Omni Bridgeway Limited (OBL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Omni Bridgeway Limited Half Year Results 2021 Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Andrew Saker, Managing Director and CEO. Please go ahead.

Thank you, Ashley. Good morning, ladies and gentlemen. My name is Andrew Saker. I'm the Managing Director and CEO of Omni Bridgeway. The purpose of today's call is to present our results for the period ended December 31, 2020. Joining me on today's call is Stuart Mitchell, our Group CFO; and Jeremy Sambrook, our Group GC and Company Secretary. To some extent, this half's performance is typical of litigation funding as a business. There will be periods, when measured in 6-month increments, where there are few completions or where there are some unexpected losses, or as in this case, where there are both. These are short-term phenomena and not reflective of the long-term model. There is no doubt COVID has affected our business. Whilst we've seen some positives to the business, with the accelerated growth of our portfolio, including 11% jump over the last half to $17.6 billion in EPV. We've also seen some negatives with delays in completions, particularly in the U.S. This is something that our peers have also experienced. And for those with a less-diversified portfolio, this will create enhanced risk. However, as you will see later in this presentation, our portfolio is highly diversified with significant growth outside of the U.S. As you will note, this half has generated a loss after tax and NCI of $150 million. This loss is attributable to the provisions for impairment on 2 material investments, foreign exchange adjustments, both of which are noncash expenses, a loss in Funds 2&3 coupled with few completions. The provisions for impairments are discussed later in this presentation. The foreign exchange adjustment relates to temporary movements in the exchange rate, predominantly affected by the strengthening of the Australian dollar against the U.S. dollar. This is also a noncash expense. The one material loss in Fund 2&3 as a consolidated entity which is on a European waterfall, translating to the loss being attributable to the manager. The adverse cost expense is paid by the fund and exhausts the deductible, such that all future losses in Funds 2&3, up to $30 million, will be paid by our insureds in relation to those costs. With respect to completions, we have seen a continued slowdown in U.S. completions this half, reflecting the effective cessation of jury trials in most U.S. states. Without the stick of a trial, coupled with the defendants' desire to retain cash, we've seen a marked slowdown in settlements and completions in the U.S. Given the current status of the U.S. legal system with a significant backlog of cases, we expect that the next 6 to 12 months will also have few completions. However, with most cycles, when the pendulum swings back, there is likely to be a flurry of activity and an acceleration of completions. As such, long-term cycle will resume its normal operation. We generated a cash surplus from operations during this period from a combination of completions and collections of receivables. Our liquid position at 31 December, 2020, remains very strong with a clear line of sight to completions in the short term that will enhance our liquidity. During this half, our costs were relatively flat, notwithstanding an increase in headcount. We have focused on controlling costs to the extent possible without compromising our operational effectiveness or plans set out in our new 5-year strategy. Consistent with our new 5-year strategy, we launched new operations in New Zealand and our Latin America initiative. The New Zealand business is already starting to bear fruit with a number of new funding opportunities being identified, building on those that we already had in [ training ]. We've now moved into our second year post-merger. The Omni Bridgeway European business has exceeded our expectations in terms of new work generated, contribution to our co-funding opportunities and integration targets. The EMEA business exceeded its target for new business by 18% and assisted with the acceleration of the investments in Fund 5. As you'll be aware from some groundbreaking news, a portion of the Wivenhoe matter has now settled. The claims against the state and Sunwater, representing 50% of the total claim, we settled for an amount of $440 million. This is a fantastic result for our clients and for our shareholders. The balance of the Wivenhoe claim, being the remaining 50% against Seqwater, continues to be progressed on a dual-track process, preparing for the appeal in May, whilst at the same time, seeking to progress opportunities for settlement. The interlocutory decisions that have been handed down since the first instance decision in November 2019 have generally supported our positive views on this investment. Our estimates of revenue that may be derived from this matter are conservative, and although subject to various uncertainties, are likely to be at the higher end of the range that we have previously advised the market. We have obtained our AFSL, being we first litigation funder in Australia to do so. We have also launched 2 MIS complaint class actions, again, being the first funder in Australia to do so. We have 5 class actions announced or in the pipeline, including an environmental class action, shareholder class actions and negligence class actions. This will lead to an increase in multiparty actions as a proportion of our EPV and confirm Omni Bridgeway as the leading class action funder in Australia. Turning to Slide 3 and those impairments. As you'll be aware from our announcements over the period, we experienced setbacks in relation to 2 investments, being Westgem and an investment in Fund 4. In both instances, we have appealed the first instance decisions and remain confident in the outcome of those appeals. However, following discussions with the auditors and in line with our historical treatment of first instance losses, pending an appeal, the intangible asset balances for each investment was fully impaired and an adverse cost provision raised for the uninsured portion of the estimated adverse cost exposure in Westgem. For the Fund 4 investment, 100% of the impairment provision was reflected in the group's consolidated accounts with 80% attributed to the external fund for investors and 20% to the shareholders of Omni Bridgeway with the fund's owned structure. This approach is consistent with our reputation for transparency and conservatism. If we succeed in our appeals, these impairments will be reversed and the intangible reinstated. Turning to Slide 4. As noted in my opening, we experienced a net loss of $150 million, which was attributable to 4 factors, including the small number of completions resulting in revenue of $44 million in the half; an impairment expense of $107 million; an expense of derecognition of a material lost investment in Fund 2&3; and FX losses. Most of these expenses are noncash in nature and expected to reverse in time. The strengthening of the Australian dollar against the U.S. dollar has the collateral benefit of reducing our Aussie dollar costs or contributions to meet our funding commitments. However, I note there is