IMF Bentham's (ASX:IMF) annual report describes its business as ‘international litigation funding’, conjuring up images of high profile lawyers and tense court battles. In practice, though, what it does is very similar to what we do everyday here at Intelligent Investor.
When IMF considers funding a case, management needs to decide three things: how much the case might return, over what period, and how certain the potential return is. That’s textbook value investing.
The only difference between us and IMF is the source of the cash flows. IMF estimates how much cash a case might return, whereas we're thinking the same things about businesses. To be specific, IMF is closer to an activist investor, as it can influence the outcome of its investments, whereas we're much more passive investors.
IMF has funded 187 cases over its 16-year life. 123 have been settled while 13 have been won. If we regard all settlements as wins (which seems fair as a settlement delivers some cash for the plaintiff), this means IMF has a strike rate of 73%, a level even Warren Buffett would be proud of.
High strike rates translate into attractive returns. For each dollar invested, on average IMF’s cases have returned $1.55 over 2.4 years. When you can put large sums to work, as you can in the increasingly litigious markets of Australia and the US, this makes for big business.
But there’s a pinch. Barriers to entry are low and this means rising competition. Like value investing, all that's needed is capital and the belief in one’s ability to pick winners, however misguided that might be.
IMF used to have the market to itself, similar to when Warren Buffett was investing in the 1950's. But its success has been noticed and this has attracted copycats ranging from conventional competitors to even hedge funds.
Increasing competition is shown in its numbers. In 2012, IMF had funded a total of 137 cases at a strike rate of 77%, 4% better than today’s level. This might not seem like a significant erosion but it is: the 50 cases funded since 2012 have seen IMF's strike rate fall to just 66%.
We think value investing is a good guide for how competition will continue to affect IMF. The high returns achieved by Warren Buffett and others from the 1950’s to the 1990’s encouraged many others to follow suit. There are countless value investing funds and amateur enthusiasts around today. This means competition for attractive investments is fierce, and the prospective return is much lower than it was in Buffett’s heyday.
We suspect the litigation funding industry will follow a similar path, taking IMF's profitability with it.
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