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Ann: Launch of Bentham IMF US Investment Vehicle, page-21

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denk12

7,445 Posts.

14/02/17

09:56

Post #: 22589303
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Originally posted by Jimmy_C ↑

Some interesting comments regarding IMF's SPV, and i think there's a little confusion as to what's going on here. It's a large strategic development and the 3-page announcement leaves out a lot of detail i'd regard as critical to understanding the probabilities for success, but in summary i see it as potentially quite a large, long-term positive.

IMF is a business that i've long been interested in and i once held the IMFG convertible notes, so it's a business that i keep an intermittent eye on. I like the structural trends underpinning their business and i've always thought of it as a well-managed company that communicates clearly with its shareholders, and produces relatively clean financial statements. The key issues with this business have always been:

1) Inherently lumpy nature of earnings (tied to the often-binary outcomes of the cases they fund);

2) As a direct consequence of (1), IMF has always been 'capital inefficient' - they have little access to debt capital due to the very lumpy nature of the business' cash flow/profitability (and what debt they can get is costly), so they are forced to hold large amounts of cash and effectively equity-fund the entire business. This has been particularly punishing over the last 3-4 years as they've been growing their case book and expanding internationally.

By setting up the SPV, IMF appear to be transitioning themselves from a litigation manager, to a fund manager. This is something many real estate and infrastructure companies have done over the last 10-15 years, as they face some of the same inherent challenges IMF does (i.e. lumpy earnings and capital intensity of the enterprise). As a result of moving to an SPV structure, i expect IMF to reap the following benefits:

1) Development of an annuity earnings stream - i imagine IMF will be charging an asset/fund management fee on the $150m Fortress investment. Not a huge number, but could be something in the order of 1-1.5% p.a.

2) 75% reduction in capital intensity (because Fortress is funding 75% of the vehicle) with, apparently, no change in case selection discretion. I struggle to believe that Fortress won't at least have some say on which cases the SPV undertakes, albeit i suspect it to be a relatively pro forma box-ticking type approval process to ensure IMF's discretion isn't heavily impeded. If Fortress have, indeed, been given significant case selection discretion, then the whole concept doesn't work as IMF won't be nimble and at liberty to run its business according to its own judgment.

3) Potential performance fees ('preferential returns') - it looks to me like this is where the greatest confusion lies and, based on the way IMF has explained it, i expect it to work for IMF the same way it does for other fund managers (in real estate, equities and so on). The 15/85 split above the (as-yet undefined) return hurdle simply means that when the SPV reaches its maturity, after Fortress hits its pre-determined pref hurdle (whatever that may be), IMF get 15% of the surplus funds generated above that preferred return hurdle - it's potentially a big free kick to the fund manager at the end of the fund life.

Some of the key details lacking are:

1) Tenor of SPV: This is absolutely critical - IMF effectively need perpetual or near-perpetual funding given the underlying demands of their business, but equity investors in SPVs (like Fortress) usually want to have some future right to call their equity back. If there were to be a wind-up of the SPV at some future date, that would be a messy thing - the underlying assets aren't readily sale-able, so IMF would either need to find a new investor to replace Fortress, or raise equity to take out the underlying investors themselves.

2) What triggers the performance fee? For stocks and real estate SPVs / managed funds, usually there's a fixed fund term and when that fixed term expires, the manager simply sells the underlying assets to realise the portfolio, OR investors agree to roll the fund over but the underlying assets are easily marked-to-market to determine a fund life IRR, which triggers the payment of the performance fee to the manager (in the event the IRR is above the preferred return hurdle). In IMF's case, i don't think a case portfolio is an easily sale-able asset (nor is there an easily determined marked-to-market value), so i don't understand how the wind-up of the SPV might work, nor how the performance fee will be triggered and calculated.

3) What costs is IMF going to load into the SPV? Given the SPV has exclusivity over all US cases until the earlier of 3 years or until the $200m is allocated, are all IMF's direct US costs going into the SPV or is some staying on IMF's own P&L? This is always an interesting discussion between the fund manager and incoming investors...

4) What is Fortress' preferred return hurdle?

I will hang out for further details and i think it's incumbent on IMF management to answer some of those fundamental questions above (in addition to others), but if IMF have indeed thoughtfully and correctly structured the SPV, i'd consider that to be a significant, long-term positive for the business.

Expand

Thanks Jimmy_C

A good perspective. Thank you! Musch appreciated.

Are you correct here tho' Re. Point 7. "The 15/85 split above the (as-yet undefined) return hurdle simply means that when the SPV reaches its maturity, after Fortress hits its pre-determined pref hurdle (whatever that may be), IMF get 15% of the surplus funds generated above that preferred return hurdle - it's potentially a big free kick to the fund manager at the end of the fund life."

The Priority Returns ► The pre-determined pref hurdle (whatever that may be)

The Manager Returns ► The residual net cash flows are to be distributed 85% to IMF-Bentham (Class A Stock) and 15% to Fortress Credit Advisors LLC (Class B Stock) (NYSE FIG)

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At first blush, I thought this funding agreement and creation of this "Special Purpose Vehicle" was primarily to fund the current US/Canada Case Investment Portfolio.

Mainly due to my own bias...

I consider that the AUD$142 m on hand at y/e 2016 is not going to be enough UNLESS Proceeds from Litigation Funding reliably bucked up substantially over 2017, 2018, 2019.

I have expected and concerned myself that IMF-Bentham would be forced at some awkward time, & before the loan caveat in the 2020 Fixed Rate Notes expires, to be potentially forced to have an equity raising, out of need/necessity.

A placement with IMF-Bentham's back to a wall.

Thankfully imback, brought my attention to note 17. ( Sadly I tend to dose off towards any document end, and should realise that the significant terms are too often swept in right at the end. )

That single note changes this entire disclosure! So from funding (my bias) i.e. from existing Cases in "The USA & Canada matters" in the Case Investment Portfolio to NEW cases only.

This changes the flavour for me, quite considerably, as this means IMF-Bentham can grow substantially, off this funding over the next three years, and beyond. We are also advised that this is the "vehicles" that will be favourably eyed for adoption into other countries.
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It is still a disclosure without the key descriptor(?) and so diminishes the worth of the disclosure. The Priority Return - a capped priory return - is neither scaled or quantified.

I believe the historic return in the US of IRR of 83% is perhaps the result of early low hanging fruit picking. Something that IMF-Bentham achieved in it's virginal expansion into Australia too, in the 2010's & earlier. But in a mature industry, we discover, cases are appealed to the highest courts, and MOIC's at less breathless highs. Is a litigiousness USA going to be passè on lost outcomes. I'd be surprised.

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For the quirky The Fixed Rate Notes are underwritten by FIIG Securities, and it is in the face of their caveat that FIG - Fortress Investment Group (NYSE:FIG) create this "Special Purpose Vehicle" with "a bespoke construct" to circumvent the ambit of their safeguards! (The neither Stock nor Loan; neither Fish nor Fowl; neither pref. share nor pref. debenture )

God spare us the court reports should FIIG seek redress against FIG!

IMF would be pi55ed.

IMF Price at posting: $1.83 Sentiment: Hold Disclosure: Held
3 Upvote

0 Great analysis

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