more downside risk than upside risk to the exchange rate relative to the U.S. dollar, and as such, this benefit may not be in the -- for the long term. As you will note, our liquid assets remained strong at around $250 million. This position will be enhanced by anticipated short-term completions discussed later in this presentation. We have written down the carrying value of our intangibles to reflect the impairments to Westgem and our Fund 4 investment, and we expect these write-downs to be reversed on successful completion of our appeals. We have not written down our EPG associated with these impairments, which is a non-balance sheet measure, and we remain confident in the diversification of our portfolio. Turning to Slide 5. During the half, we had strong collections of receivables, both on our balance sheet and within our funds, which, coupled with cash generated from completions enabled a small cash surplus from operations on a consolidated basis. Measuring cash generation in 6-month increments can be skewed by the timing of completions and collection of receivables. If matters complete as we currently anticipate in our quarterly portfolio update, we will expect to see a strong cash generation in the second half. Turning to Slide 6. Cash costs during the period were reasonably flat compared to those in the last period. The increase in cash costs is attributable to a small discretionary bonus paid to support staff for the last financial year; the timing of the collection of an NCI contribution in Fund 6, which occurs in the second half of the year; and an increase in headcount by 5%. We're not anticipating any material change to the cash expenses during the second half. Turning to Slide 7. As you'll note from this slide, our cash and receivables position remains strong at around $250 million. We had strong collections of receivables, which was used to fund operations, contributions to our funds and investments on our balance sheet. From a balance sheet and EPV perspective, but from the impairments, we've seen a net growth in investments and EPV, which underpins future profit-generation capacity. The net asset position has been affected largely by the impairments to our intangible balance, which, as previously noted, will be reversed if we succeed our appeal. Turning to Slide 8. The negative movement in intangibles is attributable to the impairments of 2 investments, the derecognition of completed matters and FX adjustments. The FX adjustment is expensed through the P&L, which was the bulk of the noncash FX movement. As previously mentioned, this is noncash and more likely subject to reversal given the relative strength of the AUD against the USD. From an operational perspective, you will note investments in new and existing matters exceed those that were derecognized from completions, which in part explains the growth in our EPV. Turning to Slide 9. This slide shows our long-term conversion rate and aggregate EPV conversion for the period from FY '16 to H1 '21. Our LPCR cannot be assessed in 6-month increments, but needs to be assessed over multiple periods to avoid the impact that occurs in the short term. Over the past 5.5 years, our LPCR has been reasonably consistent, around 18% and above our 20-year historical long-term conversion rate of 15%. turning to Slide 10. In terms of the anticipated completions, you will recall from our quarterly portfolio update at 31 December, 2020, we anticipate that approximately $1.3 billion of EPV will be completed in the second half of the financial year, some of which have been identified in various judgments and settlements achieved to date. The most significant contribution to revenue in the second half is derived from the completion of the Wivenhoe matter. Whilst we've obtained a successful first instance decision and a series of decisions that are supportive of a positive outcome, the first instance decision is subject to an appeal, which is likely to be heard in May 2021. With the settlement that's now being achieved with the state and Seqwater, that has reduced the amount that will be subject to the appeal, which will progress with respect to only the portion attributable to the Seqwater claim. Turning to Slide 11. As many of you know, we measure EPV diversification by geography and investment type. Historically, we had a concentration of investments in one jurisdiction or another with the attendant risks of being exposed to regulatory intervention or competition. As such, we sought to diversifying our portfolio to the extent possible. From a geographic perspective, we've largely achieved our diversification goals with a split of investments between EMEA, U.S. and other jurisdictions. With respect to investment type, whilst we've also achieved a high degree of diversification into investments, including arbitration, litigation and post-judgment enforcement, we continue to have significant exposure to class actions, which still represent approximately 30% of the book. These class actions include securities class action, securities claims, environmental product liability and other class actions in a variety of jurisdictions, including Australia, EMEA and Canada. With the regulatory developments in Australia, we anticipate continuing to have a significant exposure to class actions with several new opportunities in the pipeline. Turning to Slide 12. As you'll note, our first-generation funds are practically fully committed, and as such, we now invest entirely from our second-generation and acquired funds. Given the capacity limits in Fund 6, we are exploring opportunities with our LP investor to restructure Fund 6 to create additional capacity whilst the go to market to raise a new fund, global enforcement investments, EMEA merits opportunities and distressed debt investments. We expect this new capacity will be required before the end of this financial year. We have scaled back expected completions in Fund 1 to this financial year, reflecting the continued delays we and others are experiencing in the U.S. court system. Turning to Slide 13. Further to the analysis of our first-generation funds. As you will note, notwithstanding the slowdown in completions, particularly in Fund 1 and the loss in Fund 2&3, there remains a substantial number of investments in each fund with significant EPV, which should provide sufficient capacity to see distributions to preferred capital and returns, a return of capital and fees to OBL and a distribution of profit. It appears that, subject to the anticipated completions being achieved, distributions will likely be achieved from Funds 2&3 around the same time Fund 1, both during financial year '22. Turning to Slide 14. Our focus during the next half will be on the continued execution of our 5-year strategy with continued geographic and product expansion. We anticipate seeking to raise new capital for our next fund to replace Fund 6 as a potential follow-on fund or new fund. And finally, the continued consideration of this potential change for our listing venue. As I've previously mentioned, I intend to relocate to the U.S., and it's possible that, that may occur in April of 2021, subject to the current COVID situation. Thank you. That completes the presentation, and I'll hand back to the operator to open the lines for questions.

