Burford Capital –An Exception to the Stock Rank Rules?

27th Jul '17 by iwright7

407 comments 63192 reads

I have great respect for the credibility of the Stockrank system and it is not a coincidence that >70% of my holdings have a SR>80. However, my single biggest holding Burford Capital (LON:BUR) is notably different with the lowest SR of all - Just 45. Worse it is classified as a “Momentum Trap” because of its strong M (100) and low Q (36) and V (14) scores. Yet it has been my best preforming company by a mile.

It’s not only the SR that take a cautious view of BUR because broker forecasts have repeatedly underestimated Burford Capital (LON:BUR) earning potential. Today’s H1 earnings announcement has again surprised to the upside and the house broker has upgraded its full year EPS by +74%, adding that they are unsure how to value the company.

This strengthens my view that it is important to look at a company as a whole and consider news, growth potential and its metrics. As ever please DYOR. Ian

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mojomogoz

2nd May '19

Thanks, I'll take a look for context relative to Burford partly.

I happened to look at Gateley Holdings (LON:GTLY) recently just as it popped up in something I was looking at. I'm not comparing to the litigators directly but tangentially as its a listed legal practice (it looks like fees from property drive their returns so essential to take a view on property market activity). Anyway...

I feel cautious of listed legal or other professional services businesses...so why £BUR?....well...

I see it as a event driven /special situations investment fund that gets to generate its returns from a higher level of analysis and idea origination than any competitor. Probably by quite a distance although undeniably very high returns must attract competition. However, I remain skeptical that that competition can close the gap in the type of high value high return business that Burford are after. So Manolete Partners (LON:MANO) etc are taking the model and applying it somewhere slightly different or differently...I should look a bit more but I confess to feeling happy with what I see as the moat and downside protection from Burford. What the Cannacord analysis gives as criticism should probably go more acutely for other less established players?

Howard Adams

Hi

Adding to the Manolete Partners (LON:MANO) post earlier.

If this interests you note the 73% holdings by handful of shareholders including CEO (and his mother). Some investors like this tightly aligned stakeholders and its not uncommon in early stage IPO's. Others are less keen.

Worth noting though.

https://investors.manolete-partners.com/share-information/significant-shareholders

Regards
Howard

William K

3rd May '19

Keystone Law (LON:KEYS) will be reporting its preliminary numbers on 8th May. It's predicting profits comfortably ahead of expectations. I hold.

Investors will be looking for signs that Keystone’s proprietary platform model is still successfully drawing in lawyer recruits. (Reported in today's IC.)

iwright7

Worth noting latest repeat guidance from Arden suggesting some 40% Burford Capital (LON:BUR) upside.... Current market concerns surrounding an overstated ROIC and aggressive fair value accounting are unfounded, in our view. We reiterate our Buy and 2,300p price target.

The drift down continues...Cannacord must be right ;)

I suspect that some are leaving purely due to price action. Some will be leaving on the news perhaps not previously understanding the way that the company reports earnings and how there is a gap with cash flows and some knock on pressure/limitation on what can be funded and how.

Where Cannacord may get their moment of glory is if there is a significant judgement coming against a Burford case. The visibility of that for a hard to predict earning profession generally would cause a down. Unless the judgement was against the Burford business model it would be great buying opp IMO. Anyone with a whiff of something?

donald pond

I think BUR have previously said that the downside from any single case wouldn't exceed 3%, so even if there was a loss, it isn't going to be material. And the nature of funding is that all they lose is the funding they have provided: as has been done to death, they don't book upside unless something has happened in the case to justify them doing so.
I think the real issue with BUR is that it has outgrown AIM. It needs a main market listing and, I suspect, a US listing. It also needs to improve its corporate governance a little. The business itself is fine but it was set up as a sub £100m Guernsey litigation fund with a typical offshore board. It needs to change structure to reflect the business that it has become. Molot and Bogart should be on the board for starters, as BUR isn't a fund but a fund/bank/fund manager hybrid leveraging its balance sheet. And although they are resistant, they need a US listing: after all, they are predominantly a US business.

pka

For what it's worth, the ShareProphets website has recently posted a bearish article about Burford Capital:

https://www.shareprophets.com/views/42374/burford-capital-a-screaming-short

Don't pay for SP...what's the argument? Different from Cannacord?

