Burford Capital - It Still Doesn't Quite Convince Me
Summary
- Burford Capital was subject to a hard-hitting Muddy Waters short-selling report alleging inconsistencies in profit realisation.
- The stock dropped like a stone and management insisted they would do things differently and they do seem to have done so.
- The end result looks impressive but it still just doesn't quite convince if I'm honest about it.
Burford Capital (NYSE:BUR) and litigation finance
There's no absolute reason why financing legal cases shouldn't work as a business plan. Going to law in a complex case is expensive. Commercial cases can be about considerable sums of money. So, there's every possibility that there's room in there for someone to finance cases in return for a piece of the recovery.
This being the business Burford Capital is in and as I say there's just no reason at all why there shouldn't be someone successful in this space. The second question though is whether these are the people who are going to be so.
Muddy Waters
It looked like Burford was being successful in this space, the stock was up at around £20 on London's AIM market (the junior part of the London Stock Exchange) at one point. Then in came Muddy Waters with a short-selling report and it's fair to say that they weren't the only people with the occasional question about how the firm was really doing rather than how it was reporting it was doing.
The stock slumped as a result and hasn't, really, recovered since then. This leaves open the obvious question therefore – should it have done? If the management has changed what was previously perceived to be at fault and is also reporting entirely reasonable returns then perhaps the stock should be "re-re-rated" back upwards?
This is not something that has an absolute answer. It depends upon what everyone else thinks about the stock for a start, so we're trying to second guess other peoples' actions. The best we can do is try to come to some view about the stock ourselves, take our preferred actions and then hope that everyone else catches up with us at some point.
My answer here is that I'm not, as yet, persuaded and so am not going to take a position as yet.
The problem identified
The basic problem identified was that Burford was recognising revenue too early. Or perhaps when it was too uncertain.
Commercial court cases can take many years to come to fruition given the possibility of appeal and so on. Even one level of a case can take months to years to a verdict. Costs and expenses of course flood out in a stream. But revenue is only going to come, actually arrive, at the end of this process. Thus there's going to be – not really whether there should, there just is going to be – some recognition of revenue before it actually arrives. Everything from we think we'll get a bit back here through to we're really very sure that this case isn't going to be overturned on that last-ditch appeal so we can pretty much say that the cash is in the bag.
Exactly how each piece of revenue is allocated to which part of that process is going to be much more of an art than a science. This means that it's also arguable at any and every point. The Muddy Waters allegation was that revenue was being recognised much too early.
That, in itself, isn't all that much of a problem. But the continuation of the claim was that this led to revenue being overstated. That is, not so much early, as with too great a certainty. That revenue recognition then led to sums that might not actually arrive in the end being declared as profits, paid out in dividends and thus hollowing out the capital base of the company.
This led to a significant fall in the share price:
(Burford Capital stock price from London Stock Exchange)
That drop from 1500 to 700 in the summer of 2019.
As we can see no one's been terribly excited by the company since. The London all share index is up perhaps 30% since summer '19, Burford is down 25% since the same point in time (calculations by Eyeball Mark I, no more accurate than that).
So, what's happened since then?
Well, the management has promised to be much more careful about revenue recognition, of course they have. In the latest results we see a certain insistence upon actual cash receipts rather than just revenue recognised that might then be received:
Burford had the best year in its history for portfolio performance, generating record levels of realized gain and more cash from successes than ever before.
Quite so, realised gain not recognised. However, there are still two things that worry me.
The US quote
Burford is now quoted in the US as well, starting last fall:
(Burford US quote from Seeking Alpha)
That's a secondary quote but a one on the full NYSE. And we'd rather expect a company dealing in US litigation (largely at least), reporting in dollars, to do well on a US market. That would be rather the point of having that quotation. But it seems not to be happening.
My read of this is slightly cynical. Litigation financing is not really a well known thing in England, in English law, or the English market. It's, as far as I know at least, much more common in the US. So, we might expect a more serious valuation to be applied by a US market to the same stock.
Even if that is too cynical I do take it that the lack of a bounce following the US listing is not a good thing.
The big case
The other thing is that Burford really does rely upon just a couple of large cases. It's rather like a fund manager that has a portfolio, many small stocks but a couple of very large positions. The big positions drive the valuation, even as the small positions might mature and be cashed out.
From Investors Chronicle:
There is still a big question mark over the Petersen and Eton Park claims, which have a carrying value of £773m, of which a whopping £734m is made up of unrealised gains.
Now that's where we came in with the Muddy Waters report. Those claims of recognised – and thus contributing to profit – but not realised gains that were out of line with reality. That's a pretty big chunk of valuation there.
The company also tells us this:
Notably, Burford's YPF-related assets (comprising the Petersen and Eton Park claims) did not contribute to earnings in 2020, for the first time in five years.
Well, that's cool. They've not recognised any more revenue over the year from those possibly contentious amounts. But look at this the other way too. It's another 12 months further on and they've not received any money from these claims either. Meaning that their revenue recognition was a further year ahead of reality, no?
I think Burford has a near-permanent problem with those two big cases.
My view
I'm entirely willing to believe that the cases resolved and cashed in this year are now the normal run of the mill business. I do sorta expect behaviour change after a short-selling report and a stock slump after all. However, there was so much past revenue recognition – and, don't forget, profit declaration and dividend distribution – tied up in those two major cases, $700 million and change, that this is really the defining point of valuation.
If those cases do end up cashing out those amounts then the stock will move sharply upwards. If they end up paying out seriously reduced sums then equally, a significant move downwards. We've no real way of knowing which is going to happen.
That's also on the basis that the ongoing business really is looked at in the best light, that revenue recognition is conservative, that cases are being resolved and cash collected.
The investor view
I also take it that this is the general view of the market as a whole of this stock. This is also why no boost from the US quote. Sure, OK, the chastised management is running a perfectly fine business now but they've those twin albatrosses of two very large cases with possibly aggressive past revenue recognition. Until those two are resolved – either collect the revenue recognised or not – then the clouds over the valuation aren't going to lift.
Or, of course, it all takes so long, so many years as in Jarndyce v Jarndyce, that the two cases just become irrelevant to the size of the business.
I thus recommend staying out of Burford until some resolution of those two cases turns up. For I don't think the valuation is going to change much until there is a resolution there. My personal opinion, for what little that's worth, is that the resolution will be on the downside. But that's not the investment point here. Rather, however well the ongoing business is run there's not going to be significant movement until the settlement of those two. And we've no real way of knowing which way those cases will resolve. We face uncertainty, not a good thing in an investment.
This article was written by
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