Update following audited results for FY ended March 2024
Following that challenging Covid period, the insolvency market picture has now completely changed, presenting Manolete with the most attractive trading conditions since the business was formed in 2009. Significantly higher prevalent interest rates, heightened concerns over geo-political conflicts in Eastern Europe and the Middle East and the withdrawal of the largescale financial supports provided by the Government to UK businesses during the Covid-19 period, has resulted in the highest level of UK insolvencies for 30 years. Insolvency Service statistics from January 2024 show the number of Creditor Voluntary Liquidations, the largest constituent part of the UK insolvency market, in 2023 was at its highest level since 1960.
The Company delivered strong performance in the year ending 31 March 2024, with a record 311 new case investments, up from 263 in FY23. This growth reflects the Company’s expanding network of insolvency practitioners and lawyers across the UK, allowing it to capitalize on a market that has rebounded from the static conditions caused by the government's temporary Covid support measures.
Financially, the Company reported a 27% increase in revenue, reaching £26.3m, compared to £20.7m in FY23. Operating profit stood at £2.5m, a significant improvement from the £3.1m operating loss in the previous year. There were 251 case completions, generating £24.2m in realized revenue, and gross cash recoveries from completed cases amounted to £17.7m. The Company ended FY24 with 418 live cases in progress, up from 351 in FY23.
There have been more material and positive developments relating to the Company's cartel cases in recent months. Early in calendar year 2023, the judgments for the large truck cartel cases relating to BT Group Plc and Royal Mail Group Limited were handed down with significant damages and interest being awarded to the Claimants. Following publication of these rulings, an independent expert valuation firm has assessed the value of Manolete's 22 cartel cases. The cartel case carrying valuation as at 31 March 2024 was £15.1m and the valuation therefore represents Manolete's percentage ownership of the overall case valuation. These claims are currently stayed pending resolution by means of alternative dispute resolution (negotiated settlement) which is likely to be successful based on the precedent set by the BT and Royal Mail claims. In the event that a mutually agreeable settlement is not reached, the case is expected to be decided by Court hearing in September 2025. This implies at at some time in the next 12 months, the financial position of Manolete will change significantly and a re-rating is likely.
Despite carrying a net debt of £12.3m, which the business expects to pay down when the Cartel cases settle, the Company has agreed to revised covenants with HSBC, transitioning to cash-based rather than profit-based measures, and reducing its debt facility size to £17.5m.
With a significantly improved business performance, a growing team, and a high number of corporate insolvencies in the UK, the Company is well-positioned for sustained growth, further supported by a recovery in larger case investments in the latter half of FY24.
UPDATE: Interim Results November 2023 - When increasing insolvencies becomes good news!
MACRO: In the UK, insolvency volumes saw an uptick amidst a challenging corporate operating environment exacerbated by higher interest rates and inflation. Recent data reveals a notable 25% increase in the number of businesses experiencing critical financial distress between Q2 and Q3 2023. Approximately 480,000 UK businesses are currently grappling with 'significant' financial distress, marking an 8.7% increase from Q2 and a 4.7% rise compared to the previous year. Sectors causing heightened concern include construction (up 46% from Q2 to Q3), real estate and property (up 38%), followed by the retail sector. The confluence of factors such as high inflation, elevated interest rates, weakened consumer activity, and an uncertain economic environment collectively intensifies the pressures on businesses.
MICRO: In the context of the macro backdrop, and after almost two years of the UK Government's efforts to temporarily suppress insolvencies during the Covid pandemic, UK insolvencies and Creditors Voluntary Liquidations (CVLs) have surged to levels comparable to those seen during the 2008 financial crisis. Larger company insolvencies, primarily entering the process via Administration, have also rebounded to pre-pandemic levels. Manolete, a company specializing in insolvency litigation financing, began benefiting from increased business in H2 FY23, resulting in robust growth. H1 FY24 financial results exhibit continued strong growth across all key performance indicators, with a notable 104% revenue increase compared to H1 FY23. Profitability numbers YoY are misleading because of an extraordinary write-down that occurred last year, but the company is generating positive cash flows and the portfolio of cases is growing at an impressive rate. The Company ended H1 FY24 with 417 live cases in-progress, a 58% increase over the previous period-end. In anticipation of greater volumes of work, the business has expanded its litigation team by 15%. All of this implies that a key inflection point has been reached and current levels of profitability are likely to be the start of far better things to come.
It should also be noted that the initial surge in insolvencies post-April 2022 was driven by a sharp and sustained rise in CVLs, mainly representing smaller companies with lower claim values. This resulted in an 18% lower average completion value per case in H1 FY24 (£79.3k per case) compared to H1 FY23 (£96.8k per case), excluding an exceptionally large single case. The recent seven-month period has witnessed a sustained recovery to pre-pandemic levels of Administration appointments, and as the insolvency market evolves through the current business cycle, the Directors anticipate a return to higher average case sizes, reflecting a greater mix of larger company insolvencies.
The Cartel cases are expected to settle in 2024 which will result in a large extraordinary cash flow event to the upside.
Last but by no means least, the pilot project undertaken to recover monies fraudulently claimed during the pandemic under the Bounce Back Loan (BBL) scheme, has been been a success. The volume of these claims is anticipated to increase from Barclays bank, Manolete's partner in the pilot project. Additionally, a second major UK bank will be appointing Manolete to act on its behalf in this regard. This is high margin business which will augment cash flows from underlying insolvency work.
In summary, all looks good and 2024 promises to be a good year for shareholders. It is entirely baffling why a company which finds its prospects to be better than ever has a share price trading at the lowest end of its 5 year range, but this almost certainly looks like a fantastic opportunity to jump in or to scale up.
As a result, all litigation financing firms in the UK have seen their share price negatively impacted.
This is a symptomatic knee-jerk reaction.
The market has not taken the time to digest or to understand the news.
What does this mean for Manolete Partners?
