BUR.L - Burford Capital

[no_free_lunch]

No position yet, just recording my research.

 

Burford specializes in legal financing.  Essentially they will take on the cost of a lawsuit in exchange for a cut of the profits.  It appears to be a win-win business proposition.  The claimant takes on no cost for the lawsuit and shows the market that litigation will be pursued.  If they win they get a portion of the profits, if they lose it comes them nothing.  Burford can and does lose but they have a large portfolio of investments.  They are up to around 100 cases invested in per year.  This should be a recession resistant industry, you can see how there might even be more demand for this type of thing during a recession.  Presumably in a downturn there wouldn't be the excess cash to pursue lawsuits.

 

They are a fast growing company, the stock is about 15x since the 2010 IPO.  As you would expect  they are not cheap, they are sitting around 3x BV.  However they are highly profitable and are at around 13x PE based on lawsuit payouts.  They have an asset management wing and there is something like $2B managed, not sure how to add that into the valuation.  The industry is substantial, they did about $1B in commitments last year and there are something like $400B in tort settlements in a year, so maybe there is still room for growth? 

 

ROE claims from the company are substantial.  They are generally hitting 20-30% ROE.  There are some gotchas though, some lawsuits are still pending after years.  They also tend to over-commit capital and not end up deploying it.  To me that doesn't seem to be a bad thing but the ROE would be lower if you included the full commitment.

 

They appear to be logical business men.  They only write 5% or so of the deals that they review. 

 

They claim to be the dominant player, out-sizing the next largest firm by over 5x as I recall.  As a result, they claim to have some scale advantages.

 

The real questions are: can they continue to grow this quickly and what will happen to their ROE as they grow?  If you look on their website there is a link to investments in Australia.  In the link they say a deal was signed at a 10% ROE level so maybe the profits are going to start shrinking?

 

I know there are lawyers on the board.  Appreciate any feedback.

[cameronfen]

I'm long Litigation Capital Management (LIT.L) which is an litigation financing company that is much smaller and so it has a larget oportunity set.  I don't know if Burford can compound capital at the same rate historically given its size.  There are a couple other litigation finance firms that are also the same size as LIT.L.  There probably is some scale advantage for investing in a portfolio of cases which Burford does a lot of, however I think the RoE is more attractive when you have a smallish portfolio as cases require usually something less than 5 million dollars.  If you want to look at IRR tends in real time in the industry (more relevent to small players) Lexshares is a "crowdsource" litigation finance platform and if you register I think you can see returns on recent cases allowing you to monitor the health of the industry. 

[peterHK]

I'm long Litigation Capital Management (LIT.L):which is an litegation financing company that is much smaller and so it has a larget oportunity set.  I don't know if Burford can compound capital at the same rate historically given its size.  There are a couple other litigation finance firms thatvare also the same size as LIT.L

 

Burford's size IS it's advantage. It's gotten something like 2/3 of all new fund inflows into the space, ROIC's are still in the 30's, but the risk is far lower because Burford can spread its portfolio out over more bets. They can pay more, attract better talent, and have better institutional relationships and dealflow, which is very very important in this business. I wouldn't be long anyone else in this industry.

 

I'm very long Burford. My thinking is this: if they can compound off of book value at 30% falling to 25% over the next 3 years, and then 15% after that, they are easily a double from here. That leaves out the upside from their growing asset management business (which looks far worse than it is because performance carry won't likely start for another year or so). Note that at 3x BV today, 3 years of compounding at 30% means you trade at book value in 3 years.

 

What's the value of a business that can earn 15% IRR's unlevered, 20% ROE's, with a WACC of 10% (implying say 12% for the equity) that pays out 100% of earnings? 2x book value (I won't put the math here, but this is a provable fact). So even if returns compress very quickly, this business is still worth 2x book value, meanwhile book value/share should double from here quite easily. What happens, also, if ROIC's don't decline to 15% in 3 years? Well then you have a business earning probably 35-40% ROE's that can reinvest most of those earnings back into the business. That alone is worth far more than 3x book.

 

Over time, I think this evolves into a PE style industry, and Burford is going to be the Blackstone/BAM of it. Returns will fall, but they need to still be high because of the binary nature of the underlying litigation, so my guess is that they settle out in the 15% IRR range. Again, PE firms have tons of competition, but regularly earn mid teens returns, so there's no reason that competition here has to erode returns immediately.

 

Woodford owns a big stake, that's why the stock is where it is. I'd be buying hand over fist. I think the risk of permanent capital loss is very low, while the opportunity for this to be a 2-5x over the next 5 years is very high.

