RBG Holdings (RBGP): Earn-out write-back and fair-value adjustments

The latest note from my SharePad writing colleague Bruce Packard tweaked my interest:

Bruce wrote:

“My comments on Cerillion and RBGP may seem harsh, but we’re in a bull market where often investors are prepared to accept headline numbers and not delve too deeply below the surface.”

Always worth delving deep to see what lurks beneath the headline numbers.

I looked at Cerillion here. Now for RBG Holdings (RBGP).

Bruce wrote:

RBGP Holdings, the law and corporate finance firm announced FY Dec 2020 results, with revenues up +8% to £25.6m and PBT up +1% to £7.7m. However that £7.7m is flattered by two large items, without which profits would have been down -56%.

Adjustments: The first item is a £2.6m write back from the Convex Capital earnout. Checking back, the earnout was originally £4.38m (recognised on the 2019 balance sheet within “other payables”) of which £1.8m was to be paid in cash and £2.6m to be paid in shares at 92p, so it looks as if the £2.6m worth of shares that RBGP are not now going to issue to Convex staff has been written back through the p&l.

The second item which flatters RBGP 2020 profits is a £1.9m fair value adjustment from litigation assets (there wasn’t an equivalent item in 2019). If we take the “hairshirt” approach of deducting both items from statutory PBT, then the fall is -56% vs 2019.

First the £2.6m earn-out adjustment, which RBG actually declares to be ‘non-underlying’:

The write-back is legitimate for accounting purposes. The Convex acquisition created an earn-out liability that was not entirely achieved, and so a corresponding write-back had to be carried through the P&L to reduce the liability on the balance sheet. This write-back can be ignored for valuation purposes.

Normally a notable earn-out write-back would raise questions as to why the acquired business did not perform as expected – but on this occasion we can blame the pandemic.

This note shows the £1.9m fair-value adjustment to the litigation assets:

Different litigation funders have different approaches to this accounting. Manolete and Burford (and RBGP) adopt fair-value accounting – i.e. recording gains and losses based on regular revaluations by the directors. Litigation Capital Management by contrast books gains or losses only when a definitive investment result is achieved.

Note RBGP’s reported profit includes the £1.2m gain from litigation-asset disposals as well as the £1.9m fair-value adjustment. The accounting is legitimate, but for valuation purposes I would not assess RBGP on total reported profit. (Valuing a portfolio of assets (be it in shares, litigation or bitcoin) based on its annual gains does not seem sensible to me.)

I would instead value RBGP’s litigation assets on a multiple of their book value, while I would lump the other divisions (Legal services and Other Professional services) together and apply a suitable multiple to their combined profit. The two calculations can then be added together for a sum-of-the-parts valuation.