In truth, very little changes, yet the share price is down about 20% from recent levels.
Manolete Partners operates in the specialist field of insolvency litigation. I cannot overstate the importance of this nuance. Insolvency is the only branch of UK law where a third party is permitted to acquire rights in a legal claim. 94% of the claims in the Manolete portfolio are owned by Manolete and so unaffected by the Supreme Court judgement.
Of the very small number that may be impacted, it will simply mean restructuring current Litigation Funding Agreements (LFAs) away from a return based on a proportion of the damages recovered (technically a 'damages based agreement' (DBA)), to a structure where the return is calculated by reference to a multiple of the amount invested (technically not a DBA).
We may also see legislators seeking to add clarity to the poorly drafted DBA regulations, which frankly is long overdue.
Long story short, the impact to Manolete is little or nothing at all, yet the shares are now available at a significant discount. These market anomalies don't last for long. You heard it here first!
One topic I’m curious about from the trading update is the bounce back loan program. It seems like it would be a no brainer that banks and the government would want Manolete to take on BBL cases and recover money for the government. What are the barriers to expansion of the program?
Manolete represents the best option for bounce back loan recovery. Barclays bank has discovered that and I think that there are pilots with at least one other bank (I think Lloyds Banking Group). The issue is that there are so many of these fraudulent cases, and the average size is relatively small. Although Manolete receive a very healthy share of monies recovered (up to 50%), the issue is one of capacity. It only has a team of lawyers numbering in the high 20s or low 30s. There are only so many cases that they are able to manage. The other issue that may exist, I am only speculating because I have not seen the legal terms that they have with the banks, is that while they receive a high 50% payout of monies recovered, out of that they almost certainly need to cover the litigation costs themselves. Since the cost of litigating is relatively similar, no matter how large the claim, small claims are less viable to pursue because the costs eat a disproportionately large part of the recovery sum. So it may be that Manolete is being selective.
For me, this bounceback loan recovery is not core business but a short term ancillary revenue stream. It is a situation that arose out of the Covid crisis and will not be repeated. It therefore does not represent a sustainable long term revenue stream for Manolete. The same is true of their cartel cases. When analysing the business I prefer to focus on the core business and track how that is growing. The trading update is encouraging in that regard.
I would like to see them clear the extraordinary items, particularly the Cartel cases, and to reinvest the proceeds into growing the core business. Perhaps that will happen this year. Then I view the bouceback recovery earnings as cream on top, which we will enjoy over the next few years but which should never take precedence over growing the underlying business.
what can you tell about the lackluster growth in equity compared to competitors like litigation capital? And can you re-explain why buying the legal claims is actually better than financing them. Thank you.
Manolete Partners operates in a niche field of insolvency litigation. During the Covid pandemic the UK government introduced emergency measures to prop-up struggling businesses. The result was that insolvency numbers were artificially suppressed. It spent billions of pounds propping up many businesses that were simply not viable. Ironically, all that they achieved was to delay the inevitable, but at great expense to the tax payer.
For two years insolvency numbers dropped and that had a negative impact on Manolete Partners. This is where you are able to distinguish them from Litigation Capital which was not subject to the same issue as it does not specialize in insolvency litigation.
The good news, at least for Manolete Partners, is that the government's emergency measures came to an end in the fourth quarter of 2022. At that point the flood-gates opened. Insolvency numbers shot up. All of the businesses that had been maintained on life support began to flat-line. This was purely due to Covid. But then came the Ukraine war which caused inflation and interest rates shot up sharply introducing still more duress to the economy. Raging inflation caused input prices to rise and not all of that could be passed through, so margins were squeezed putting more strain on an already weak economy. Businesses that were over leveraged and with a weak balance sheets collapsed under the pressure of rising financing costs. And if that wasn't enough, inflation and higher rates resulted in a cost of living crisis which dampened demand. It was the perfect storm.
Long story short, insolvency levels are at record highs at the moment, on par with where they were during the 2008 credit crisis. This is terrible for the economy, but wonderful for Manolete Partners. It is perfectly counter-positioned.
So that answers the first part of your question. In relation to the second part it is very straightforward. If you fund someone else's claim, then they are in the driving seat and make the decisions around whether to compromise and settle early, or whether they have the fight to go the distance. More particularly, if circumstances change and the prospects of the claim diminish, it is the owner of the claim who decides whether to discontinue proceedings and risk throwing good money after bad in legal fees. This is a huge risk for those concerned with litigation finance. Someone else, who is invariably unqualified, is effectively managing their investment. By contrast, if Manolete Partners acquire the claim then they are back in control. They can abandon claims if the prospects of success diminish thereby curtailing losses, while running with the winners, much as you would with your equity investments.
There is an added benefit. The Supreme Court's decision in the PACCAR case suggests that the legal basis on which many litigation finance firms operate may be unlawful. This means that they may have no rights under the claims that they are funding. This caused the value of all litigation finance firms to drop like a stone last year (Manolete Partners included). Ironically, that judgement applies to contracts governing litigation finance of a third party claim. It does not apply where the claim is owned (Manolete Partners owns 94% of its claims). So while that judgement cause the share price to be dragged down, Manolete is about the only litigation firm that remains unaffected.
At this juncture it is worth noting that it is only possible to acquire all rights in a third party claim in insolvency law (explained in my article above), so there is another key distinction between Manolete and Litigation Capital. the latter doesn't have the option to buy the legal claims.
In summary, this explains why this is a great investment opportunity - an unjustified discount on the share price which means that you can buy the stock at 2018 valuations while the business is in significantly better shape now than it was back then and its forward prospects are better than they have ever been. When intrinsic value goes up, but the market price goes down, that's when a good investor acts and then waits for equilibrium to be restored.
It certainly helps. Thank you for your fast reply. Your answer to my 2d question inherently makes sense to me. I wonder though what negatives you see on choosing for acquiring the claims vs financing them. (So I follow your reasoning completely, but what are the downsides you see to this model?)
