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Published 17 May 2012 05:10, Updated 17 May 2012 09:35
Much has been written about the in-principle $200-million Centro settlement this month, the largest for an Australian shareholder class action. Less considered is what the decision and the outlook for class actions mean for litigation funder IMF (Australia), which bankrolled the Centro action.
IMF is the only significant ASX-listed litigation funder. Another, Hillcrest Litigation Services, has struggled in recent years and is now capitalised at $1.8 million. Listed law firm Slater & Gordon leads high-profile class actions, but engages specialist litigation funders for cases that can cost millions and take years to resolve.
Litigation funding is a deceptively complex business. Typically, a litigation funder receives about 30 per cent of the settlement and its legal bills are reimbursed by the losing side. It is big business: the Aristocrat class action settled in 2008 for $135 million and the Multiplex action settled in 2010 for $110 million meant tens of millions of dollars of income for litigation funders. Appeals can further lift the percentage that litigation funders receive.
High fees, however, reflect the high risk in funding class actions. When a case is lost, millions of dollars must be found to reimburse the other side’s legal costs. The real skill of firms such as IMF is in choosing the right class actions to back and working with good law firms. A few adverse judgments can blow up smaller litigation funders.
IMF was a popular stock after the global financial crisis. Its shares rallied from 70¢ in early 2008 to $1.90 in 2009 as the market expected more shareholder class action against failed companies. The shares are now $1.39. The Centro news was priced in well before the in-principle settlement; its shares sometimes lift in anticipation of a settlement and fall after it is announced.
This column has followed IMF on and off over the past four years. It has good management and an excellent board led by Rob Ferguson, former chief executive of Bankers Trust Australia. It has a sound record, having funded 130 completed cases since 2000, which secured about $1 billion for plaintiffs in class actions and just over $300 million for the firm.
But I’ve had a few concerns about litigation funding. First, that all the talk about an explosion of class actions here, and a more aggressive United States-style approach to litigation, was just hype. There have been more shareholder class actions since the GFC, and more about to start, but the overall number has been reasonably steady in the past decade.
A second concern has been regulation. It is unusual that an industry whose main offering is a form of investment product is not heavily regulated. Calls for regulation have grown much louder this year and the Centro settlement is likely to amplify them.
There is a view that litigation funders earn super-normal profits and the prospect of more class actions will encourage lower-quality funders to set up in Australia, pursue more low-merit class actions and try to bully companies and their boards into a quick settlement before trial, to make actions that can disrupt management and damage the brand, go away.
The third concern is the nature of IMF’s earnings. Although it has shown good growth, earnings can be lumpy because of the nature of large cases, and the stock has less dividend certainty. I prefer small companies with more certain, visible earnings and dividend growth, and franking credits. I confess I struggle to understand IMF’s franking position or its dividend policy.
Even so, IMF is at an interesting stage. It has funded at least six actions due to be completed in the second half of 2012. Most are of a decent size, and managing director Hugh McLernon, a conservative type, described them as among the firm’s “favourite cases” when he announced IMF’s half-year profits in February.
Other big class actions continue, and an action against XYZ Learning Centres (formerly ABC Learning Centres) could be a whopper.
I have also wondered how litigation regulation, if it happened, would affect IMF. It could benefit reputable firms such as IMF, by enforcing higher standards and making the industry less attractive to new firms. IMF is the only big Australian litigation funder that already has a financial services licence; requiring offshore litigation funders to be licensed could have tax impacts for them.
That said, I doubt litigation funding is as lucrative as it appears on paper. It is certainly less attractive than in the US, where the losing side does not reimburse the other’s legal costs, where juries, which are notorious for large settlements, decide cases and where judges can award triple damages in some jurisdictions. US litigation funders typically take about 33 per cent of the settlement.
My read of the regulatory debate is that regulators see the benefit of litigation funders bankrolling class actions that help plaintiffs seek access to justice, and take pressure off public legal resources. But they want funders that are substantial and act appropriately, pursuing cases where there has been demonstrable heinous action by companies and directors, not low-merit cases that can make a quick buck through early settlement.
Experienced, long-term investors comfortable with small caps could do worse than consider IMF. The best time to buy is after big cases settle and the stock falls, as it did soon after the Centro news. The valuation looks more tempting than it did in late 2009, despite IMF’s progress since then and a pipeline of upcoming case completions.