[cameronfen]

Sure, but the roi on there deals are lower.  If you look at lexshares, small deals have roi in the 60 to 70%. Asset management firms have decreasing returns to scale and that should be your prior.  The main reason, I think, they invest in portfolios instead of individual deals is because they are too big for small deals to make economic sense.  Remember in a portfolio of uncorrelated assets, there are very marginal returns to risk adjusted return after the 20th equal weighted asset.  Maybe Burford has some special sauce that makes them better than the competition and they likely can attract better talent, but the diseconomies of size usually win out for asset managers.  Furthermore this isnt like BAM or BX for one reason because there are no single mega deals that only the big guys can only finance.  Like 99.99999% (exaggeration but...) of the deals that need financing require less than 10 million in capital (although I have read somewhere some firms put you on retainer and on call for more but again they wouldn't do that unless they got a decent deal).  The reason Burford is bigger than the competition is likely due to being the first to the public market and they issued stock and lots of it (which is exactly what you should be doing when you trade at 3x book and have roe in the 30% range and historically plenty of investment opportunity).  However, everyone has picked up on this and is copying the Burford strategy.  Even so, currently dealflow is not a worry for anyone.  LIT has 40 pounds million in equity and 200+ million in deal flow. Again, maybe I'm being a cowboy, but LIT.L has a historical IRR of 77% vs 30% for Burford and as a sanity check this is inline with returns you can get with Lexshares (if you can get a deal.). 

 

I think woodford's long this because the fund is too big to invest in anything else (but don't know if he would invest in another player). 

[Gregmal]

I bought a little starter here this morning. Very unique business. Seems to have lower correlation to broader market. Kind what I'm looking for in my investments at the moment. Thanks for bringing this up. And LIT as well cameronfen.

[peterHK]

Sure, but the roi on there deals are lower.  If you look at lexshares, small deals have roi in the 60 to 70%. Asset management firms have decreasing returns to scale and that should be your prior.  The main reason, I think, they invest in portfolios instead of individual deals is because they are too big for small deals to make economic sense.  Remember in a portfolio of uncorrelated assets, there are very marginal returns to risk adjusted return after the 20th equal weighted asset.  Maybe Burford has some special sauce that makes them better than the competition and they likely can attract better talent, but the diseconomies of size usually win out for asset managers.  Furthermore this isnt like BAM or BX for one reason because there are no single mega deals that only the big guys can only finance.  Like 99.99999% (exaggeration but...) of the deals that need financing require less than 10 million in capital (although I have read somewhere some firms put you on retainer and on call for more but again they wouldn't do that unless they got a decent deal).  The reason Burford is bigger than the competition is likely due to being the first to the public market and they issued stock and lots of it (which is exactly what you should be doing when you trade at 3x book and have roe in the 30% range and historically plenty of investment opportunity).  However, everyone has picked up on this and is copying the Burford strategy.  Even so, currently dealflow is not a worry for anyone.  LIT has 40 pounds million in equity and 200+ million in deal flow. Again, maybe I'm being a cowboy, but LIT.L has a historical IRR of 77% vs 30% for Burford and as a sanity check this is inline with returns you can get with Lexshares (if you can get a deal.). 

 

I think woodford's long this because the fund is too big to invest in anything else (but don't know if he would invest in another player).

 

Burford invested $17 million in Petersen and it's now worth $1 billion and they have realized $200+ million in proceeds already from the sale of their stake, and retain a 60%+ stake on the balance sheet. What's that for an ROI?

 

The problem for smaller operators is precisely that because the outcome of litigation is binary, they are at risk of a string of negative outcomes. The portfolio approach has lower returns, but is far more sustainable and carries far lower risk of permanent capital loss. This is why it's like BAM/BX: only the big guys with sufficient capital can have their portfolio diversified enough through portfolios as well as different strategies that returns across the book are diversified, steady, but still high. I'd rather have a sustainable stream of 30% than a 70% and then a -30% and then a 70% and -30% etc.

 

Also worth noting that the real money here is going to be in the AM business, I think. It allows, for the sovereign wealth fund for instance, Burford to put up 33% of the risk, and receive 60% of the reward between the return on their balance sheet investments and the management/carry fees. Volatility in results doesn't translate well into a sustainable AM business, you need to demonstrate a repeatable process across the portfolio that can work, and I think only BUR has really got there today.

 

Also worth noting (IIRC) BUR was NOT the first to the public market and certainly, by quite a long ways, BUR was NOT the first in this industry. They have been vastly more successful than others in performance and fundraising for other reasons than just first mover advantage.

[writser]

Burford invested $17 million in Petersen and it's now worth $1 billion and they have realized $200+ million in proceeds already from the sale of their stake, and retain a 60%+ stake on the balance sheet. What's that for an ROI?

 

But that was kind of cameronfen's point, right? They only invested $17m in this deal. Can they find another 200 deals of this size that are even remotely as attractive? It's an interesting business for sure, and looks like a good one too. Seems like they had a few home runs and then quickly raised a lot of capital at a super high valuation and secured AUM at very favorable terms. Very smart moves. But hard to believe growth won't slow down after that. Still, intriguing idea.

[Jerry Capital]

Heads I win a lot tails I lose a little.

