third-party fund of US$150 million (post-period)

· Cumulative 139% ROIC and 79% IRR over the last 8.5 years*

· Total cash generated of A$18.9 million (post-period cash receipt totalling A$9.7 million)

· Four single-case investments in APAC generated a combined revenue of approximately A$14.9 million and contribution to gross profit of approximately A$7.8 million

· Significant traction in key growth area of corporate portfolio funding:

- Construction portfolio: resolved two disputes out of seven matters; generated revenue of A$8.6 million and provided a contribution to gross profit of A$4.3 million

- First matter resolution in the aviation portfolio; generated revenue of A$0.6 million and provided a contribution to gross profit of A$0.2 million

· Strategic Alliance with international law firm delivered material opportunities and over 30 applications, including both single case and corporate portfolio. Second Alliance initiated with an international law firm which has already generated corporate portfolio applications

*FY12 to HY20, including losses. The Company reports performance over the last 8.5 years since FY12 as the Board deems it the period most representative of the current business

Summary of financials

Post-period events

· First close of US$150 million LCM Global Alternative Returns Fund (the Fund) - US$140 million committed investments from global blue-chip investors with balance of US$10 million which LCM expects to be subscribed in the near term

- Fund will supplement the deployment of capital from LCM's balance sheet, significantly increasing the Group's ability to invest in new opportunities.

- Transitions LCM into an alternate asset manager specialising in investments relating to the global disputes market

· Post period cash received on projects resolved - A$9.7 million, as a result of resolutions occurring close to the end of the financial period

Current trading and outlook

LCM moves forward as an alternate asset manager specialising in investments relating to the global disputes market with two complementary business models: direct investment from the Company's balance sheet and asset management following the first close of the US$150m fund. In the second half, we will continue to execute our strategy of growing and diversifying our portfolio by investment activity and geography, taking advantage of the numerous and exciting growth opportunities available to us in a measured and disciplined way.

In relation to the COVID-19 pandemic, we continue to monitor the developing situation closely and heed the advice of governments in our various jurisdictions. As we stand, whilst we are all still in the early stages of understanding the wider impact of the virus, management does not currently anticipate a negative impact on the business.

Historically, in times of economic uncertainty, the volume of disputes generally increases, and there is typically a greater reluctance by corporates to fund them. One might also expect an increase in the number of bankruptcies and liquidations and in each of these scenarios, it is logical that LCM would see an increase in opportunities across its three strategies.

With a burgeoning global infrastructure in place, an increasingly diversified portfolio and a strong pipeline supported by a robust balance sheet, third-party funds and growing pool of the best talent in the industry, while the nature of LCM's business model means that returns will not always result in a linear growth pattern, the Board is confident the Company will continue to grow and deliver strong returns.

Patrick Moloney, CEO of LCM, commented: "In the first half, LCM has continued to strengthen its market position in all of the geographies we operate. The development of our corporate portfolio strategy is gaining significant traction and already paying dividends in an area where we are a global leader in the provision of portfolio financing to corporate clients. With the first close of LCM's US$150 million fund we are well placed to significantly increase the portfolio of investments under management, enabling LCM to expand its business in all of the geographies in which we operate. The launch of the fund in parallel with direct balance sheet investments signals the transition of the business into a global alternate asset manager."

Nick Rowles-Davies, Executive Vice Chairman of LCM, added: "Momentum in corporate portfolio opportunities has increased in the first half with the Fund now enabling LCM to invest in larger corporate portfolio transactions which have previously been beyond the capacity of our balance sheet. This provides an important catalyst for the ongoing development of LCM's corporate portfolio strategy."

To access the investor presentation and watch a short video of Patrick Moloney and Nick Rowles-Davies summarising the results please click here.

The analyst briefing at 09:30 today, 17 March 2020, will now be held via conference call. Please contact lcm@almapr.co.uk for instructions on how to connect.

As a result of unprecedented global events leading to heightened border controls, CEO Patrick Moloney returned from London to Sydney over the weekend and was therefore unable to proceed with in-person presentation arrangements. Please direct any questions you may have to lcm@almapr.co.uk.