With the return on equity… I believe the government giving lifeblood to dying companies had a negative impact on the company. Also logically speaking the COVID period is one where operation must have been postponed/made more difficult etc. However, I’m afraid whether this is really the whole story? The larger case that was denied and now goes to the court of appeal… how can this have skewed the ROE perhaps? I’m afraid to be missing something ‘under the hood’ rather than external/one-off causes.
Thank you for this write-up. You convinced me of the general thesis behind it. Personally, I see a company with a moat (strong reputation) operating in a business that’s a lot better than it looks like. Higher interests rates (and bad economic environment) are a nice catalyst.
However, I must admit that I’m a relatively inexperienced investor and find difficulty in figuring out the proper valuation and/or understanding the figures.
Can I ask you about the net cash generation and/or the amount of cash they reinvest in new legal claims? I would like to know more about the costs. Not really the upfront cost of acquisition and legal fees, but more about the total costs taking everything into account, in order to have a better understanding of their net results. Generally speaking I don’t like ‘gross’ figures...
Also, speaking of the catalyst of the higher interest rates => more claims available. To what extent is this actually a catalyst when the real limitation to growth is the amount of cash they have (and not the number of claims available)?
Could you talk more about management? How, I see it atm is that they are very competent in their business activity, but not as a public company. The dividend policy and also the accounting with the IFRS-6 where they basically don’t listen to investors and seem to make wrong decisions that put the company at risk/are value destructive, worries me.
There is no quick and easy answer to your question. The truth is that conventional accounting practices were designed around industrial businesses that make things. They don't work at all well for investment firms, yet this is exactly what Manolete Partners is.
The difficulty is this. You start with $1 and are able to generate a 50% return, so you receive $1.50 back but immediately reinvest that in the business. Your net cash flow is zero because money in equals money out, but your investments have grown by 50% and will keep compounding at the same rate going forward.
Manolete acquires claims and then leaves external lawyers and insolvency professionals to do the heavy lifting in terms of work load. This means that the business is very scalable. Consider that the number of cases is at record levels, up 104% YoY in terms of revenue and up 58% in the number of cases sequentially, but the increase in the size of the legal team has only been 15%. That points to operating leverage which means that as the top line grows, more of it falls to the bottom line.
The company ought to be viewed as any other investment firm but with a key difference. Consider a VC firm investing in start up companies. They generally expect 90% of their investments to come to nothing and hope that the other 10% will become winners to an extent that it more than compensates for the losers. That's a risky game. VC firms come and go because they operate in a fiercely competitive space where everyone is chasing the next big winner. Additionally, if you invest in the next tech winner, it may take 10 years for them to prove themselves winners. By contrast, Manolete Partners have a wide moat with little real competition. They cherry pick cases offered to them and have a success rate of circa 93%, so most investments will be winners. They have a very consistent model, with most cases settling in only 11 months. This stability makes the business easier to manage because it is far more predictable, thereby mitigating operating risk.
For me this is a very interesting opportunity, a flower that will very soon bloom.
In terms of the management team, I have been particularly unimpressed by the CFO as he has made several silly mistakes that were avoidable. The CEO is very good, he founded the company, but this is his first foray running a public company and he too is making errors as a consequence of relying on guidance from external consultants. The recent announcement of an LTIP linked to the share price is laughable. It also points to the competence of the remuneration committee being well below par. But this is a young company and it needs to mature. The key issue is that the board is made up of lawyers and insolvency professionals, but there is a lack of corporate finance expertise and the CFO certainly doesn't have it. They need better NEDs at the very minimum to introduce constructive challenge. But these challenges are not unique to Manolete Partners. Most young companies go through this phase and as they grow they are able to attract more 'A' team players to join the team.
The investment thesis is still in tact. Perhaps more so at these discounted share prices.
Do you have any updates on Manolete Partners? The only negatives I see are that the case appeal was lost and debt covenants had to be renegotiated with a slightly higher interest rate. The positives seem to be that cases signed, realized gains, and cash generated were up for FY23. I saw that >80 cases were signed in Q1 FY24 (actually maybe >90). They said at least 3 million pounds gross cash were generated that quarter, so that should roughly cover expenses for that quarter (assuming Manolete gets half that cash and the operating cost is 6 million per year). Also, their live cases continue to grow (probably greater than 400 by now).
Any thoughts on the truck cartel cases? It seems that the calculations for damages are established and some of the cases not owned by Mano have been settled.
One risk I’ve been worried about is that the net wealth analysis of defendants fails due to the poor economy and realized gains don’t get converted into cash. Do you have any thoughts on this risk, the renegotiated debt covenant, or anything else related to Manolete? I just want to compare notes.
The share price has been adversely impacted by the PACCAR judgement in the UK Supreme Court.
All litigation finance firms have been marked down by the market, notwithstanding the fact that not all litigation firms are impacted. See my comment above on this.
As such the value of the business and the share price have become detached, at least temporarily. In my mind this is a wonderful buying opportunity.
In terms of the Cartel cases, these are a class action which are spread across many litigation firms. The judge correctly stayed some, pending the outcome of the larger claims. Since they all turned on the same fact set, there was no sense in consuming judicial time arguing the same facts in different claims. The idea was to use the larger claims as test cases and then to use that precedent to help settle the others.
The good news for Manolete is that the big claims succeeded, so the Manolete claims will almost certainly also succeed. The question now is to have the stay of proceedings lifted so that the other side is pressured to settle. I can't see the defendant's throwing good money after bad by incurring duplicative legal fees in defending themselves when they have already lost that battle. But by the same token, cash flows mean that there is no incentive on them to settle earlier than necessary. So they will sit on their hands until the stay is lifted. Manolete has already applied for that to happen, so this is a cash windfall for the company that will materialize in the coming months.