[cameronfen]

Sure, but the roi on there deals are lower.  If you look at lexshares, small deals have roi in the 60 to 70%. Asset management firms have decreasing returns to scale and that should be your prior.  The main reason, I think, they invest in portfolios instead of individual deals is because they are too big for small deals to make economic sense.  Remember in a portfolio of uncorrelated assets, there are very marginal returns to risk adjusted return after the 20th equal weighted asset.  Maybe Burford has some special sauce that makes them better than the competition and they likely can attract better talent, but the diseconomies of size usually win out for asset managers.  Furthermore this isnt like BAM or BX for one reason because there are no single mega deals that only the big guys can only finance.  Like 99.99999% (exaggeration but...) of the deals that need financing require less than 10 million in capital (although I have read somewhere some firms put you on retainer and on call for more but again they wouldn't do that unless they got a decent deal).  The reason Burford is bigger than the competition is likely due to being the first to the public market and they issued stock and lots of it (which is exactly what you should be doing when you trade at 3x book and have roe in the 30% range and historically plenty of investment opportunity).  However, everyone has picked up on this and is copying the Burford strategy.  Even so, currently dealflow is not a worry for anyone.  LIT has 40 pounds million in equity and 200+ million in deal flow. Again, maybe I'm being a cowboy, but LIT.L has a historical IRR of 77% vs 30% for Burford and as a sanity check this is inline with returns you can get with Lexshares (if you can get a deal.). 

 

I think woodford's long this because the fund is too big to invest in anything else (but don't know if he would invest in another player).

 

Burford invested $17 million in Petersen and it's now worth $1 billion and they have realized $200+ million in proceeds already from the sale of their stake, and retain a 60%+ stake on the balance sheet. What's that for an ROI?

 

The problem for smaller operators is precisely that because the outcome of litigation is binary, they are at risk of a string of negative outcomes. The portfolio approach has lower returns, but is far more sustainable and carries far lower risk of permanent capital loss. This is why it's like BAM/BX: only the big guys with sufficient capital can have their portfolio diversified enough through portfolios as well as different strategies that returns across the book are diversified, steady, but still high. I'd rather have a sustainable stream of 30% than a 70% and then a -30% and then a 70% and -30% etc.

 

Also worth noting that the real money here is going to be in the AM business, I think. It allows, for the sovereign wealth fund for instance, Burford to put up 33% of the risk, and receive 60% of the reward between the return on their balance sheet investments and the management/carry fees. Volatility in results doesn't translate well into a sustainable AM business, you need to demonstrate a repeatable process across the portfolio that can work, and I think only BUR has really got there today.

 

Also worth noting (IIRC) BUR was NOT the first to the public market and certainly, by quite a long ways, BUR was NOT the first in this industry. They have been vastly more successful than others in performance and fundraising for other reasons than just first mover advantage.

 

So first of all, you will make a lot of money in BUR likely as well IMO.  So I'm not saying BUR is a bad stock to buy.  If you are only comfortable with big names then that's your choice. 

 

Attached is LIT's portfolio performance.  You will notice unweighted (and unweighted IRR was derived by combining average ROIC with time to resolve) IRRs are around 41% (they say IRR is 75+% but I'm guessing their winners have higher amounts of capital and you have higher IRRs by staggering investments and payouts). 

 

In terms of volatility, they have only 4 cases out of 35 where they lost money.  The reason is in civil trials 95% of cases settle, and the financing is set up in a way so that you still make a lot of money when you settle.  So the benefit of diversification is muted by the fact that all these are uncorrelated assets and these things typically make money most of the time.  The risk of a string of negative outcomes with permanent loss of capital is basically zero as long as you have a portfolio that's larger than 10-15 million pounds (and you know what your doing). 

 

I think you are right that the asset management business is where BUR will shine as the big names will want to partner with Burford (for both rational and irrational reasons I think but it's true).  Again all the firms in litigation finance are now building out asset management businesses.  But Burford will attract the bulk of the fund flows and basically reap infinite ROI on these flows. 

 

So I don't know if BUR was first to the public markets.  Based just looking around, I'm pretty sure they were the ones with the ideas to repeatedly issue stock and invest in attractive returns which is the correct strategy, but also the reason they are so much bigger than everyone else. 

 

edit comment: The other thing to note is LIT.L is generating these IRRs unleveraged I think.  BUR is using modest amounts of leverage to do this.  As alwasy BUR is doing the right thing, but again the small guys all already know the playbook, and wouldn't be surprised if they started copying BUR. 

 

Regarding the Peterson stake LIT.L has one deal that had an ROIC of 56x (roughly in line with Peterson ROI) and another at 39x so these returns aren't abnormal for the industry.  I guess what I'm trying to say is this is a really good industry to be in, for all players, and the vast majority of BUR growth is due to financial engineering (which everyone has caught onto) rather than a really good moat. 