Operational review

The first half of FY20 has been a period of sustained progress and delivery against our six principles of growth and focus to:

· Ensure the natural diversity of our pipeline of opportunities to build on our diverse portfolio of investments

· Maintain the discipline of underwriting quality investments as a key driver to delivering high returns

· Identify additional strategic alliances in the market with similar values to innovative development

· Continue to cement our position as leading the global market in corporate portfolio transactions

· Build on the progress of international expansion both in current jurisdictions and new territories

· Utilise LCM's growing balance sheet of permanent capital, and the newly established US$150 million third-party fund (LCM Global Alternative Returns Fund)

LCM currently operates two business models. The first is direct investments made from LCM's permanent balance sheet capital. The second is funds and/or asset management. Under those two business models, LCM currently pursues three investment strategies:

Single-case funding: The first and currently largest strategy, is single-case funding. That is, the investment in a single dispute. This is a strategy that LCM has maintained since its inception (through its predecessor company) 21 years ago. Currently, the majority of LCM's investments are in single-case investments.

Corporate portfolio funding: The second strategy pursued by LCM is in corporate portfolio funding. That is, the funding of a bundle of single disputes in which LCM's capital investment is collaterally secured against the proceeds of the entire corporate portfolio. LCM is an emerging global leader in the provision of corporate portfolio financing to corporate clients.

Acquisitions of Claims: The third strategy is the investment in smaller disputes (typically insolvency-based) through the acquisition or assignment of the underlying cause of action.

LCM generates its revenue from both its direct investments and also performance fees through asset management.

HY20 and the start of H2 has been a productive period for the development of LCM's international expansion with growth in London and Singapore building on the established platform that Sydney, Melbourne and Brisbane provide to the Group. The HY20 results demonstrate clear growth in LCM's business and is a reflection of investment decisions made in prior periods.

Looking ahead, the first close of the US$150 million LCM Global Alternative Returns Fund as an alternate source of capital for investment provides a more robust platform for LCM to grow its business with the objective of also providing shareholders with significant financial returns over time with reduced capital risk. The launch of LCM's fund management business to operate alongside its direct balance sheet investments signals the transition of the business into an alternate asset manager specialising in investments relating to the global disputes market.

Current portfolio

LCM's direct investments are currently funded 100% from the Company's balance sheet, and the direct investment portfolio currently comprises 24 separate investments, two of which comprise corporate portfolios. LCM's balance sheet is unlevered and operates with no debt. The mix of LCM's corporate portfolio via sector includes class actions, international arbitrations, commercial disputes, insolvency and corporate portfolios. LCM continues to maintain an investment strategy which involves balance and diversity across industry sectors as well as capital commitment. Whilst each of the individual investments are uncorrelated to economic cycles, political influence, financial markets or each other, LCM maintains a healthy balance across sectors. Additionally, LCM manages its portfolio investments such as to ensure that one particular single-case investment does not dominate its capital commitment. Through a diverse portfolio, LCM ensures that its risk is not concentrated in one single-case investment.

The balance sheet portfolio has a current total estimated capital commitment of A$96 million. Of that, LCM has funded A$37 million. This leaves a balance funding commitment, to be invested progressively over the next three years, of approximately A$59 million. With the capital tools presently available, the Company is confident that the total direct investment portfolio can be funded from existing and organically generated capital.

Single-case investment settlements

In HY20, LCM resolved three single-case investments, all of which were Australian-based projects. Combined revenue derived from those resolutions was A$14.0 million and contributed to LCM's gross profit of approximately A$7.1 million. Of those resolutions cash has been received of A$6.2 million and the remaining revenue is expected to be received before the end of the current financial year.

LCM achieved a partial resolution in its first enforcement project, generating a revenue of A$0.9million and a contribution towards gross profit of approximately A$0.7 million. The balance of the recovery proceedings continues in various jurisdictions and the team is confident with respect to the ultimate outcome of that investment.

Single-case investments have been a fundamental part of our business model since LCM's inception and the settlement of these respective disputes reinforces the ongoing opportunity and demand for investment in such cases.