Renegotiating debt at a time when rates have moved sharply higher is a macro economic challenge rather than being Manolete specific. Their use of debt is prudent. I have no balance sheet concerns.
In terms of defendants, please be reminded that many of these claims largely involve fraudulent activity around an insolvent business. Many of the defendants are liable in a personal capacity and so claims may be brought against their homes and other assets. An economic downturn will have a limited impact on recoveries. Also, the average time to settle a claim is 11 months, so these are not legal actions that drag on for years. It is a question of assessing the claim, assessing the ability to recover from the defendant and then bringing legal proceedings. Everything happens quickly and circumstances don't typically change very much over these time frames.
I hope that this helps.
Please also be reminded that interim results will be announced in November, so it isn't long before you see a clearer picture from the company. I would anticipate a recovery in the share price at that time as the market discovers the disconnect between intrinsic value and market cap.
I emailed Steven and he promptly replied, "... More specifically on Manolete: very much inline with recent disclosures - we have around 400 cases running at the moment, only 20 (5%) are on Funding Agreements, the 380 are Purchased and so no impact at all. On the 20 funded, we think most can easily be switched to our Purchase Model. This may leave one or two immaterial funded matters (smaller personal bankruptcy rather than larger corporate insolvency cases). We might need to write those off but we are reviewing with Counsel as our Funding Agreements may be enforceable, despite yesterday’s Supreme Court ruling. Overall: immaterial impact."
James, thanks for this post. I follow a company in a similar space called Cartiga (private company) but your analysis on Manolete helps me better understand both businesses.
"Under insolvency proceedings for banks in Britain, some depositors are eligible for up to 85,000 pounds ($102,000) of compensation for cash held at lenders, or 170,000 pounds for joint accounts. Customers may not be able to recover deposits in excess of those sums, which are small relative to the deposits some startups had with the bank."
I have no further insight. Just sharing. Would be interesting if there's something for Manolete here.
Hi James, thank you very much for writing this. Incredibly fascinating company and space. I'm curious to know, given the incredibly attractive ROI on cases, what prevents competitors or new entrants from undercutting MANO and taking market share?
BE AWARE: Everyone is very focused on the ROI numbers in the table. Please understand that these are gross ROI. it is industry standard practice to quote these. Gross ROI is the unadulterated return on money invested in settled cases based on the sum recovered in the legal action. It does not account for money currently invested in yet to settle cases and does not factor in OPEX expenditure. Working out the exact return on capital gives a number closer to 29% depending on how you run your calculations. However, being able to constantly compound at 29% works for me.
Also bear in mind that there are other sources of income (the bounce-back loan debt recovery which promises high margins and the truck cartel cases which are carried at a fair value of about £12.2m and which may settle in 2023). This is all cream on top of the 29% pie.
In answer to your question on competition, it comes down to personnel (Manolete has a great team) and reputation (Manolete has a first mover advantage and 67% market share).
Of relevance is that in 2020 Rosenblatt Group (RBG Hldgs) announced the launch of its new insolvency litigation financing solution. The statement made reference to the bull fighting logo and name of Manolete Partners by referring to a dominant provider in the space claiming that its solution was both cheaper and more flexible. Rosenblatt named the division ISLERO, the name of the Spanish bull famed for killing the bullfighter Manolete in 1947. To date Rosenblatt and Islero have made no material impact in the insolvency litigation sector!
Thanks for the reply. And also for the interesting tidbit about the company names. How cheeky of RBG.
I just watched this interview about Burford to be more familiar with litigation financing space https://youtu.be/qBuH8pyc8Y0?t=827. They brought up the points you mentioned along with a couple others. My favorite is that the TAM is likely growing because litigation financing enables more cases to be brought to court/arbitration. The pie seems to be big enough that Manolete and others can keep doing well.
Burford concerns itself with litigation across multiple jurisdiction and in all branches of law. Its biggest case is the YPF case in which it is suing the Argentine Government for unlawful repatriation of energy assets. The case has been going on for a decade or more and we still have no idea when judgement will arrive. Even if judgement is given in favour of Burford's client, it needs to enforce it against a powerful government. That isn't easy, will involve further expense and who knows how long it will take.
Against that backdrop, how do you model an investment like Burford? The valuation will vary enormously based on the outcome of the YPF case because it has high concentration risk there. If I can't quantify an investment, then I am speculating not investing. This is one reason that I haven't put money into Burford.
Manolete is different. It has no concentration risk because it has a diverse portfolio of assets (claims). It has an 87% success rate, 12+% of cases result in the litigation being abandoned, and less than 1% of claims is lost. These ratios are relatively stable. This is because Manolete only accepts 30% of claims offered to it. Said differently, it cherry picks the best claims and so skews its chances of success to be as favourable as possible. for more than a decade, the average time that it takes to settle a claim from initial investment is 11 to 13 months (very predictable). It takes a few months more to enforce judgement and to receive settlement of an award. So, conservatively call it 2 years per investment from start to finish. That makes it really easy to model the business.
The added benefit is that Manolete acquires the claims and so is in the driving seat when it comes to deciding how best to proceed with each claim. Burford doesn't have that advantage, it funds claims but doesn't own them and so litigation decisions are out of its control.
Finally, Manolete specializes in UK insolvency law. It is known as the best in that niche field and so has no shortage of business opportunity. The business finds it, rather than the other way around.
For me Burford and Manolete couldn't be more different as investment opportunities.
Update following audited results for FY ended March 2024
Following that challenging Covid period, the insolvency market picture has now completely changed, presenting Manolete with the most attractive trading conditions since the business was formed in 2009. Significantly higher prevalent interest rates, heightened concerns over geo-political conflicts in Eastern Europe and the Middle East and the withdrawal of the largescale financial supports provided by the Government to UK businesses during the Covid-19 period, has resulted in the highest level of UK insolvencies for 30 years. Insolvency Service statistics from January 2024 show the number of Creditor Voluntary Liquidations, the largest constituent part of the UK insolvency market, in 2023 was at its highest level since 1960.