 

[Foreign Tuffett]

1) What keeps new companies and capital from flooding into the litigation funding market, thereby depressing returns for existing players?

 

2) As others have mentioned, I would question the runway here given the large size of the company relative to the niche (?) nature of litigation funding.

 

Looking at the total $ value of tort settlements and trying to somehow distill the future size of the litigation funding market seems misguided.

 

[Jerry Capital]

At this valuation you can safely put the onneous of TAM size on the bear not the bull.

 

It's at least as large as the current year plus a good chunk larger than GDP given its really only operating in a few countries for the last few years... It's safe to say that it is highly likely to be significantly larger.

 

Why do some asset managers earn good returns while others don't?

 

Infinite money can flood into equities and there will always be someone that generates alpha. If that's BUR you make tremendous gains. If they just get their share of fund flows at market ROIs but the market is structurally attractive for 10 to 15 years you make tremendous gainz with little downside.

 

Not enough of the bears can paint a scenario with more than 20 to 30 downside... CG did a good job painting it down to 12 ish...

 

 

 

[peterHK]

At this valuation you can safely put the onneous of TAM size on the bear not the bull.

 

It's at least as large as the current year plus a good chunk larger than GDP given its really only operating in a few countries for the last few years... It's safe to say that it is highly likely to be significantly larger.

 

Why do some asset managers earn good returns while others don't?

 

Infinite money can flood into equities and there will always be someone that generates alpha. If that's BUR you make tremendous gains. If they just get their share of fund flows at market ROIs but the market is structurally attractive for 10 to 15 years you make tremendous gainz with little downside.

 

Not enough of the bears can paint a scenario with more than 20 to 30 downside... CG did a good job painting it down to 12 ish...

 

And CG was full of crap.

 

On returns and valuation, I think people miss the interplay.

 

Today, Burford earns ~40% ROE's, conservatively. Book value as of the last statement is 4.89GBP. It's worth noting that last year's 30% ROE was an abnormality:

 

"the FTSE 250 average) needs a word of explanation. Our ROE is of course affected not only by earnings, which increased materially, but also by the rate of growth in our net assets. Thus, because we deployed a record-breaking amount of new investment capital in 2018, we pushed down our ROE for the year".

 

If we get 40% ROE, then BV/Share at the end fo the year will be 6.85.

 

If next year returns compress to 25% ROE's (almost a 50% decline!), book value will  be 8.56.

 

If the year after that returns compress to 20% ROE's (which equates to ~15% ROIC's on their portfolio, down from 30% ROIC's today), then ending book value is 10.27.

 

Let's say BUR stops there and decides to pay out 100% of its earnings, reinvest nothing in the business, and has no asset management business generating any earnings. At 20% ROE's, and 10% WACC the justified P/B of this company is, with 0 growth (because they pay out 100% of earnings): (ROE - g)/(r - g). 20%/10% = 2x.

 

This gives us on 10.27 of book value x 2 = 20.54/share. This is with 0 value given to the fee stream from an asset management business, it assumes BUR pays out 100% of earnings in a dividend and does not grow. Were BUR to reinvest 10% of its earnings @ 20% ROE's, that gives you 2% growth, which means the justified P/B would be 2.25x (18%/8%). Even a little growth gets you to over 23GBP even if returns compress almost 50% from today over a mere 3 year period. Good for mid teens returns.

 

Now, what happens if returns DON'T compress?

 

If BUR compounds at 40% for 3 years, BV/S will be 13.41 share. What's the valuation of a business that can earn 40% ROE's, reinvest significant parts of their earnings and grow? Well, lets say you assume 30% ROE's is more normal, and they reinvest only 10% of earnings (growth is 3%): justified P/BV @ 10% WACC = 2.7x. That gives you 36 GBP price target on just book value, leaving alone any asset management business they have.

 

For the AM business, if you manage $3bn @ 1.5%/20% carry with an 8% hurdle and returns are 20%/year, you get a fee stream of $60mn in mgmt fees @ a ~50% operating margin, maybe 40% after tax (note that margins are high because BUR bears much of the costs of investing already, so there are a lot of synergies to doing your own BS investing and having a fund management business). At a 12x multiple, that's worth $288mn.

 

Your carry is another ~$70mn a year, say at another 50% margin. Capitalize that at 5x, another $180mn in value. So the AM business gives you another ~$470mn or so in value (~1.70GBP per share).

 

So if this goes poorly, you're looking at maybe 37GBP, 32% annualized.

 

For you to be a bear at today's prices, you need to prove that returns will compress immediately, and that Burford will be able to reinvest very little back into the business and that the asset management business will not do well.

 

 

[spartan]

These types of investments really make me struggle... On the one hand, you have a large and growing industry that has been producing very attractive returns. On the other hand, there are a list of potential problems that cause me to worry, including:

 

1. No significant moats (at least none that I can think of). Capital is not a durable competitive advantage, especially in today's environment. Added to which, lots of lawyers hate their jobs. If they see other lawyers making more money than them doing something that sucks less, the industry will get flooded with new entrants. It does not survive Buffett's punch card test.

