Burford Capital –An Exception to the Stock Rank Rules?

27th Jul '17 by iwright7

407 comments 63194 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

Unlock with Email

Unlock with Google

Already have an account?
Login here

JohnEustace

30th Mar '18

I do think that Burford Capital (LON:BUR) are as conservative as the accountancy regulations allow them to be in recognising income. I think the CEO would prefer not to book any income at all until the cash has been received as he is very aware of and frequently emphasises the point that nothing is certain in their business until the other side has actually paid up.
They hold their investments at their sunk cost until they have a legal basis for writing them up such as an offer to settle, winning a case, winning an appeal etc.
The CEO said in the recent results call that they have only ever written down the value of two investments that they had previously written up.

abtan

31st Mar '18

I'm not saying that Burford Capital (LON:BUR) are recognising income incorrectly in their P&L.

Nor am I suggesting they are valuing their investments incorrectly on their balance sheet.

I am, however, stating that for a company such as Burford, where cases are decided/settled/concluded first, and then payments/settlements are received second (not the other way around) recognised income should never be lower than cash received.

So this tiny, yet highly important and visible, section of Burford's last annual report doesn't make sense to me.

It is not a timing issue (ie old cases coming to fruition), nor a funding issue (ie nothing to do with the funds the company raises for itself, as far as I can see). I must be missing something, but I really don't know what it is.

I sold a significant portion of my holdings last week and with the seeds to doubt planted I'll probably sell out fully next week. No doubt I'll probably end up regretting it!

DaviStoVest

I think that the only way to become comfortable about this is to take a very close look at their books. I am fairly sanguine about it, nevertheless.

For example, you argue that cash can only arrive for Burford after income is recognised because cases have to be settled before (sometimes, well before) the money can flow in. But we know that Burford is selling on a share of its interest in cases that have yet to settle. If it has taken a conservative approach to valuing those cases in its books, will that not result in a cash inflow that exceeds the value written down as a result of the sale?

I'm not the 'finance guy' and somebody with better finance knowledge and skills should probably advise on how this would be reflected in the accounts ... above and below the line.

bestace

abtan, did you try to find an answer to that issue from the company before deciding to sell? Their IR team are normally pretty good at responding to queries.

I think there may be a simple answer in that cash proceeds from litigation includes the capital originally invested whereas income does not. It may be worth revisiting the 2012 Annual report as that's the year they first adopted IFRS9 and they gave quite a lot of narrative on the implications for their accounts. Here's an extract (from page 10):

Using the figures from that example, assuming they invest $100 in year 1, they revalue to a fair value of $175 in year 2, and the case settles in year 3 for the full $300, how would that be reflected in their accounts?

In year 1, they hold an investment on their balance sheet of $100, there is no impact on income, and $100 of cash leaves the business.

In year 2, they book $75 of income from the fair value adjustment, the investment on their balance sheet rises to $175 and there is no cash movement.

In year 3, they book $125 of income (being the $200 profit less the $75 recognised in year 2), the investment is de-recognised from the balance sheet and they receive $300 in cash.

So looking at year 3 in isolation, gross cash received in the year is 240% higher than the income recognised in that same year. The difference appears to arise primarily from 2 things:

- the figure for cash received includes the original investment of $100 however income will only ever reflect the gain over and above the cash invested.

- the fair value adjustments lead to income being recognised over multiple periods, which reduces the income recognised in the year that the case settles relative to the cash received.

Even if there were no fair value adjustments at all, they would still receive $300 of gross cash in year 3 but income would be only $200, representing the difference between the original $100 investment and the amount received.

Hi Bestace

Thanks for that excerpt.

The key takeaway from the example, for me at least, was not so much the income/profit recognition across the 3 years, but the statement/assumption that the cumulative cash figure at the end might include cash profits + original cash investment.

If that is correct I would find the publication of a "Cash Generation" figure highly misleading; the cumulative $894m cash generation figure for 2013-2017 could therefore be made up of any combination of original cash investments returned + actual profits.

I just don't know why a company would want to highlight this, other than to show a lot of big numbers going up (they already publish return metrics elsewhere).

I have actually emailed Burford Capital (LON:BUR) since I sold (I have no problem selling and buying back in later if something really looks amiss).

In case you're curious my query to Burford concerned the $143,639,000 "Increase in third-party interests in consolidated funds" sitting on the balance sheet and why it has only appeared in 2017 for the first time (i.e not in 2016)?

This is the exact difference between cumulative income and cash receipts that I'm questioning.

It makes me wonder whether Burford Capital (LON:BUR):

recognise only their majority income in the P&L,
collect ALL cash for a completed case (hence why cumulative cash received > income recognised),
then disperse minority cash rewards to the relevant parties at a later date.

This would actually make sense...apart from the fact that $0 has been recorded for 2016 (when there was a similar income vs cash recognition difference for the years 2012-2016).