The Company delivered strong performance in the year ending 31 March 2024, with a record 311 new case investments, up from 263 in FY23. This growth reflects the Company’s expanding network of insolvency practitioners and lawyers across the UK, allowing it to capitalize on a market that has rebounded from the static conditions caused by the government's temporary Covid support measures.
Financially, the Company reported a 27% increase in revenue, reaching £26.3m, compared to £20.7m in FY23. Operating profit stood at £2.5m, a significant improvement from the £3.1m operating loss in the previous year. There were 251 case completions, generating £24.2m in realized revenue, and gross cash recoveries from completed cases amounted to £17.7m. The Company ended FY24 with 418 live cases in progress, up from 351 in FY23.
There have been more material and positive developments relating to the Company's cartel cases in recent months. Early in calendar year 2023, the judgments for the large truck cartel cases relating to BT Group Plc and Royal Mail Group Limited were handed down with significant damages and interest being awarded to the Claimants. Following publication of these rulings, an independent expert valuation firm has assessed the value of Manolete's 22 cartel cases. The cartel case carrying valuation as at 31 March 2024 was £15.1m and the valuation therefore represents Manolete's percentage ownership of the overall case valuation. These claims are currently stayed pending resolution by means of alternative dispute resolution (negotiated settlement) which is likely to be successful based on the precedent set by the BT and Royal Mail claims. In the event that a mutually agreeable settlement is not reached, the case is expected to be decided by Court hearing in September 2025. This implies at at some time in the next 12 months, the financial position of Manolete will change significantly and a re-rating is likely.
Despite carrying a net debt of £12.3m, which the business expects to pay down when the Cartel cases settle, the Company has agreed to revised covenants with HSBC, transitioning to cash-based rather than profit-based measures, and reducing its debt facility size to £17.5m.
With a significantly improved business performance, a growing team, and a high number of corporate insolvencies in the UK, the Company is well-positioned for sustained growth, further supported by a recovery in larger case investments in the latter half of FY24.
UPDATE: Interim Results November 2023 - When increasing insolvencies becomes good news!
MACRO: In the UK, insolvency volumes saw an uptick amidst a challenging corporate operating environment exacerbated by higher interest rates and inflation. Recent data reveals a notable 25% increase in the number of businesses experiencing critical financial distress between Q2 and Q3 2023. Approximately 480,000 UK businesses are currently grappling with 'significant' financial distress, marking an 8.7% increase from Q2 and a 4.7% rise compared to the previous year. Sectors causing heightened concern include construction (up 46% from Q2 to Q3), real estate and property (up 38%), followed by the retail sector. The confluence of factors such as high inflation, elevated interest rates, weakened consumer activity, and an uncertain economic environment collectively intensifies the pressures on businesses.
MICRO: In the context of the macro backdrop, and after almost two years of the UK Government's efforts to temporarily suppress insolvencies during the Covid pandemic, UK insolvencies and Creditors Voluntary Liquidations (CVLs) have surged to levels comparable to those seen during the 2008 financial crisis. Larger company insolvencies, primarily entering the process via Administration, have also rebounded to pre-pandemic levels. Manolete, a company specializing in insolvency litigation financing, began benefiting from increased business in H2 FY23, resulting in robust growth. H1 FY24 financial results exhibit continued strong growth across all key performance indicators, with a notable 104% revenue increase compared to H1 FY23. Profitability numbers YoY are misleading because of an extraordinary write-down that occurred last year, but the company is generating positive cash flows and the portfolio of cases is growing at an impressive rate. The Company ended H1 FY24 with 417 live cases in-progress, a 58% increase over the previous period-end. In anticipation of greater volumes of work, the business has expanded its litigation team by 15%. All of this implies that a key inflection point has been reached and current levels of profitability are likely to be the start of far better things to come.
It should also be noted that the initial surge in insolvencies post-April 2022 was driven by a sharp and sustained rise in CVLs, mainly representing smaller companies with lower claim values. This resulted in an 18% lower average completion value per case in H1 FY24 (£79.3k per case) compared to H1 FY23 (£96.8k per case), excluding an exceptionally large single case. The recent seven-month period has witnessed a sustained recovery to pre-pandemic levels of Administration appointments, and as the insolvency market evolves through the current business cycle, the Directors anticipate a return to higher average case sizes, reflecting a greater mix of larger company insolvencies.
The Cartel cases are expected to settle in 2024 which will result in a large extraordinary cash flow event to the upside.
Last but by no means least, the pilot project undertaken to recover monies fraudulently claimed during the pandemic under the Bounce Back Loan (BBL) scheme, has been been a success. The volume of these claims is anticipated to increase from Barclays bank, Manolete's partner in the pilot project. Additionally, a second major UK bank will be appointing Manolete to act on its behalf in this regard. This is high margin business which will augment cash flows from underlying insolvency work.
In summary, all looks good and 2024 promises to be a good year for shareholders. It is entirely baffling why a company which finds its prospects to be better than ever has a share price trading at the lowest end of its 5 year range, but this almost certainly looks like a fantastic opportunity to jump in or to scale up.
UPDATE: Manolete Partners Plc
Last week saw the surprising PACCAR judgement in the UK Supreme Court (https://www.supremecourt.uk/press-summary/uksc-2021-0078.html). It concerned litigation finance and may impact some firms operating in this industry.
As a result, all litigation financing firms in the UK have seen their share price negatively impacted.
This is a symptomatic knee-jerk reaction.
The market has not taken the time to digest or to understand the news.
What does this mean for Manolete Partners?
In truth, very little changes, yet the share price is down about 20% from recent levels.
Manolete Partners operates in the specialist field of insolvency litigation. I cannot overstate the importance of this nuance. Insolvency is the only branch of UK law where a third party is permitted to acquire rights in a legal claim. 94% of the claims in the Manolete portfolio are owned by Manolete and so unaffected by the Supreme Court judgement.
