Burford Capital Update

Steve Clayton - Fund Manager

29 August 2019

We have exited our position in Burford Capital, following the short selling attack by Muddy Waters.

Muddy Waters made their name spotting wrongdoing in Chinese-run companies, like Sino Forest, which vigorously refuted the allegations made, only to concede and collapse later on. Since then, their track record isn’t perfect but they have claimed some notable scalps.

These situations are always complex, with claim and counter claim about what the target may, or may not, have been doing. We don’t know whether or not they are right about Burford.

We think the company did a pretty good job in demolishing many of Muddy Waters’ claims. And we think there’s little substance in Muddy Waters’ second and third notes on the company.

So why did we sell the holding?

Burford is a litigation funder, its clients are law firms and litigants. Their model is to raise money from investors, deploy that into funding legal claims around the world and make their returns from a share of the successful cases.

Hitting the headlines in this fashion is not good PR. Clients need to know that their funder will keep funding them through to the conclusion of their case.

Burford have always said that when progress in a case is significant, they consider whether to revalue the asset that case represents in their books. We think it is fair to do this, but it does raise the risk that Burford could misread the ultimate strength of their case.

Muddy Waters allege that Burford are too optimistic in how they revalue their assets. For their side, Burford insist they are not, but will not reveal what value they have put on individual cases, arguing that it would give their client’s opponents too much information.

The only way to settle this argument would be to run down the portfolio, settle the cases for better or worse and see what the eventual value turned out to be. That’s not going to happen, of course, so the argument can run and run, keeping the stock under a cloud.

Burford have one case that dwarfs all others, the Petersen affair, which might one day be worth billions if Burford’s clients prevail in the case. The case looks strong: Argentina nationalised an energy company without compensating its owners, some of whom went under as a result. Burford is funding their Administrator’s claims against Argentina through the US courts. Other claims relating to the affair have been settled for very large sums.

But Argentina is in crisis and their willingness and ability to settle is under serious question, we believe. A meaningful part of Burford’s book value rests in this case and the recent collapse of the Argentine currency and its domestic bond market has to be of concern.

So there is a question mark over the current value of Burford’s largest asset, which is outside of their control.

Muddy Waters also raised issues about governance at Burford. The company has announced changes in response, which is welcome, but they are happening slowly and with insufficient impetus, we feel.

Ultimately, Burford can only shake off a naysayer like Muddy Waters if they allow daylight to shine clearly onto the workings of the business. We feel the company has been found lacking here.

Burford is an increasingly complex company. It invests its own money into cases. It also runs funds that invest into cases on behalf of third party investors, often alongside Burford’s own money. And it has a relationship with a Sovereign Wealth Fund that could generate potentially lucrative returns for both parties.

The flip side of this is that cash flows and accounting are hard to reconcile. Burford have so far demurred from providing investors with a clear reconciliation of how the cash moving between all of these investors, in and out of cases, matches up to the illustrations they provide to the market.

Burford need to access outside capital to continue funding their growth. The resolution of cases is unpredictable and so is the cash generation of the business, hence that need for outside capital. We think that access is likely to have been impeded by the short selling attack.

This threatens the company’s ability to maintain its stellar growth rates. Should Burford either lose Petersen or have to recognise that Argentina is unlikely to settle for a long, long time to come, their balance sheet would be weakened, perhaps significantly.

We run concentrated portfolios, so we have to have real conviction in every holding. Muddy Waters have not proven that Burford is a chimera, but questions have been raised that so far remain unanswered.

If Burford are right, then the group faces a great opportunity, so long as they retain that access to external capital. If Muddy Waters are right, then the outlook is troubled. We would rather not have your fund’s capital at risk whilst these issues are resolved.

Impact on the funds

With the funds having launched at different dates, and bought into Burford at different times, the impact on the funds is quite different.

For UK Growth Shares, owning Burford added over 3% to the value of the fund because it bought early, just at the start of a great run by the stock, and the exit price represented an 80% premium on the purchase cost.

UK Income Shares launched later and did not buy Burford on day one, because the stock’s low dividend yield made it hard to accommodate the stock. Later on, with the fund having boosted its income position, we bought into Burford. Initially the stock was a big winner, but the recent sharp drop has left the overall outcome at a cost to the portfolio of 1.25%.

Global Growth Shares bought in at its recent launch and as a result saw its early gains from the stock wiped out and more, leading to an overall net loss of 1.5% of the fund’s value.

Parting thoughts

We may have been wrong to have sold out, or we may have been wrong to have bought in the first place. Either way it’s disappointing to see what had been a big winner for all of the funds turn sour.

Burford was always a unique position, the company was leading the creation of a new industry and appeared to be making high returns along the way. It was always clear that profits were a combination of realised gains and estimated increases in the future value of cases in progress. But we think Burford now needs to move decisively to show, beyond question, that the value of its mark-ups are conservative and that the business can generate cash flows sufficient to make external capital an optional extra rather than a requirement.