Shark Prime

Well, I am long IMF now. Not the IMF that all readers may be familiar with. IMF is a company listed on the Australian Stock Exchange. It makes money by funding large scale litigation and taking a nice big slice (bite) of the proceeds.

This "loan shark" company is run by lawyers and bankers- what a match. Management has a sizable stake, and looks like the company is in the right place at the right time with a few spectacular near corporate collapses in the market, and by my reckoning, quite a few to come.

There is some $42m in the bank and no debts, the company redeeming all of its convertible notes recently. It has 120 m shares on issue, so we have cash backing of about 35 cents per share. Looking at getting a further $37 m by August if the Court approves the settlement deal with the poker machine giant Aristocrat. I do not see why the Court will stand in the way. So that adds another 31 cents for cash backing, and voila, we have 66 cents per share. The shares last traded at 68 cents. We have 2 cents per share for ongoing enterprise value

So, for a measly A$240,000, you get to own a portfolio of over 28 pieces of funded cases. Ok, just for clarity, current market cap is $82m, cash and expected cash by August is $79 m. So about $300,000 for enterprise value being ascribed by Mr Market at the time I write.

Let's see, from 2003 to 2008, the company funded about 29 cases which have concluded. They lost or withdrew from 10, but settled or won 19, so about 2 to 1 ratio. Over the same period, it spent $23m and recovered $77m. Past performance is no indication of future performance of course. But the industry mechanics are favourable. Consider this, the cost of litigation has gone up steadily over the years, but not quite nearly as much as the market capitalisation of all listed stocks, in strict dollar terms. Claim sizes based on stock market losses (or gains) as compared to litigation costs will rise on a near exponential basis. So in bald terms, for every dollar punted by IMF, it sees increasing returns in real dollar terms. It is like a company selling a product which has a ratchet price increase build in- much like cigarettes and petrol in Australia. Perhaps a comparison of the case portfolio and recoveries over the last few years will illustrate this concept.

There are competitors in the market obviously, but IMF should remain top dog for quite a while. Two main reasons, first is size. The court system in Australia punishes losing litigants by making them pay a portion of the legal costs of the winning party. Another peculiarity is that the court also ensures that winning litigants are not out of pocket for such legal costs against a losing litigant, by making plaintiffs provide security for costs. Therefore, balance sheet size matters, because not only is the litigation funder such as IMF required to pay the plaintiff's own legal bills, it has to provide a bank guarantee for the other side's legal bills in case it loses. In a multimillion dollar claim, legal costs could exceed several million. Multiply that over a portfolio of 30 cases.

Second reason is that it is not just a question of deep pockets that makes this business successful. You have to pick your cases well. IMF loses money not only if it loses the case, but also if the case drags on for several years without a verdict. The quality of your portfolio is essential. And also you need to have a sizable portfolio to smooth out results. And there is a virtuous cycle at work. Because IMF is choosy and picky over its cases (plus it has an investigative arm to fund investigations into a case), potential litigants and their lawyers will approach IMF for funding purposes first, because if it is approved by IMF, chances are you have a near sure winner. I think of this concept as being the case of "the fish that John West rejects."

Well, let's see. Time will tell. I believe that by year end, cash in bank for IMF net of loans will exceed market cap. Pure dirty "Ben Graham" play with a bit of Fischer upside. You got to love that.