Of the very small number that may be impacted, it will simply mean restructuring current Litigation Funding Agreements (LFAs) away from a return based on a proportion of the damages recovered (technically a 'damages based agreement' (DBA)), to a structure where the return is calculated by reference to a multiple of the amount invested (technically not a DBA).
We may also see legislators seeking to add clarity to the poorly drafted DBA regulations, which frankly is long overdue.
Long story short, the impact to Manolete is little or nothing at all, yet the shares are now available at a significant discount. These market anomalies don't last for long. You heard it here first!
One topic I’m curious about from the trading update is the bounce back loan program. It seems like it would be a no brainer that banks and the government would want Manolete to take on BBL cases and recover money for the government. What are the barriers to expansion of the program?
Manolete represents the best option for bounce back loan recovery. Barclays bank has discovered that and I think that there are pilots with at least one other bank (I think Lloyds Banking Group). The issue is that there are so many of these fraudulent cases, and the average size is relatively small. Although Manolete receive a very healthy share of monies recovered (up to 50%), the issue is one of capacity. It only has a team of lawyers numbering in the high 20s or low 30s. There are only so many cases that they are able to manage. The other issue that may exist, I am only speculating because I have not seen the legal terms that they have with the banks, is that while they receive a high 50% payout of monies recovered, out of that they almost certainly need to cover the litigation costs themselves. Since the cost of litigating is relatively similar, no matter how large the claim, small claims are less viable to pursue because the costs eat a disproportionately large part of the recovery sum. So it may be that Manolete is being selective.
For me, this bounceback loan recovery is not core business but a short term ancillary revenue stream. It is a situation that arose out of the Covid crisis and will not be repeated. It therefore does not represent a sustainable long term revenue stream for Manolete. The same is true of their cartel cases. When analysing the business I prefer to focus on the core business and track how that is growing. The trading update is encouraging in that regard.
I would like to see them clear the extraordinary items, particularly the Cartel cases, and to reinvest the proceeds into growing the core business. Perhaps that will happen this year. Then I view the bouceback recovery earnings as cream on top, which we will enjoy over the next few years but which should never take precedence over growing the underlying business.
Thank you for the reply
what can you tell about the lackluster growth in equity compared to competitors like litigation capital? And can you re-explain why buying the legal claims is actually better than financing them. Thank you.
Thank you for the question.
Manolete Partners operates in a niche field of insolvency litigation. During the Covid pandemic the UK government introduced emergency measures to prop-up struggling businesses. The result was that insolvency numbers were artificially suppressed. It spent billions of pounds propping up many businesses that were simply not viable. Ironically, all that they achieved was to delay the inevitable, but at great expense to the tax payer.
For two years insolvency numbers dropped and that had a negative impact on Manolete Partners. This is where you are able to distinguish them from Litigation Capital which was not subject to the same issue as it does not specialize in insolvency litigation.
The good news, at least for Manolete Partners, is that the government's emergency measures came to an end in the fourth quarter of 2022. At that point the flood-gates opened. Insolvency numbers shot up. All of the businesses that had been maintained on life support began to flat-line. This was purely due to Covid. But then came the Ukraine war which caused inflation and interest rates shot up sharply introducing still more duress to the economy. Raging inflation caused input prices to rise and not all of that could be passed through, so margins were squeezed putting more strain on an already weak economy. Businesses that were over leveraged and with a weak balance sheets collapsed under the pressure of rising financing costs. And if that wasn't enough, inflation and higher rates resulted in a cost of living crisis which dampened demand. It was the perfect storm.
Long story short, insolvency levels are at record highs at the moment, on par with where they were during the 2008 credit crisis. This is terrible for the economy, but wonderful for Manolete Partners. It is perfectly counter-positioned.
So that answers the first part of your question. In relation to the second part it is very straightforward. If you fund someone else's claim, then they are in the driving seat and make the decisions around whether to compromise and settle early, or whether they have the fight to go the distance. More particularly, if circumstances change and the prospects of the claim diminish, it is the owner of the claim who decides whether to discontinue proceedings and risk throwing good money after bad in legal fees. This is a huge risk for those concerned with litigation finance. Someone else, who is invariably unqualified, is effectively managing their investment. By contrast, if Manolete Partners acquire the claim then they are back in control. They can abandon claims if the prospects of success diminish thereby curtailing losses, while running with the winners, much as you would with your equity investments.
There is an added benefit. The Supreme Court's decision in the PACCAR case suggests that the legal basis on which many litigation finance firms operate may be unlawful. This means that they may have no rights under the claims that they are funding. This caused the value of all litigation finance firms to drop like a stone last year (Manolete Partners included). Ironically, that judgement applies to contracts governing litigation finance of a third party claim. It does not apply where the claim is owned (Manolete Partners owns 94% of its claims). So while that judgement cause the share price to be dragged down, Manolete is about the only litigation firm that remains unaffected.
At this juncture it is worth noting that it is only possible to acquire all rights in a third party claim in insolvency law (explained in my article above), so there is another key distinction between Manolete and Litigation Capital. the latter doesn't have the option to buy the legal claims.
In summary, this explains why this is a great investment opportunity - an unjustified discount on the share price which means that you can buy the stock at 2018 valuations while the business is in significantly better shape now than it was back then and its forward prospects are better than they have ever been. When intrinsic value goes up, but the market price goes down, that's when a good investor acts and then waits for equilibrium to be restored.
I hope that this helps.
It certainly helps. Thank you for your fast reply. Your answer to my 2d question inherently makes sense to me. I wonder though what negatives you see on choosing for acquiring the claims vs financing them. (So I follow your reasoning completely, but what are the downsides you see to this model?)