[Operator Instructions] Your first question comes from Michael Peet with Goldman Sachs.

Andrew, Stuart and Jeremy. Can you hear me okay?

Yes. Thank you, Michael.

Just wanted a little bit more clarity on the last point you made there, the relocation to the U.S. At this point, are you looking to read on the listing side for the stock. Is that still under consideration for the U.K.? And I'm just wondering if you can provide us some more detail on that.

Well, the whole issue is still under consideration in terms of the change of venue for listing. At this stage, no decision has been made. I was talking about my physical location, Michael, I'm planning to move to the U.S. as part of the execution of the next business plan.

Okay. Understood. Just on the cash and receivables. I think it's pretty obvious. But I think the Wivenhoe, there's nothing in there in terms of receivable on cash there. So that will slot in, obviously, given today's announcement.

Yes, that's correct, Michael. It literally was late-breaking news. I think the settlement was achieved, subject to documentation and court approval, literally 50 minutes before this call. So no, none of those receivables or receipts have been factored into the balance at December 31.

Every case is different, I guess. But what's your expectation on timing of receiving cash on that one?

Look, I think it's subject to court approval. I would expect the court approval is going to be -- happen before the appeal, I would hope. So I expect it to be before the end of this financial year.

Okay. You mentioned new capacity for fund to replace Fund 6. But is that -- was there any other new capacity? Just interested in any update on upsizing Series 2 for Funds 4 and 5. Or any overflow fund in the other parts of the business?

At this stage, the upsizing of Funds 4 and 5 are on track for our expectations for that to occur during the third year of the life of those funds. At the moment, we're at about 25%, 26% capacity on Fund 4 and about 35%, 36% capacity on Fund 5. So there's still plenty of headroom in those funds for the current year and next. We anticipate to be probably closer to around 50% in each of those funds by the end of the financial year and then up to about 75%, 85% by the end of the third year.