LCM is confident that the single-case investments will generate profitable outcomes in line with prior performance. This confidence is further underpinned by the visibility on these cases as they progress and mature well through the court or arbitral process.

Corporate portfolio funding - a corporate finance product

Perhaps the most significant development in the period was the traction gained in corporate portfolio funding.

LCM entered this new market in 2019, funding two corporate portfolios from 15 applications in that period. Put into context, LCM outperformed its peers globally in this market with the two portfolios, highlighting the nascent nature of this market but one in which LCM is already witnessing significant opportunity.

In HY20, LCM resolved two disputes in its construction and building portfolio, out of the original portfolio of seven. LCM has invested total capital of c A$4.3 million, of which the two resolved disputes have generated revenue to LCM of A$8.6 million and provided a contribution to LCM's gross profit of A$4.3 million.

The portfolio currently contains five unresolved disputes which LCM is funding. As communicated to the market, LCM anticipated that the financial metrics of corporate portfolios would generate an approximate return on invested capital of 100%. So far, the building and construction portfolio is providing a return commensurate with that model. LCM is also considering the inclusion of two additional disputes into the existing portfolio which are subject to due diligence and underwriting considerations. LCM is pleased with the performance of its first corporate portfolio, and although it is yet to reach a conclusion, it has allowed LCM to generate healthy profits at far lower risk.

LCM has also resolved its first matter in the aviation portfolio, providing a credit facility to fund the prosecution of a number of commercial disputes. Originally, the facility was funding a total of 38 disputes. The term of the facility is five years and involves a profit split of recoveries. To date, LCM has invested capital of A$0.4 million and has received revenue of A$0.6 million. This revenue figure has contributed A$0.2 million of gross profit for the period. With respect to the aviation portfolio, consideration is also being given to the inclusion of further disputes.

Having further strengthened its team, LCM is the global leader in this innovative new area of litigation finance, where capital is invested across a number of an organisation's legal cases as opposed to a single one. This provides the organisation with several financial benefits while reducing risk for both parties and providing the investor with a generally steadier income stream.

The London team, which drives LCM's corporate portfolio offering, made excellent progress, generating material returns in a remarkably short space of time. Revenue generated from the newly established London office accounted for almost half of all Group revenues in the first half, which is a great achievement from a near standing start. While this should not be extrapolated or used to predict the revenue split going forwards, it demonstrates tangible progress and supports our view that corporate portfolio funding is a key growth area.

A significant contributing factor to the Group's success in the space has been our proactive, rather than reactive approach to origination. As an example, with corporates now exercising much greater cost control and demanding more creative and alternative pricing arrangements of their legal service providers, we have been working hard to educate law firms globally as to the value of our corporate portfolio funding offering. To date the reception has been good - more and more law firms now see us as a trusted adviser in the corporate finance space, capable of helping them maintain and win new business in what is an increasingly challenging marketplace. While thus far we have only really scratched the surface in terms of creating new investment opportunities on this front, it is a channel that is already showing real promise.

Looking forward, the corporate portfolio funding team is engaged in due diligence on a number of significant new projects in the corporate portfolio space and have a high-quality, increasingly diverse pipeline that continues to grow.

Acquisition of claims

This strategy was conceived as a result of two factors: the first is based on a single-case investment strategy which has limitations in terms of claims size as the economics of providing single-case funding prevents LCM funding claims under A$6 million to A$7 million in damages size as the economics of funding single-case investments at the lower end of the range are not attractive. The second is a result of changes recently made to the insolvency laws in both Australia and the United Kingdom which permitted insolvency practitioners, for the first time, to sell or assign statutory causes of action.

A combination of these observations enabled LCM to develop a strategy whereby smaller claims or disputes which traditionally did not meet its single-case investment strategy or were by necessity in the hands of an insolvency practitioner, became available for acquisition or assignment. In circumstances where those claims or causes or action were acquired and assigned to LCM as principle it would have complete control over the claim and thus the economics made the investments viable.

To date, the acquisition of claims strategy has shown very significant potential. Since the pilot programme commenced in May 2019, 96 separate applications have been received and considered. Those applications have largely been received from insolvency practitioners in the jurisdictions of Australia and the United Kingdom. Those applications have resulted in nine matters being signed up to date, seven are in Australia and two in the United Kingdom.