With the return on equity… I believe the government giving lifeblood to dying companies had a negative impact on the company. Also logically speaking the COVID period is one where operation must have been postponed/made more difficult etc. However, I’m afraid whether this is really the whole story? The larger case that was denied and now goes to the court of appeal… how can this have skewed the ROE perhaps? I’m afraid to be missing something ‘under the hood’ rather than external/one-off causes.
Thank you for this write-up. You convinced me of the general thesis behind it. Personally, I see a company with a moat (strong reputation) operating in a business that’s a lot better than it looks like. Higher interests rates (and bad economic environment) are a nice catalyst.
However, I must admit that I’m a relatively inexperienced investor and find difficulty in figuring out the proper valuation and/or understanding the figures.
Can I ask you about the net cash generation and/or the amount of cash they reinvest in new legal claims? I would like to know more about the costs. Not really the upfront cost of acquisition and legal fees, but more about the total costs taking everything into account, in order to have a better understanding of their net results. Generally speaking I don’t like ‘gross’ figures...
Also, speaking of the catalyst of the higher interest rates => more claims available. To what extent is this actually a catalyst when the real limitation to growth is the amount of cash they have (and not the number of claims available)?
Could you talk more about management? How, I see it atm is that they are very competent in their business activity, but not as a public company. The dividend policy and also the accounting with the IFRS-6 where they basically don’t listen to investors and seem to make wrong decisions that put the company at risk/are value destructive, worries me.
Thanks in advance.
Kilian Pico
There is no quick and easy answer to your question. The truth is that conventional accounting practices were designed around industrial businesses that make things. They don't work at all well for investment firms, yet this is exactly what Manolete Partners is.
The difficulty is this. You start with $1 and are able to generate a 50% return, so you receive $1.50 back but immediately reinvest that in the business. Your net cash flow is zero because money in equals money out, but your investments have grown by 50% and will keep compounding at the same rate going forward.
Manolete acquires claims and then leaves external lawyers and insolvency professionals to do the heavy lifting in terms of work load. This means that the business is very scalable. Consider that the number of cases is at record levels, up 104% YoY in terms of revenue and up 58% in the number of cases sequentially, but the increase in the size of the legal team has only been 15%. That points to operating leverage which means that as the top line grows, more of it falls to the bottom line.
The company ought to be viewed as any other investment firm but with a key difference. Consider a VC firm investing in start up companies. They generally expect 90% of their investments to come to nothing and hope that the other 10% will become winners to an extent that it more than compensates for the losers. That's a risky game. VC firms come and go because they operate in a fiercely competitive space where everyone is chasing the next big winner. Additionally, if you invest in the next tech winner, it may take 10 years for them to prove themselves winners. By contrast, Manolete Partners have a wide moat with little real competition. They cherry pick cases offered to them and have a success rate of circa 93%, so most investments will be winners. They have a very consistent model, with most cases settling in only 11 months. This stability makes the business easier to manage because it is far more predictable, thereby mitigating operating risk.
For me this is a very interesting opportunity, a flower that will very soon bloom.
In terms of the management team, I have been particularly unimpressed by the CFO as he has made several silly mistakes that were avoidable. The CEO is very good, he founded the company, but this is his first foray running a public company and he too is making errors as a consequence of relying on guidance from external consultants. The recent announcement of an LTIP linked to the share price is laughable. It also points to the competence of the remuneration committee being well below par. But this is a young company and it needs to mature. The key issue is that the board is made up of lawyers and insolvency professionals, but there is a lack of corporate finance expertise and the CFO certainly doesn't have it. They need better NEDs at the very minimum to introduce constructive challenge. But these challenges are not unique to Manolete Partners. Most young companies go through this phase and as they grow they are able to attract more 'A' team players to join the team.
The investment thesis is still in tact. Perhaps more so at these discounted share prices.
Thank you!
Do you have any updates on Manolete Partners? The only negatives I see are that the case appeal was lost and debt covenants had to be renegotiated with a slightly higher interest rate. The positives seem to be that cases signed, realized gains, and cash generated were up for FY23. I saw that >80 cases were signed in Q1 FY24 (actually maybe >90). They said at least 3 million pounds gross cash were generated that quarter, so that should roughly cover expenses for that quarter (assuming Manolete gets half that cash and the operating cost is 6 million per year). Also, their live cases continue to grow (probably greater than 400 by now).
Any thoughts on the truck cartel cases? It seems that the calculations for damages are established and some of the cases not owned by Mano have been settled.
One risk I’ve been worried about is that the net wealth analysis of defendants fails due to the poor economy and realized gains don’t get converted into cash. Do you have any thoughts on this risk, the renegotiated debt covenant, or anything else related to Manolete? I just want to compare notes.
Alex
Thank you for your questions.
The share price has been adversely impacted by the PACCAR judgement in the UK Supreme Court.
All litigation finance firms have been marked down by the market, notwithstanding the fact that not all litigation firms are impacted. See my comment above on this.
As such the value of the business and the share price have become detached, at least temporarily. In my mind this is a wonderful buying opportunity.
In terms of the Cartel cases, these are a class action which are spread across many litigation firms. The judge correctly stayed some, pending the outcome of the larger claims. Since they all turned on the same fact set, there was no sense in consuming judicial time arguing the same facts in different claims. The idea was to use the larger claims as test cases and then to use that precedent to help settle the others.
The good news for Manolete is that the big claims succeeded, so the Manolete claims will almost certainly also succeed. The question now is to have the stay of proceedings lifted so that the other side is pressured to settle. I can't see the defendant's throwing good money after bad by incurring duplicative legal fees in defending themselves when they have already lost that battle. But by the same token, cash flows mean that there is no incentive on them to settle earlier than necessary. So they will sit on their hands until the stay is lifted. Manolete has already applied for that to happen, so this is a cash windfall for the company that will materialize in the coming months.
Renegotiating debt at a time when rates have moved sharply higher is a macro economic challenge rather than being Manolete specific. Their use of debt is prudent. I have no balance sheet concerns.