An interesting one for sure. Hopefully the mystery will unravel itself in due course as nearly everything else about Burford Capital (LON:BUR) makes it look like a no-brainer.

Happy holidays

I would put it in the category of a minor quibble about labelling rather than being highly misleading. They're simply highlighting the items in the cash flow statement that relate to proceeds from investments, which by accounting convention will always be shown on a gross basis.

Perhaps they could have labelled the chart 'proceeds from investments' rather than 'cash generation', but a glance at the cash flow statement clearly shows what they mean and given all the accounting complexities around fair value movements and income recognition, highlighting to investors the cash proceeds from investments seems perfectly legitimate to me.

What I find more interesting (and less explainable) is that the historic figures in the chart appear to have changed this year. This is how the FY17 chart (on the left) and FY16 chart (on the right) compare:

All the numbers in the FY16 chart on the right can be tied back directly to the cash flow statements for those respective years. Not so for the historic figures in the FY17 chart.

That 3rd party interest is a red herring as far as the difference between cash and income is concerned. The reason it appears for the first time in 2017 is that it arises from the $500m complex strategies fund which closed (i.e. completed its fundraising) in June 2017. They discussed the accounting for this at the interims and it's clear that were it not for the requirements of the IFRS regulations, they would not have chosen to account for the fund the way they have done.

Hi Bestace

I personally couldn't reconcile cash receipts/cash generated from the cash flow statement with the cash figures in those charts.

And as for the numbers changing (excellent spot by the way), who knows what that is about?

As mentioned before I could be kicking myself in a few years for not just going with it.

gus 1065

1st Apr '18

I took the liberty of contacting Burford Capital investor relations via e-mail. Copy of the correspondence copied below (my original e-mail at the bottom with the response from Burford at the top). I think this covers the point but feel free to contact Elizabeth directly. Pleasantly surprised they (in the person of the CFO) took the time and effort to reply so promptly, not least on an Easter Sunday evening.

Gus.

——————

Dear Gus,

Many thanks for your significant interest in Burford.

The cash receipts figure we graphically display at the front of the annual report is total cash generated in the business. This cash receipts figure includes gross cash receipts on investments (so includes the return of the initial investment and the profit) along with the cash generated from the insurance and investment management business segments. We think this is an important figure for investors to see because it demonstrates the availability of cash to recycle back into new investments.

Realised investment income on the other hand is a net figure - ie gross proceeds less the initial investment.

To use a real life example – let’s looks at the concluded investment example we wrote about on page 24 of the shareholder letter in our recent annual report. In this arbitration investment Burford invested $4.7 million. At the successful conclusion of the matter, Burford received gross cash proceeds of $16.0 million for a profit of $11.7 million. (That $16.0 million gross cash received will show up on our cash flow statement in the first line of the second section “Proceeds from investments”. The $11.7 million will be recognised as realised income – or some subset of the $11.7 million will be recognised as realised income if the investment previously had its fair value adjusted.)

Please let me know if I have sufficiently answered your question. Again, we truly appreciate your shareholding and interest.

Best,

Elizabeth

Elizabeth O’Connell, CFA
Chief Financial Officer
BURFORD CAPITAL
www.burfordcapital.com

-----Original Message-----
From: Gus —-
Sent: Saturday, March 31, 2018 2:27 AM
To: Elizabeth O'Connell
Subject: Investor Enquiry re. income Recognition vs. cash Receipts

Hi Elizabeth.

Not sure if this is the correct channel of enquiry, but if not please could you forward it to the appropriate person for a response. I am a shareholder in Burford and have been following a discussion among follow investors on the company’s income recognition policy. If you can access it, here is the link:-

https://www.stockopedia.com/content/burford-capital-ndashan-exception-to-the-stock-rank-rules-202527/?comment=115#115

The gist of the issue is that according to the annual reports, Burford has cumulatively recognised approximately $150m less as income than it has received in cash over the past five years. This seems odd in that most company’s typically look to accrue/recognise income before they receive cash. Why would a company receive more cash than it is entitled to? Given the nature of Burford’s business, litigation finance, one would expect this to be the case here.

It may well be there is a simple explanation (for example, when a case settles do you receive cash from the other side and then make distributions to your clients) but rather than speculate, it would be very helpful if the company could confirm the position. You will appreciate there is some nervousness in the current climate where apparent anomalies exist in published accounts and it’s fair to say several investors have expressed concerns on the issue. In responding, please would you confirm if it is OK to post your reply on the referenced bulletin board.

Many thanks,

GrahamF

2nd Apr '18

So what they refer to as ‘realised income’ is what another company might call ‘gross profit’ ??

Thanks Gus ... for asking the question and for posting the answer. A very helpful clarification. And it's nice to see just how responsive the CFO proved to be. Encouraging.