 

2. It is very difficult to predict future cash flows. For a variety of reasons, courts can very easily begin to reign in on litigation finance. It is already illegal in some states. And how can we determine the probability of winning the cases that these firms are committing capital? We can't.

 

3. It is unclear how shareholders will be treated. Companies are plowing back capital in their high ROIC businesses, which is obviously a good thing. But it is unclear whether this rationality will translate into more rationality down the road. Will they use cash to enrich shareholders? Or will they end up plowing it back into their businesses as their ROIC's inevitably decrease, thereby destroying value?

 

4. It is not entirely clear if this is an uncorrelated bet. When the economy begins its downturn, there is more incentive to litigate. People need the money and are generally more on edge. However, it's not clear whether payouts will match the increase in litigation in times of downturn.

 

I once heard a story about a bank that basically ran the tobacco loan industry in a particular region in the US (Well Fargo, but I could be wrong). Deutsche Bank saw this as an opportunity to enter and began committing capital to applicants that were turned down by the first mover bank. They ended up getting creamed because the first mover had all the data on these particular types of loans. They had been operating there for years and knew exactly who to loan to.

 

Perhaps data is a durable competitive advantage and Burford is large enough, and been around for long enough, to be able to make the smartest decisions. But after reading their annual report, they only briefly mention this. Seems to me like data is the most important part of a long-term investment thesis for Burford. Not sure how to analyze this though... maybe the low multiples are justified.

[Packer16]

This is an interesting business but I wonder how sustainable the advantage Bruford has is.  Fast growth allows others to enter & I have a hard time seeing what Bruford is providing other than financing which in the end is commodity in this low interest rate environment.  The thesis is Bruford can obtain scale/diversification quicker than others, this is true but I do not see anything that someone else could not copy.  Now if litigation finance was a slow growing field I would feel there is more of a barrier.  The growth itself allows competitors to get to scale also.  Also, I do not see what Bruford can do to increasing switching costs or make search more difficult.

 

How do you know the past returns are not just luck and the risk premium here will not be whittled away as in other asset classes?  Are there unique aspects to the business where the risks are hidden & not present in past returns?  Could the hidden risks be why the returns are so high?

 

Packer

[Jerry Capital]

Downside 30% upside 10 year compounder, hit the bid

[Jerry Capital]

Don't focus on the upside focus on the downside

[peterHK]

This is an interesting business but I wonder how sustainable the advantage Bruford has is.  Fast growth allows others to enter & I have a hard time seeing what Bruford is providing other than financing which in the end is commodity in this low interest rate environment.  The thesis is Bruford can obtain scale/diversification quicker than others, this is true but I do not see anything that someone else could not copy.  Now if litigation finance was a slow growing field I would feel there is more of a barrier.  The growth itself allows competitors to get to scale also.  Also, I do not see what Bruford can do to increasing switching costs or make search more difficult.

 

How do you know the past returns are not just luck and the risk premium here will not be whittled away as in other asset classes?  Are there unique aspects to the business where the risks are hidden & not present in past returns?  Could the hidden risks be why the returns are so high?

 

Packer

 

Litigation is binary. YOu either win, or you lose 100%. So that is why returns are high IF you have skill in underwriting. Burford already has scale and diversification, they do not need to achieve it quicker than other.

 

Why does BAM keep earning good returns? They're good underwriters, they're disciplined, they have relationships across the globe. Why does Buffett earn good returns: he's a good underwriter, he's disciplined, he has good relationships. Why does Fundsmith earn good returns? Etc. etc. etc. What's the sustainable competitive advantage to First Republic Bank? It's customer service. What's Markel's sustainable competitive advantage? Again, Gaynor is a good underwriter, he's disciplined.

 

The finance industry is never a "moaty" industry really, but you can do exceptionally well if the people and culture of the firm are exceptional. Spend your time looking at that and reading Burford's commentary and listening to what they have to say, rather than wasting time on whether they have switching costs or network effects or that sort of nonsense.

[cameronfen]

1) What keeps new companies and capital from flooding into the litigation funding market, thereby depressing returns for existing players?

 

2) As others have mentioned, I would question the runway here given the large size of the company relative to the niche (?) nature of litigation funding.

 

Looking at the total $ value of tort settlements and trying to somehow distill the future size of the litigation funding market seems misguided.

 

1.) The current litigation market size is 50 - 100 billion USD.  (https://www.marketwatch.com/story/in-low-yield-environment-litigation-finance-booms-2018-08-17).  I read somewhere there is probably room to double that, but not much more.  Can't find that source as I read it a while ago.  Here is something that says commercial funding TAM is about 30 billion in the US.  You can at least double that for personal lawsuits, I think, and then apply some sort of multiple for the world (https://www.lawpracticetoday.org/article/trends-litigation-finance-2/https://www.lawpracticetoday.org/article/trends-litigation-finance-2/).