Notably, LCM anticipates that the investment period will be significantly shorter than single-case investment strategy.

International overview

APAC

LCM continues to strengthen its market position in the geographies in which it operates. In LCM's founding markets of Australasia, it continues to see strong demand for its finance products, particularly in single-case funding both with respect to litigious disputes and international arbitration.

During HY20, 90 separate applications were considered in APAC. Of those applications, two were for corporate portfolio facilities. Not only is the level of applications growing in number, they are also growing in quality and first time in LCM's history it is seeing the first applications for corporate portfolios coming from APAC. Historically, corporate portfolio activity only occurred in the Northern Hemisphere, most notably the UK and North America.

Having established a permanent presence in Singapore in late 2018, of particular note in APAC is the increase in the number and quality of applications received through this office during the six-month period and continuing into 2020. The level of activity in this region has increased to such an extent that consideration will need to be given during the next financial period to increasing LCM's team of investment managers in this location.

In addition to increased activities, the Singapore government has signalled it is considering expanding the types of disputes to which litigation finance can be applied. Currently, and pursuant to legislation passed in 2017, litigation finance products can be used in both insolvency and international arbitration in the jurisdictions of both Singapore and Hong Kong. Recently, the Singapore government has considered expanding those categories to domestic arbitral disputes as well as litigious disputes adjudicated through the Singapore International Commercial Court (SICC). Such changes would expand the investment opportunities in relation to both single case and corporate portfolios in the jurisdiction of Singapore. Further, LCM would expect, over time that if the changes occur in Singapore that the Hong Kong Legislative Council will follow.

Whilst Singapore goes from strength to strength, Hong Kong has seen more subdued activity over the past six months due to the political protests which have plagued Hong Kong and general civil unrest. Over time LCM expects the unrest to settle and the market and general dispute activity within the jurisdiction of Hong Kong to increase. With an existing presence in the region, LCM is poised to take advantage of that opportunity.

UK/EMEA

During the six-month period, 98 separate applications were received from EMEA. It is important to note those applications are all received and initially considered through LCM's London office. The volume of applications received during that six-month period demonstrates the importance of London as a global disputes centre and also a hub for the litigation finance industry. The strength of LCM's London office also fortifies the view that greater opportunity for investments in disputes arises in the larger and more developed global economies. Whilst LCM has a long history in APAC, the quality and number of applications now being received through the London office is already very similar to the markets where LCM has operated for over 20 years.

Notably, of the 98 separate applications, 10 were for corporate portfolios. As anticipated, LCM is seeing a measured but steady demand for disputes finance by large, sophisticated and well-capitalised corporates. Those applications range across industry sectors such as building and construction, oil and gas, infrastructure, commodities trading, aviation and outsourcing. By and large, those industries operate with high volume but low margins, where disputes expenditure has a significant and detrimental effect on a corporation's profitability. Those corporate portfolio applications also represent larger investment opportunities with less capital risk.

Of the 10 applications received from EMEA, the potential investment size ranged from A$7 million through to A$36 million. Portfolio finance, therefore, provides LCM with an opportunity to invest greater capital at lower overall risk. LCM also anticipates the formation of enduring relationships as a result of providing a finance solution to corporates. These relationships are far more valuable to an ongoing business than single-case investments.

New territories

The Board continues to monitor opportunities in new jurisdictions and territories closely, including North America. The US is the largest litigation market globally but the least penetrated by the litigation finance industry, meaning there is enormous potential for growth.

The Board would only ever consider entry into a new jurisdiction or territory once satisfied it is the correct strategic fit, and not before the right senior hires are in place. Any decision of such kind would be underpinned by a rigorous due diligence process prior, as was the case before LCM established its Singapore and London operations.