I don't pay for the ShareProphets website either, as I am not impressed by the quality of the articles on it. But I used to have a free subscription to it and that still seems to let me view some articles.

The article about Burford is by Nigel Somerville. His main argument seems to me to be in the following paragraphs:

"My biggest concern is how Burford arrives at its reported profits. When it takes on a case for litigation funding, it values the case higher and higher at each step of the process – but there is no actual cold, hard cash to show for it, only bills. Now obviously, if the case eventually goes on to achieve a win in court - and the recoveries are there - then it will result in a nice big payout. But until the judge rules and the cash is paid up, these apparent profits are for the fairies. After all - and put very simply - each case will have one winner and one loser, and the final determinant of who wins is not decided until the case is heard. So to book profits based on case progress, but without it actually getting to court, strikes me as being insane – and to base a £3.5 billion valuation on the stars lining up looks to be just pure folly."

"To understand the risks here, I gather that unrealised gains made up 60% of income in 2018, but made up 81% in H2. So if Burford loses a few cases, the P&L - not to mention the balance sheet - will take a major hit. And despite all the assurances in the world, until those cases actually go to court nothing is certain (apart from the wealth of the lawyers!). Yet Burford is reporting an increased proportion of its profits in this way. This method of accounting is referred to as mark-to-market – but valuing a case on its progress (and then finding someone else who might buy it) is very different from a more conservative valuation method which holds back value until there is a win in court. Burford’s competitor, IMF Bentham (ASX:IMF), does not mark-to-market and whilst Burford is valued on the market at three times its balance sheet, Bentham’s figure is just 1.5. Go figure."

"The $476 million of balance sheet recoveries to date have come from $113 million invested in only eight cases. That’s a very small sample size – and 45% of recoveries have come from just 9% of completed or partially competed cases. Now it could be that Burford has some kind of magic formula, but given that it has deployed $2.6 billion during 2017/18, yet only half of that between 2009 and 2016, it seems an extraordinary act of faith by investors to assume that these returns (however you measure them!) can continue at those rates. Surely, as is a common assumption, as the size of the operation grows the returns will tend to become far more ordinary as the net is cast more widely over perhaps weaker cases. And if Burford is in a unique market, well there are plenty of competitors springing up: there does not seem to be much of a barrier to entry, beyond having enough cash. Surely competition will bite – and even Burford has flagged that investors should not extrapolate past growth going forward."

"This idiot would therefore conclude that 85% returns (based on accounting rules which ignore the reality of the court case determining the actual outcome) will drop, in part due to Burford’s increasing size and in part due to increasing competition. For 2018, Burford reported post-tax profits of $318 million – call that around £240 million. Its market capitalisation is around £3.5 billion so that puts it on a PE of around 14.6. If we take loan capital into account, of $648 million, then it seems that EV/E would come in at around 16.7. It might seem reasonable – but only if those reported earnings actually come to pass. But against reported earnings of around £240 million, a look at the cashflow statement shows an outflow of $233 million (call that £180 million) from operating activities. So although Burford is reporting mega-earnings, it is burning cash. That, for me, is a major Red Flag."

I expect that this argument has been addressed previously by posters on Stockopedia who have a better understanding than me of Burford's business.

bestace

It does seem odd that Burford Capital (LON:BUR) 'fair value' their investments and claim they are required to do so, whereas IMF Bentham do not, and neither do Litigation Capital Management (LON:LIT), who claim it as a positive that they do not fair value, e.g. this from their admission document:

As far as I can work out, this situation arises because Burford Capital (LON:BUR) (as well as £MANO) account for their investments as financial instruments (subject to IFRS9, which mandates fair value accounting) whereas Litigation Capital Management (LON:LIT) account for them as contracts with customers (subject to IFRS15) and IMF Bentham as intangible assets (subject to the Australian equivalent of IFRS38).

I struggle to understand the rationale for why litigation funding contracts would not fall under the financial instruments regime of IFRS9: to me they appear to meet the definition of a financial instrument given that they consist of financing arrangements with a financial asset in one entity (the funder) and a liability in another entity (the fundee).

Based on that understanding, it appears to me that it is Litigation Capital Management (LON:LIT) and IMF Bentham rather than Burford who are out of step with the accounting standards, even if that results in a more conservative outcome as far as their accounts are concerned.