 

2.)  I agree, obviously, with that.  In addition to LIT, companies like Manolete which are even more niche (insolvency case financing) has IRRs in the 200-300% range.  BUR has already shown declines to 31% IRR.  I think, the vast majority of the competition I believe will be for the assets Burford invest's in.  50 million dollars + deals for instance to finance a company's entire litigation portfolio.  No Sovereign wealth fund is going to want their money investing in Manolete's portfolio of 1million pounds or less of individuals filing for bankruptcy.  The same is true for LIT although they seem to be going in the direction of portfolios too.  Keep in mind, BUR is also competing with large law firms and the companies who are deciding whether to farm out the financing or keep it in house.  If you are a small business or individual in a bankruptcy case (both defendant and plaintiff),  you likely don't have the same outside options as Gillette, or the class action law firm suing Gillette.  The upside for BUR is they will capture much of the assets flowing in for these kinds of deals, although there are already competing asset management firms like IMF Bentham, that can invest in these kinds of portfolios at better rates for investors. 

 

 

 

 

[deseretalts]

Burfords argument is that the nature of the business makes switching costs high because the diligence process is so intensive (with sensitive subject matter) the cost to "shop" the deal around is high. Burford's higher levels of diversification give them lower cost of capital (again w/ binary outcomes diversification is even more important than in other asset classes) and they become the "go to" for cases both large and small, picking the cream of the crop and passing the rest on to other players

[cameronfen]

At this valuation you can safely put the onneous of TAM size on the bear not the bull.

 

It's at least as large as the current year plus a good chunk larger than GDP given its really only operating in a few countries for the last few years... It's safe to say that it is highly likely to be significantly larger.

 

Why do some asset managers earn good returns while others don't?

 

Infinite money can flood into equities and there will always be someone that generates alpha. If that's BUR you make tremendous gains. If they just get their share of fund flows at market ROIs but the market is structurally attractive for 10 to 15 years you make tremendous gainz with little downside.

 

Not enough of the bears can paint a scenario with more than 20 to 30 downside... CG did a good job painting it down to 12 ish...

 

And CG was full of crap.

 

On returns and valuation, I think people miss the interplay.

 

Today, Burford earns ~40% ROE's, conservatively. Book value as of the last statement is 4.89GBP. It's worth noting that last year's 30% ROE was an abnormality:

 

"the FTSE 250 average) needs a word of explanation. Our ROE is of course affected not only by earnings, which increased materially, but also by the rate of growth in our net assets. Thus, because we deployed a record-breaking amount of new investment capital in 2018, we pushed down our ROE for the year".

 

If we get 40% ROE, then BV/Share at the end fo the year will be 6.85.

 

If next year returns compress to 25% ROE's (almost a 50% decline!), book value will  be 8.56.

 

If the year after that returns compress to 20% ROE's (which equates to ~15% ROIC's on their portfolio, down from 30% ROIC's today), then ending book value is 10.27.

 

Let's say BUR stops there and decides to pay out 100% of its earnings, reinvest nothing in the business, and has no asset management business generating any earnings. At 20% ROE's, and 10% WACC the justified P/B of this company is, with 0 growth (because they pay out 100% of earnings): (ROE - g)/(r - g). 20%/10% = 2x.

 

This gives us on 10.27 of book value x 2 = 20.54/share. This is with 0 value given to the fee stream from an asset management business, it assumes BUR pays out 100% of earnings in a dividend and does not grow. Were BUR to reinvest 10% of its earnings @ 20% ROE's, that gives you 2% growth, which means the justified P/B would be 2.25x (18%/8%). Even a little growth gets you to over 23GBP even if returns compress almost 50% from today over a mere 3 year period. Good for mid teens returns.

 

Now, what happens if returns DON'T compress?

 

If BUR compounds at 40% for 3 years, BV/S will be 13.41 share. What's the valuation of a business that can earn 40% ROE's, reinvest significant parts of their earnings and grow? Well, lets say you assume 30% ROE's is more normal, and they reinvest only 10% of earnings (growth is 3%): justified P/BV @ 10% WACC = 2.7x. That gives you 36 GBP price target on just book value, leaving alone any asset management business they have.

 

For the AM business, if you manage $3bn @ 1.5%/20% carry with an 8% hurdle and returns are 20%/year, you get a fee stream of $60mn in mgmt fees @ a ~50% operating margin, maybe 40% after tax (note that margins are high because BUR bears much of the costs of investing already, so there are a lot of synergies to doing your own BS investing and having a fund management business). At a 12x multiple, that's worth $288mn.

 

Your carry is another ~$70mn a year, say at another 50% margin. Capitalize that at 5x, another $180mn in value. So the AM business gives you another ~$470mn or so in value (~1.70GBP per share).