Understood. Just Slide 9, that conversion rate that you mentioned around 18% over the last sort of 5 years or so. Is that like-for-like, apples-to-apples with the 15% that you've talked about? Or does the 15% include losses?

No, the 15% and the 18% includes losses. It's just a different time period. So the 15% is a measure over 20 years, and that 18% is just over the last 5 years -- well, 5.5 years.

Your next question comes from Peter Meichelboeck with Select Equities.

Can you hear me okay?

Yes. Thanks, Pete.

Yes. Just firstly. Just in terms of the delay in releasing the result was originally due to come out yesterday and come out this morning. Any reason for that?

No, it wasn't anticipated to come out until this morning.

Right. Okay. Well, it does say yesterday on your website. But look, if I could just move on to first-generation funds, specifically Fund 1. I'm just trying to work out the return over the rest of the life of the fund. I mean, if I go back to the portfolio report in the December portfolio report that came out last month, you gave some statements there around the confidence that you had around the return of the capital, et cetera. I'm just trying to -- once again in the presentation today. What's the ROIC that you're using on the remaining cases to be able to achieve that position where all the capital is returned?

We're using the long-term conversion range of 15% as the proxy for what we would generate out of that EPV.

But in terms of ROIC? Sorry.

Well, we're using the EPV percentage, Peter, a long-term conversion rate.

Okay. Because if I look back to -- there were a couple of presentations that came out last year, towards the end of last year in September, October, where it was a similar page to this one. And you referred to the ROIC, the quoted ROIC of 20% and the capital remaining. If I use 20% -- maybe if you can just help me where I'm making an error here. But if I look at the total fund commitments of the U.S. of that Fund 1, which is the USD 165 million total committed capital. So I assume a 20% ROIC on that over the life of the fund, I only end up with USD 33 million. Yet when I look at the total preferred return, that's already USD 40 million and rising. And then there's your management fee of $5 million, another special distribution of $1.8 million. So I'm just trying to work out how -- if the previously quoted ROIC or the current run rate, which is now actually about 15%, how that actually covers everything. Am I missing something here?

No. I think you're looking at what's been completed to date and applying that to the future. And if you do that with the 15% ROIC or a 20% ROIC, then there's no doubt your calculations are probably going to be correct. But that's not the numbers that we're using for our views on the performance of those funds. We anticipate to generate 15% long-term conversion ratio to EPV of those funds. And that generates sufficient capacity to pay out the preferred returns -- the preferred capital and also on the Bridgeway investments and our management fees and still have sufficient headroom to pay out the profit.

Yes. I appreciate that you're focusing now on the EPV, the 15%. But if I look back at those presentations towards last year, you also used the -- you also referred to the 20% ROIC...

No. I don't think that's correct, Peter. I think what we referred to is the -- which is on Slide 12, the actual ROIC that has been achieved on historical performance. So you can -- as I said, you're more than welcome to make whatever assumptions you wish about those funds and future performance. We make our own, you can make yours. What we reported is the historical performance.

Right. So -- okay. So you're not willing to sort of share what that 15% EPV would be in terms of ROIC for the remaining cases at this point?

Well, you can do your own calculations on that, Peter. What we've done is 15% of EPV is what our estimate of the revenue generation of these funds, which is the way it's performed historically.

Okay. Look, I'll move on. Just in terms of costs, obviously, costs have been rising for a number of years, both sort of expense and capitalized costs. And you did speak about sort of focusing on sort of controlling costs where possible. And this is, I guess, in the environment where revenue has disappointed in recent times and also being diluted by the fact that you're bearing 100% of the cost, but you're getting sort of 20% of the revenue in effect. I'm just wondering what you're looking at in terms of trying to control those -- control the cost base. If theres particular things that you're actually doing.

Sure, Peter. I think there's a number of errors in your statement. The costs increasing in terms of expensed and capitalized costs. In fact, our capitalization rate decreased from 15% to 14% this period. And you'll see that in terms of total capitalized costs, that dropped from 11.4% in the last half to 9.9% this half. In terms of employee costs, that dropped from 32.6% to 28.5%. So putting aside some of these misstatements, we are looking at focusing on cost control, notwithstanding our headcount has increased from 37 to 175 over the last 5 years and increased offices from 7 to 18. So costs are being controlled through the usual mitigations of managing marketing costs, managing our overheads with property costs and managing staff growing costs.