US$150 million fund (post-period event)

On 10 March 2020, LCM announced the first close of a new third-party fund of USD$150 million, the LCM Global Alternative Returns Fund. The first close of the Fund raised USD$140 million leaving USD$10 million of commitments to finalise. The close of this Fund marks LCM's return to managing third-party funds, following the building of a permanent source of balance sheet capital through the equity markets. The raising of this significant pool of third‑party capital is part of LCM's stated strategy to manage not only its own balance sheet capital but also third‑party capital. LCM acts as a fund manager in respect of those third-party funds.

In terms of LCM's overall business, the additional capital supplied by the Fund will enable LCM to significantly increase the portfolio of investments under its management. It will allow LCM to expand its business in all geographies in which it operates. In addition, the Fund will permit LCM to invest in larger corporate portfolio transactions which have previously been beyond the capacity of LCM's stand-alone balance sheet. That will provide an important catalyst to the development of LCM's corporate portfolio strategy.

The dominant cornerstone investors in the Fund are US-based, large sophisticated blue chip investors and comprise a large University endowment fund and a global investment bank. Each have had very significant investment experience in the litigation finance sector. The size of their investments and their choice of LCM as a fund manager both endorses LCM's disciplined investment approach and its track record and the asset class more generally. The balance of smaller investors in the Fund are also highly experienced investors in the litigation finance sector with one investor managing a pool of capital solely devoted to investments in litigation finance.

LCM has a co-funding right with the Fund. All qualifying investment opportunities will be funded as to 75% by the Fund and 25% via LCM's balance sheet. LCM will receive the entire economic benefit of its 25% direct balance sheet investment and a performance fee in respect of the Fund investment in recognition of its management of that pool of capital. In respect of its profit split, LCM will receive 25% of the profit over a soft return hurdle of 8% and in addition an outperformance fee of 35% of all profits over an IRR of 20%. Importantly, that performance fee will be payable to LCM as fund manager on the basis of a deal-by-deal waterfall.

The Fund will have a term of six years including an inception period of two years, during which investments can be made. LCM seeded the Fund with nine single-case investments which include international arbitrations, class actions, commercial disputes and investor-state treaty claims. These investments are not being seeded from LCM's existing balance sheet portfolio which LCM will continue to manage. The total initial capital commitment of the Fund will be approximately USD$33 million representing a total commitment of the Fund on day one of approximately 22%. LCM remains confident that it will fully commit the Fund well inside the inception period.

LCM believes that the first closure of the Fund and more particular the nature of the investors in the Fund will lead to a long-term investing relationship. Each of the cornerstone investors has entrenched rights to participate in LCM's next two funds which provides a strong base from which LCM can build out a large and global third-party fund management business.

LCM believes that not only is the establishment of the Fund an important alternate source of capital for investment allowing LCM to grow its business but will is expected to provide shareholders with significant financial returns over time with reduced capital risk. LCM is excited at the prospect of establishing a fund management business to operate alongside its direct balance sheet investments.

Strategic alliances

In March 2019, LCM entered into a strategic alliance with an international law firm with a large disputes practice, which involved LCM working in a collaborative fashion with the global law firm providing innovative and solutions-based disputes funding products to the firms' clients. In return, LCM received a first right of refusal on all opportunities generated with the firms' clients. This alliance has proved to be an exceptionally valuable resource to both parties. Through the strategic alliance, LCM has received some 30 individual applications from the global network. Those applications have included both single-case investments as well as corporate portfolios. Notably the aviation corporate portfolio was originated through that strategic alliance and an additional three single-case investments have been entered into from those applications. Many more applications are the subject of due diligence and/or negotiation of commercial terms.

As a result of the success of the first strategic alliance, LCM has entered into a second strategic alliance with a global international law firm specialising in disputes. This alliance has commenced on a trial basis in Australia and in due course consideration will be given to expanding the relationship globally. Although the relationship is in its initial stages, it has already generated applications for corporate portfolio funding in the building and construction sector. LCM expects that the global alliance will be as valuable and as productive relationship as the existing strategic alliance.

LCM looks forward to a strong and collaborative relationship with those global firms.