 

So if this goes poorly, you're looking at maybe 37GBP, 32% annualized.

 

For you to be a bear at today's prices, you need to prove that returns will compress immediately, and that Burford will be able to reinvest very little back into the business and that the asset management business will not do well.

 

I think you will do well in Burford.  But I think you are missing the point.  People aren't saying that ROIs aren't high, our argument is you can't look backwards in terms of ROI as they compounded capital in enviroments with less competition.  If they maintain 40% ROIs no way you can lose money.  The question is with so much money flowing in, everyone is IPOing, everyone is starting funds, and everyone is evaluating if paying an external fund to finance your litigation at 40% ROIs for them is worth it when you have the money yourself.  Just on the back of how much assets they are raising by themselves, at some point they are going to run out of things to finance. 

 

If you invest 3 billion in your fund and 3 billion of your own capital, maybe the market is 60 billion dollars and 50% of that you can't invest in because its 1 million dollar cases, then you are already 20% of your TAM.  Being such a large percentage of TAM unless you have some really compelling value add, which litigation finance sort of does even at that scale due to public company accounting advantages for example, maybe you can make money.  But most of the companies you finance aren't going to have liquidity issues.  At some point many are going to get better deals for themselves and ROI will go down (and it has again compared to companies that are much smaller). 

 

To @deserelts, I think the bigger size more diversification argument is more marketing than actual substance for the company.  In the public markets there is little return to diversification after the 20th asset.  This is with assets that are correlated.  With legal financing, the assets are not only uncorrelated, but IRRs are in the 50+% range.  If you have a portfolio of 10 to 20 million dollars, no one is even close to a permanent loss of capital even at that size.  Cream of corp may be more valid, but this is asset management.  If I have a lawsuit, I don't care that a big name is financing me or not (as long as they aren't going insolvent), I just want the best deal I can get. 

 

To @peterHK Again nothing suggests Burford is unnaturally good at underwriting.  Everyone earns IRRs in 30% of higher.  They just perfected the financial engineering side before anyone else. 

 

my edit: @spartan to address one of your points, although Burford has a large North American presence, many other firms (which were all started in Australia and often listed in London) focus on markets with less regulatory risk and so you can always avoid that risk by picking firms. 

[Gregmal]

One look at the man, and Gregmal declares “he is fat”!

 

This is a great business, at the very least, as a short term investment. Potentially, it’s a long term compounder. No need to get caught up on obscure nuances. I was once told something by a mentor that has resonated ever since. The ideal combination for an investor is to be smart enough to see what’s relevant, while being dumb enough not to see or get hung up on every little arcane detail.

[peterHK]

At this valuation you can safely put the onneous of TAM size on the bear not the bull.

 

It's at least as large as the current year plus a good chunk larger than GDP given its really only operating in a few countries for the last few years... It's safe to say that it is highly likely to be significantly larger.

 

Why do some asset managers earn good returns while others don't?

 

Infinite money can flood into equities and there will always be someone that generates alpha. If that's BUR you make tremendous gains. If they just get their share of fund flows at market ROIs but the market is structurally attractive for 10 to 15 years you make tremendous gainz with little downside.

 

Not enough of the bears can paint a scenario with more than 20 to 30 downside... CG did a good job painting it down to 12 ish...

 

And CG was full of crap.

 

On returns and valuation, I think people miss the interplay.

 

Today, Burford earns ~40% ROE's, conservatively. Book value as of the last statement is 4.89GBP. It's worth noting that last year's 30% ROE was an abnormality:

 

"the FTSE 250 average) needs a word of explanation. Our ROE is of course affected not only by earnings, which increased materially, but also by the rate of growth in our net assets. Thus, because we deployed a record-breaking amount of new investment capital in 2018, we pushed down our ROE for the year".

 

If we get 40% ROE, then BV/Share at the end fo the year will be 6.85.

 

If next year returns compress to 25% ROE's (almost a 50% decline!), book value will  be 8.56.

 

If the year after that returns compress to 20% ROE's (which equates to ~15% ROIC's on their portfolio, down from 30% ROIC's today), then ending book value is 10.27.

 

Let's say BUR stops there and decides to pay out 100% of its earnings, reinvest nothing in the business, and has no asset management business generating any earnings. At 20% ROE's, and 10% WACC the justified P/B of this company is, with 0 growth (because they pay out 100% of earnings): (ROE - g)/(r - g). 20%/10% = 2x.

 

This gives us on 10.27 of book value x 2 = 20.54/share. This is with 0 value given to the fee stream from an asset management business, it assumes BUR pays out 100% of earnings in a dividend and does not grow. Were BUR to reinvest 10% of its earnings @ 20% ROE's, that gives you 2% growth, which means the justified P/B would be 2.25x (18%/8%). Even a little growth gets you to over 23GBP even if returns compress almost 50% from today over a mere 3 year period. Good for mid teens returns.