All right. Okay. Just on returns. I guess when I look across the business, I sort of look at it like being sort of 3 buckets in a way. One is the U.S. side of the business, which has been going on for a number of years and the -- apologies for focusing on ROIC, but the ROIC of the U.S. business is sort of roughly 15% pre capitalized overheads. And obviously less if you include the overhead. And the U.S. business has obviously been going now for a number of years, and in my opinion, the returns there have been pretty disappointing. And then when I look at the other 2 sort of groups, the way that I sort of tend to look at it is, it had non-class action -- class actions and non-class actions, and sort of on the research that we have done, the non-class actions, the ROICs have trended down there for a number of years and significantly lower than where they were as a sort of rolling average. So that's not looking -- in my opinion, not looking great. And then the third area is class actions. And given the sort of the regulatory -- possible regulatory and competitive headwinds you're seeing there. I guess my question is 2 parts. One is, why do you think the returns in terms of ROIC, why do you think they have been trending down? And what's caused that? And the second part, where do you see them actually improving going forward?

Again, Peter, I'm not entirely sure I accept any of -- many of the comments that you're making other than, I can say, we look at our business on it as a diversified portfolio, that was the whole purpose of expanding to the U.S. and to other jurisdictions. So focusing on ROICs in individual jurisdictions misses the picture of what we're trying to achieve as a long-term goal, which is to have a diversified portfolio. The diversified portfolio historically to date is still in the high 2.6, thereabouts, which isn't materially different from what it has been from 5 years ago, again, on the diversified portfolio basis. There's no doubt the completions in the U.S. to date have been not to the same standard that we had achieved in other jurisdictions. But that, I think, again, needs to be put into the context of the diversified portfolio. In terms of where we think it's going to stay, we anticipate that ROIC on a historical basis will continue to be around those high 2s. And -- sorry, that's [ MOICs ], I should say. And that's what -- we don't see any reason for that to materially change.

Okay. Can I just ask on class actions and the changes there? We know that you've launched the first class action, well, now the second after this morning. With the Freedom Foods one in particular, I just wanted to ask, obviously, it's the second action that Freedom Foods is facing here with Slater obviously pulling forward their action a couple of months ago, I think now. When I -- it appears to me, when I look through both sort of documents, that the return for the Freedom Foods shareholders if they were successful, it appears to me that the returns will be more favorable, could be more favorable under the Slater's action compared to the Omni Bridgeway action. I'm just trying to work out, having sort of -- if that's the case, if they're more attractive under the Slater's, and the Slates one is being done first. How do you see your class action being competitive in that environment?

Look, Peter. Again, we've got 300 -- over 300 investments, and to talk to the specifics of each of those, I think, going to be a challenge. But specifically on Freedom Food, the difference between Slater's class action and the Omni Bridgeway class action is one's being run as a GCO, and the other one is being run as an MIS. And we anticipate that the GCO is going to struggle as a consequence of it not complying with the MIS regime, and therefore, may not proceed. So we've got a view that ours provides an opportunity for investors to actually get to the end goal, which is to achieve a settlement or victory at trial against Freedom Foods and their offices.

Sorry. Sorry, Andrew. Are they subject to the MIS scheme? I didn't think they were, the contingency -- with contingency actions. Is that -- am I incorrect there? Or...

We think yes.

Right. Okay. And when I look at -- I'll move on from that. Just finally, just on the 2 impairments. The company has -- you've quite a bit, you've got confidence in successful appeals, et cetera, on that. Would either or both of those cases -- was that decision based on an independent external review of those? Or is this the opinion of the counsel that's employed by you guys?

We don't engage Deloitte to act for us. It's they act for the clients in those cases. And the have members of the independent bar. And they are based on independent advice, not just the company advice.

Sorry. Sorry, I probably misphrased. What I meant was, was the review of those, were either one of those cases reviewed by another external barrister or whatever? Or was it the barrister that's being involved in the case at this point?

Again, we have over 300 investments. So descending into the detail of each one of those is going to be a challenge. But specifically on this, to engage an independent lawyer, I think, is what you're suggesting, to review, for example, 10 years worth of court documents, interlocutory information, the evidence, the trial data, to come up with an opinion about merit would be a significant waste of time and shareholder money. The advice that we have is from the independent barrister that is involved with the case, that's been involved with it for a number of years and understands the case intimately. And they're a member of the independent bar.