HY20 Financials

The HY20 results demonstrate clear growth in LCM's business and reflect investment decisions made some time prior. LCM's due diligence and underwriting process have not changed over the recent period and as such LCM's ability to generate revenue from its investments reflects two dynamics:

The first is the ability to originate quality investment opportunities and the second is having the capital available to invest in those opportunities. With that in mind, LCM's financial performance during HY20 is a result of investment decisions made and capital invested both derived from the original IPO on the ASX and organically generated capital to that point. Financial year 2020 is the last year of harvesting investment revenue from a period of capital restraint. Beyond 2020, LCM will begin to see the benefits of investments made as a result of the equity raised upon admission to AIM together with the reinvestment of organically generated capital.

When considering interim financial performance, it is prudent to recognise that LCM's revenue trends can be somewhat lumpy and as such, financial performance during an interim period may not necessarily be indicative of full year results. Similarly, investing in disputes is not a seasonal activity. The resolution of LCM's investments may occur in one financial period or another. This revenue profile makes it prudent for LCM to pay its dividend annually. No interim dividend is, therefore, being announced by the Company. It should not be interpreted that this decision is due to a lack of confidence in our ability to deliver sound full year results.

With the above observations in mind, LCM's financial performance for HY20, when compared to HY19, is strong with gross revenue and gross profits from investments more than double. Gross revenue for HY20 is A$24.1 million, as compared to revenue in HY19 of A$11.7 million. In terms of gross profit, the half year to 31 December 2019 yielded A$12.2 million, when compared with the HY19 result of A$5.7 million. Statutory profit before tax is A$6.7 million, as compared with HY19 of A$1.0 million.

LCM expanded significantly its operational reach into the Northern Hemisphere during the second half of the 2019 financial year. Given LCM's expansion it is important to compare HY20 operating expenses with this period. The operating expenses of LCM as a business during HY20 were A$5.4 million compared to the second half of 2019 which were A$5.2 million. It is noteworthy that no significant increase has occurred with respect to operating expenses on a like-for-like basis, of particular note with the growth in size of the portfolio under management.

As at 31 December 2019, LCM had invested A$34.0 million in litigation finance projects as compared to the end of FY19 at A$27.4 million and the end of FY18 of A$13.9 million.

LCM ended the financial period HY20 with $34.7 million in cash and receivables of A$22.0 million. Such resources demonstrate LCM's ability to generate organic capital growth over a short investment period.

Dividend

LCM has not announced an interim dividend despite its positive performance for the interim period. LCM's dividend level will be assessed during H2 when visibility is achieved on the full financial period. For the period to 31 December 2019, the Board has further evaluated the predictability of the visibility of earnings in each first half period and notwithstanding the strong financial performance in HY20 has deemed it prudent to move to a final dividend for the year ending 30 June 2020. The Board believes this to be judicious at this point in LCM's growth and recognises that the revenue trends that it experiences will become more predictable as the Company transitions into a global alternate asset manager.

Current trading and outlook

LCM moves forward as an alternate asset manager specialising in investments relating to the global disputes market with two complementary business models: direct investment from the Company's balance sheet and asset management following the first close of the US$150m fund. In the second half, we will continue to execute our strategy of growing and diversifying our portfolio by investment activity and geography, taking advantage of the numerous and exciting growth opportunities available to us in a measured and disciplined way.

In relation to the COVID-19 pandemic, we continue to monitor the developing situation closely and heed the advice of governments in our various jurisdictions. As we stand, whilst we are all still in the early stages of understanding the wider impact of the virus, management does not currently anticipate a negative impact on the business.

Historically, in times of economic uncertainty, the volume of disputes generally increases, and there is typically a greater reluctance to finance them. One might also expect an increase in the number of bankruptcies and liquidations and in each of these scenarios, it is logical that LCM would see an increase in opportunities across its three strategies.

With a burgeoning global infrastructure in place, an increasingly diversified portfolio and a strong pipeline supported by a robust balance sheet, third-party funds and growing pool of the best talent in the industry, while the nature of LCM's business model means that returns will not always result in a linear growth pattern, the Board is confident the Company will continue to grow and deliver strong returns.

The above statement of profit or loss and other comprehensive income should be read in conjunction with the accompanying notes 

The above statement of cash flows should be read in conjunction with the accompanying notes