3rd Apr '18

Thanks from me too Gus for the follow-up. It's much appreciated.
Turns out it was a simple explanation after all.

A

18th Apr '18

For anyone interested, here is a presentation from IMF Bentham, who have been listed on the ASX since 2001 and are a competitor to Burford Capital (LON:BUR)

https://www.imf.com.au/docs/de...

29th Apr '18

A couple more opportunities for us to invest in the litigation space are on the way.

1. Vannin Capital are progressing towards a London IPO billing themselves as a "mini Burford"
https://news.sky.com/story/litigation-funding-giant-vannin-hires-banks-for-bumper-float-11352164

2. Rosenblatt are planning to become the fourth English law firm to float. Interestingly they are looking to raise their own funds to reduce their dependence on litigation funders.
http://www.cityam.com/284513/rosenblatt-confirms-fourth-english-law-firm-go-public

6th May '18

I see an unconfirmed report in the Sunday Times today that Burford have been hired by Tatiana Akhmedova, the ex-wife of a Russian oligarch, to help her recover a £453m settlement resulting from a 2016 High Court ruling. So far she says she has received almost nothing.
I haven’t heard of them acting for an individual before, but this would be post judgement asset recovery rather than financing of the original case.

iwright7

John,

Yes I saw the same ST article which reports that last month the ex-wife was awarded Akhmedova's super yacht worth £346M. The article also reported " ....an explosion in demand from (Burford) clients on the Continent and Asia. Bodes well for Burford Capital (LON:BUR). Ian

janebolacha

7th May '18

New hires at Burford, interesting comments on growth potential:

"In Growth Bid, Leading Litigation Financier Bulks Up Leadership"

"By bringing on two legal executives with startup experience, the world's largest litigation funder is making a bet that there is still a lot of room to grow."

Https://www.law.com/americanlawyer/2018/05/07/in-growth-bid-leading-litigation-financier-bulks-up-leadership/?slreturn=20180407080857

There is also Burford involvement in the AMP débacle in Australia:

"Law firm Quinn Emanuel Urquhart and Sullivan is mulling a possible class action against financial services giant AMP, which has admitted cheating customers.

The global firm said it had already secured the backing of litigation financer Burford Capital – the world's largest provider of litigation finance.

"The conduct admitted at the Royal Commission is starkly at odds with AMP's responsibilities and shareholders' legitimate expectations, requiring redress so that AMP's shareholders can recover the value that has been lost," Burford managing director Craig Arnott said.

AMP shares shed more than $1 billion in market value last week following damning evidence presented to the financial services royal commission. The wealth giant's head of financial advice Anthony 'Jack' Regan admitted the company had misled the corporate watchdog, and its chief executive Craig Meller resigned on April 20."

Sounds like a big one!

Read more: hxxp://www.afr.com/business/banking-and-finance/financial-services/amp-could-face-shareholder-class-action-over-damning-royal-commission-revelations-20180423-h0z408#ixzz5DSt5I5zN
Follow us: @FinancialReview on Twitter | financialreview on Facebook

Http://www.afr.com/business/banking-and-finance/financial-services/amp-could-face-shareholder-class-action-over-damning-royal-commission-revelations-20180423-h0z408

Http://www.news.com.au/national/breaking-news/amp-faces-likely-shareholder-class-action/news-story/e8f4023aa25e596a299c93e1516893da

Https://www.moneymanagement.com.au/news/financial-planning/trial-firm-investigating-class-action-against-amp

Https://www.businessnewsaus.com.au/articles/amp-faces-class-action-over-royal-commission-scandal.html

Hi Jane,
I'm puzzled by the AMP situation - won't the share holders effectively be suing themselves if they sue the company for redress because the share price has fallen? Their loss is due to a drop in the share price - it isn't money that has gone anywhere that it can be recovered from beyond clawing back pay and bonuses and other assets from senior management that seems unlikely to amount to AS$1bn.

Beyond that unless a sub-set of shareholders can claim damages from the rest I don't see how they win. Were institutional shareholders in the know and the small shareholders in the dark?

Perhaps someone can enlighten me - I am not a lawyer.

19th May '18

Chambers and Partners have started ranking litigation funders in another acknowledgment that the practice has become mainstream. Their usual business is ranking legal practitioners.

They place Burford and Bentham in Band 1, Lake Whillans and Longford Capital in Band 2, and Vannin Capital and Woodsford in Band 3
https://biglawbusiness.com/litigation-funders-now-ranked-by-chambers/

5th Jun '18

Numis have today upgraded Burford Capital (LON:BUR) from Add to Buy and increased their target from 1200p to 1900p.

Another broker struggling to keep up with events. Its one hell of an upgrade! Ian

Burford Capital –An Exception to the Stock Rank Rules?

Unlock the rest of this article with a 14 day trial

About the Author

Iwright7

407 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...