I'd be interested to hear any other views on why it's OK for Litigation Capital Management (LON:LIT) and IMF Bentham to not apply IFRS9.

In any case, I think the whole fair value discussion is a bit of a red herring. The phrase "the map is not the territory" comes to mind. Accounting is simply a representation of the business (the map), it is not the underlying business itself (the territory).

When people focus on fair value accounting to suggest that Burford are being aggressive with their accounting, they are focusing on the map rather than the territory. They might as well be complaining to the Ordnance Survey because motorways aren't actually blue in reality. Clearly fair value accounting can be abused in the wrong hands, but in my view the use of fair value in and of itself doesn't constitute a red flag, it's simply an appropriate application of IFRS9 where other litigation funders have chosen different accounting policies.

Furthermore, there is nothing inherently superior about a conservative accounting policy. Investments in litigation which remain unsettled are clearly worth something when aggregated across a portfolio of claims. To attribute zero value to them may be conservative but it is clearly not accurate and therefore is not helpful for the investor trying to value a company. Focus on the territory rather than the map would be my suggestion.

JohnEustace

Burford Capital (LON:BUR) have sold part of their interest in the Petersen case to third parties, most recently at an implied valuation for the whole of $800m. It would be bizarre to then expect them to value the majority of the claim that they retain ownership of at zero in the absence of any setbacks in the case.

Edit - they have said they hold it at less than the implied value for all the reasons they always cite about the uncertainty of legal outcomes.

Luthrin

4th May '19

From the Canaccord note:

The actual ROIC on concluded investments is 51%, which cannot be disputed. Therefore, we believe BUR should focus on reporting this return figure rather than any other. We have updated our model to reflect a 51% ROIC on the litigation portfolio, versus our previous forecast of 60% (which was based on the cumulative ROIC as given by BUR in the CY16 results). This largely drives the 18% downgrade to EPS in both FY19 and FY20.

The 51% ROIC figure is derived from Burford's published portfolio data, showing total recoveries of $583.4m on a capital deployment of $387.0m for concluded investments.

However, one major Burford investment that is missing from the concluded list is the Teinver case. Even though BUR sold its entire entitlement in Teinver for $107m cash in March last year, this is still regarded by the company as a partially realised investment. This is because the matter is subject to annulment proceedings, and should the award be annulled, the sale could be rescinded at the option of the buyers. In this event, Burford would retain a $7m fee and would also have its original entitlement back, leaving it free to pursue the claim again. According to Burford: "Annulment (the cancellation of an award) is only available in very limited circumstances of serious error by the arbitration tribunal that we do not believe exist here, with only 6% of awards ever rendered by the World Bank’s arbitration institution having been annulled (and only 3% in the current decade)."

Burford's press release last March stated that based on historical proceedings, a decision on annulment would be expected in the second half of 2019, with the caveat that individual case timing is unpredictable. However, should we get the expected resolution in the next few months, the Teinver matter will shift from the partially realised investment category to the concluded one. This will give $107m of recovery for just $13m of deployed funds, and had that case already been in the completed category, the historical ROIC would be 73%, not 51%.

So, if Teinver finally settles without annulment later this year, we may well see a marked jump in historical ROIC for concluded cases when BUR publishes its updated litigation portfolio data in March 2020 (although this will also be dependent on the performance of other concluded investments). Under such circumstances, will we see a significant profit upgrade for BUR from Canaccord once they have punched this revised number into their 'model' (cough)? I very much doubt it, because I don't for a moment think that the person who penned the CG note was making an objective assessment of the company's prospects.

6th May '19

Hi Donald, I think your points are all correct. However, they probably don't explain near term price performance...or do you think otherwise? ...Perhaps an implication of what you say is that for dedicated AIM investors (a not very set I assume) Burford is a source of liquidity...but that is likely to be outweighed by bigger funds and universe that would see a bit of AIM as an allocation for more risk seeking off benchmark?

Maddox

7th May '19

I've managed to get hold of a copy of the Cannacord report by Portia Patel. It's always easy to fall victim to one's own confirmation bias so thought it would be worthwhile to challenge my investment rationale and work my way through her valuation analysis.

