One dependable activity in a changing world is the chronic repetition of commercial bad behaviour and this is the area where litigation funder Bentham IMF (ASX: IMF) finds investment opportunities.
Over 13 years of operation Bentham IMF's record is outstanding with 73% of cases won or settled, 23% withdrawn and only 4% lost. At present, the case portfolio (cases underway or documents of claim to be lodged) stands close to $2billion, providing a pipeline of yet to be concluded cases over the next few years.
As a rough guide, the net potential profit to be realised from the current portfolio is between $160m – $200m, with a median case completion of 2.25 years. Potential investors should note this is not a company with a year-on-year predictable earnings stream as the legal process takes its own time.
Bentham IMF currently has offices in Australia and the US (New York and Los Angeles). It is also contemplating London as a European base. Growth opportunities include further development of US and European operations.
Bentham IMF is a highly astute and well structured litigation funder with the best performance record in the business. Indicative earnings per share estimates (adjusted for recently completed issues) are 18c in 2014 and 30c in 2015. The dividend payout should be approximately 50% of earnings. However these figures are indicative only – legal proceedings can be protracted. At present Bentham IMF has no borrowings and a strong net cash position.
Bentham IMF is one of my favourite companies and happily occupies a significant percentage of my portfolio.
If you're contemplating an investment in the legal business, Slater & Gordon (ASX: SGH) has a more predictable earnings stream and also strong growth prospects. Well known to Australians, Slater & Gordon has moved aggressively into the UK market (five times Australia's size and much more crusty) with considered purchases of compatible legal practices.
Slater & Gordon's major areas of expertise include employment law, industrial law, medical negligence and personal injury – broadly known as the consumer law segment. Slater & Gordon dominates this segment in Australia and is estimated to have 5% of the UK market, rapidly gaining on market-leader Irwin Mitchell which has 7%.
The UK market is highly fragmented and other acquirers have entered over the past 12 months, although Slater & Gordon retains first mover advantage. Following the recent acquisition of Pannone Solicitors, Slater & Gordon is now likely to consolidate and put further resources into building the brand in the UK.
Allowing for recent acquisitions, net debt/equity stands at 29%. Finance facilities have been renewed and Slater & Gordon has an internal gearing ratio target of 30%-45%. I wouldn't like to see the upper level being tested unless further acquisitions offer extremely compelling value.
Earnings per share are forecast to be 26c in 2014, 32c in 2015 and 34c in 2016 – placing Slater & Gordon on a price to earnings ratio of 17.7, 14.4 and 13.5 respectively. Dividends are likely to be minimal (between 2%-3% of net profit).
One of the best market performers over 2013, Slater & Gordon has further to run.
Foolish takeaway
Although acquiring and integrating white collar service businesses can be tricky (just think of some of the disasters the accounting profession has brought to the ASX), the well managed Slater & Gordon has to date been highly successful in this regard. The momentum achieved in the UK looks like continuing and Slater & Gordon still appeals as a relatively conservative long-term small-cap investment with a growing earnings stream.
Classified as a diversified financial, Bentham IMF is gaining operational traction in the US and Europe, adding to a considerable Australian legal case portfolio. Bentham IMF strongly appeals as a high-quality small-cap investment with significant medium and long-term upside. However it is not suitable for those after a predictable annual income.
Shine Corporate (ASX: SHJ) is another listed legal services company – yet to be investment grade, in my view.