In terms of defendants, please be reminded that many of these claims largely involve fraudulent activity around an insolvent business. Many of the defendants are liable in a personal capacity and so claims may be brought against their homes and other assets. An economic downturn will have a limited impact on recoveries. Also, the average time to settle a claim is 11 months, so these are not legal actions that drag on for years. It is a question of assessing the claim, assessing the ability to recover from the defendant and then bringing legal proceedings. Everything happens quickly and circumstances don't typically change very much over these time frames.
I hope that this helps.
Please also be reminded that interim results will be announced in November, so it isn't long before you see a clearer picture from the company. I would anticipate a recovery in the share price at that time as the market discovers the disconnect between intrinsic value and market cap.
Hi James, do you know if this Supreme Court decision (https://www.lawgazette.co.uk/law/shockwaves-as-supreme-court-rules-litigation-funding-deals-unenforceable/5116775.article) affects Manolete in general through DBAs or more specifically through the cartel case? LIT/LCM sent out a press release saying that they aren't affected because "LCM structures its funding contracts so that its return is calculated as a rising multiple of invested capital over time". Thanks!
I emailed Steven and he promptly replied, "... More specifically on Manolete: very much inline with recent disclosures - we have around 400 cases running at the moment, only 20 (5%) are on Funding Agreements, the 380 are Purchased and so no impact at all. On the 20 funded, we think most can easily be switched to our Purchase Model. This may leave one or two immaterial funded matters (smaller personal bankruptcy rather than larger corporate insolvency cases). We might need to write those off but we are reviewing with Counsel as our Funding Agreements may be enforceable, despite yesterday’s Supreme Court ruling. Overall: immaterial impact."
Thank you for asking and answering your own question.
Steven's response was in line with my own understanding.
James, thanks for this post. I follow a company in a similar space called Cartiga (private company) but your analysis on Manolete helps me better understand both businesses.
The SVB saga reaches the UK. https://www.reuters.com/world/uk/uk-says-it-is-working-minimise-damage-collapse-silicon-valley-bank-2023-03-12/
"Under insolvency proceedings for banks in Britain, some depositors are eligible for up to 85,000 pounds ($102,000) of compensation for cash held at lenders, or 170,000 pounds for joint accounts. Customers may not be able to recover deposits in excess of those sums, which are small relative to the deposits some startups had with the bank."
I have no further insight. Just sharing. Would be interesting if there's something for Manolete here.
Hi James, thank you very much for writing this. Incredibly fascinating company and space. I'm curious to know, given the incredibly attractive ROI on cases, what prevents competitors or new entrants from undercutting MANO and taking market share?
BE AWARE: Everyone is very focused on the ROI numbers in the table. Please understand that these are gross ROI. it is industry standard practice to quote these. Gross ROI is the unadulterated return on money invested in settled cases based on the sum recovered in the legal action. It does not account for money currently invested in yet to settle cases and does not factor in OPEX expenditure. Working out the exact return on capital gives a number closer to 29% depending on how you run your calculations. However, being able to constantly compound at 29% works for me.
Also bear in mind that there are other sources of income (the bounce-back loan debt recovery which promises high margins and the truck cartel cases which are carried at a fair value of about £12.2m and which may settle in 2023). This is all cream on top of the 29% pie.
In answer to your question on competition, it comes down to personnel (Manolete has a great team) and reputation (Manolete has a first mover advantage and 67% market share).
Of relevance is that in 2020 Rosenblatt Group (RBG Hldgs) announced the launch of its new insolvency litigation financing solution. The statement made reference to the bull fighting logo and name of Manolete Partners by referring to a dominant provider in the space claiming that its solution was both cheaper and more flexible. Rosenblatt named the division ISLERO, the name of the Spanish bull famed for killing the bullfighter Manolete in 1947. To date Rosenblatt and Islero have made no material impact in the insolvency litigation sector!
In short, Manolete has a nice moat.
Thanks for the reply. And also for the interesting tidbit about the company names. How cheeky of RBG.
I just watched this interview about Burford to be more familiar with litigation financing space https://youtu.be/qBuH8pyc8Y0?t=827. They brought up the points you mentioned along with a couple others. My favorite is that the TAM is likely growing because litigation financing enables more cases to be brought to court/arbitration. The pie seems to be big enough that Manolete and others can keep doing well.
Burford concerns itself with litigation across multiple jurisdiction and in all branches of law. Its biggest case is the YPF case in which it is suing the Argentine Government for unlawful repatriation of energy assets. The case has been going on for a decade or more and we still have no idea when judgement will arrive. Even if judgement is given in favour of Burford's client, it needs to enforce it against a powerful government. That isn't easy, will involve further expense and who knows how long it will take.
Against that backdrop, how do you model an investment like Burford? The valuation will vary enormously based on the outcome of the YPF case because it has high concentration risk there. If I can't quantify an investment, then I am speculating not investing. This is one reason that I haven't put money into Burford.
Manolete is different. It has no concentration risk because it has a diverse portfolio of assets (claims). It has an 87% success rate, 12+% of cases result in the litigation being abandoned, and less than 1% of claims is lost. These ratios are relatively stable. This is because Manolete only accepts 30% of claims offered to it. Said differently, it cherry picks the best claims and so skews its chances of success to be as favourable as possible. for more than a decade, the average time that it takes to settle a claim from initial investment is 11 to 13 months (very predictable). It takes a few months more to enforce judgement and to receive settlement of an award. So, conservatively call it 2 years per investment from start to finish. That makes it really easy to model the business.
The added benefit is that Manolete acquires the claims and so is in the driving seat when it comes to deciding how best to proceed with each claim. Burford doesn't have that advantage, it funds claims but doesn't own them and so litigation decisions are out of its control.
Finally, Manolete specializes in UK insolvency law. It is known as the best in that niche field and so has no shortage of business opportunity. The business finds it, rather than the other way around.
For me Burford and Manolete couldn't be more different as investment opportunities.