However, I've got to say its 'logic' undermines its own basis of valuation. As has been presented above in several posts PP has decided to exclude a value put on in-flight cases. This is on the basis that these valuations are based only on BUR management estimates and there isn't any mark-to-market bench-marking available as there is no secondary market and no transparency over how the estimates are derived.

OK fair enough. PP wants to base her valuation on what she terms a clean-NAV excluding un-realised cases and their dubious valuation. As she states:

"We believe that a “clean” NAV excluding the unrealised portion of litigation investments (i.e. cumulative fair value gains) is the best starting point on which to value BUR."

The problem is of course that looking forward to forecast a clean-NAV for FY20 she has to assume the realisation of currently open cases, I quote:

"Assuming a 2-3 year average life of investments, we assume that the “in progress”
investments which had some “unrealised” value attached to them in FY18 would be
resolved by FY20. Hence, FY20 NAV excluding fair value gains, which we calculate to
be $1,142.9m, is the basis for our valuation."

Surely, this is contradictory? In order to get to a 2020 NAV she is happy to assume that the 2018 unresolved cases get resolved. I thought she was excluding them and their value?

Excluding unrealised income might work as a valuation method looking backwards - where a high proportion of cases will be settled and their outcome known. But, forecasting forward a business like Burford where the vast bulk of its assets are in the form of in-flight unresolved cases - requires attributing some value to them like-it-or-not.

Regards Maddox

Nick Ray

Excluding unrealised income might work as a valuation method looking backwards - where a high proportion of cases will be settled and their outcome known. But, forecasting forward a business like Burford where the vast bulk of its assets are in the form of in-flight unresolved cases - requires attributing some value to them like-it-or-not.

The clear implication is that it is very hard to value BUR's assets. You would expect that to be reflected in BUR's volatility - which Stocko currently puts at about 50% (very high).

Back in 2017 BUR's volatility was a more palatable 30-40% and I think the change in volatility probably does fairly represent the change in the "risk" in BUR as it has grown dramatically. (But "risk" in this sense can be positive or negative: BUR could have a disaster of a year or it could win all its cases.)

Hi Nick,

As Niels Bohr, the Nobel laureate in Physics, is quoted as saying, “Prediction is very difficult, especially if it’s about the future!” ...and I wouldn't contradict him. What I can't accept is equating share price volatility with risk. I'd also question whether BUR's growth in capital increases rather than decreases the risk? BUR turns over its capital on a rolling basis and if that capital is deployed across a larger number of proportionately smaller cases then arguably the predictability of the out-turn and hence the risk will be reduced.

BUR has had some significantly large cases in the past that may have favourably distorted the quantum of their win-record. In building a more conservative BUR forecast it may thus be more prudent to model scenarios with some lower return figures.

The current share price seems to have been influenced to a remarkable degree by Cannacord's report. But I doubt whether it will to any degree influence the fate of the litigation cases that will ultimately determine BUR's performance.

I don't like the term "risk" myself either. I prefer to use "uncertainty". You can guess a mean valuation for BUR's assets in the future, but there will be a wide range of possibilities either side.

If the increase in BUR's size were due to taking on a larger number of similarly sized cases to the ones it previously had then the volatility would reduce with the square root of the change in the number of cases.

24th May '19

Some movement on the Petersen case. The Argentines appealed on sovereign immunity grounds to the US Supreme Court. They asked the US Solicitor General for his opinion. He has now said that the Supreme Court should decline to hear the appeal as the original ruling in New York was correct. It's very likely that the case will be sent back to the court in New York for hearing to proceed.

Meanwhile the Argentinian Plan B involves bringing a case in Spain to try to invalidate the original deal that Burford did to acquire their interest in the case.

patrick00

Thanks for sharing. Where did you find the news?

I have a Google news alert set up - this article is behind a pay wall but the greyed out heading is readable
https://www.law360.com/articles/1161977/justices-urged-to-pass-on-argentina-ypf-nationalization-row

There is some more discussion on the advfn thread with a translation of an Argentinian article about the Spanish case. Chrome does a reasonable translation.

https://www.clarin.com/economia/reves-argentina-gobierno-donald-trump-recomendo-juicio-ypf-siga-unidos_0_BkMDhXjhZ.html

Burford Capital –An Exception to the Stock Rank Rules?

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