 

Now, what happens if returns DON'T compress?

 

If BUR compounds at 40% for 3 years, BV/S will be 13.41 share. What's the valuation of a business that can earn 40% ROE's, reinvest significant parts of their earnings and grow? Well, lets say you assume 30% ROE's is more normal, and they reinvest only 10% of earnings (growth is 3%): justified P/BV @ 10% WACC = 2.7x. That gives you 36 GBP price target on just book value, leaving alone any asset management business they have.

 

For the AM business, if you manage $3bn @ 1.5%/20% carry with an 8% hurdle and returns are 20%/year, you get a fee stream of $60mn in mgmt fees @ a ~50% operating margin, maybe 40% after tax (note that margins are high because BUR bears much of the costs of investing already, so there are a lot of synergies to doing your own BS investing and having a fund management business). At a 12x multiple, that's worth $288mn.

 

Your carry is another ~$70mn a year, say at another 50% margin. Capitalize that at 5x, another $180mn in value. So the AM business gives you another ~$470mn or so in value (~1.70GBP per share).

 

So if this goes poorly, you're looking at maybe 37GBP, 32% annualized.

 

For you to be a bear at today's prices, you need to prove that returns will compress immediately, and that Burford will be able to reinvest very little back into the business and that the asset management business will not do well.

 

I think you will do well in Burford.  But I think you are missing the point.  People aren't saying that ROIs aren't high, our argument is you can't look backwards in terms of ROI as they compounded capital in enviroments with less competition.  If they maintain 40% ROIs no way you can lose money.  The question is with so much money flowing in, everyone is IPOing, everyone is starting funds, and everyone is evaluating if paying an external fund to finance your litigation at 40% ROIs for them is worth it when you have the money yourself.  Just on the back of how much assets they are raising by themselves, at some point they are going to run out of things to finance. 

 

If you invest 3 billion in your fund and 3 billion of your own capital, maybe the market is 60 billion dollars and 50% of that you can't invest in because its 1 million dollar cases, then you are already 20% of your TAM.  Being such a large percentage of TAM unless you have some really compelling value add, which litigation finance sort of does even at that scale due to public company accounting advantages for example, maybe you can make money.  But most of the companies you finance aren't going to have liquidity issues.  At some point many are going to get better deals for themselves and ROI will go down (and it has again compared to companies that are much smaller). 

 

To @deserelts, I think the bigger size more diversification argument is more marketing than actual substance for the company.  In the public markets there is little return to diversification after the 20th asset.  This is with assets that are correlated.  With legal financing, the assets are not only uncorrelated, but IRRs are in the 50+% range.  If you have a portfolio of 10 to 20 million dollars, no one is even close to a permanent loss of capital even at that size.  Cream of corp may be more valid, but this is asset management.  If I have a lawsuit, I don't care that a big name is financing me or not (as long as they aren't going insolvent), I just want the best deal I can get. 

 

To @peterHK Again nothing suggests Burford is unnaturally good at underwriting.  Everyone earns IRRs in 30% of higher.  They just perfected the financial engineering side before anyone else. 

 

my edit: @spartan to address one of your points, although Burford has a large North American presence, many other firms (which were all started in Australia and often listed in London) focus on markets with less regulatory risk and so you can always avoid that risk by picking firms.

 

Look at IMF Bentham. I feel like Burford has shown its underwriting is better.

 

My argument is not that returns won't decline, it's that the rate of decline priced in by the market today is, in my opinion, far too fast. I don't believe the argument that just because there's more competition, returns must decline immediately. As I said before, there are trillions of dollars chasing various private assets, yet some firms are continually able to eke out good returns from a combination of factors. Similarly, there are mutual fund firms who's only advantage is they interpret filings better than other people, yet that is enough to keep them compounding in the teens for many years. Increased competition is a necessary, but insufficient condition for a very rapid decline in returns.

 

It's also worth noting that as BUR takes on different types of investments, their returns will fall naturally, as they indicated at a number of investor days. For example, if you have an investment in a mediated case that settles quickly with lower IRR's, but you can increase asset turns, then your "returns" fall, but you can compound capital at comparable rates because of increased asset turns.

 

As for risk, lets say you have a random 50/50 flip of heads and tails. Heads you win 200%, tails you lose 100%. Yes, your expected value is positive, but there is still a non-zero chance that you lose absolutely everything because of the binary outcome. 2 points to this. First, a firm with a greater number of cases, more capital, and therefore more coin flips, is going to have a lower level of risk. So diversifying beyond your 20th asset DOES matter.

 

Second, in order for the expected value to make sense in the above, you have to have 101% win, 100% losses and over time with enough coin flips you can make money. Now, let's say you were very skilled in evaluating opportunities so you could tilt the odds instead of 50/50 to 60/40. Expected returns there would be 20%, up from 0.5% with 50/50 odds. Thus, even very tiny shifts in the ability to judge outcomes skews expected returns massively because of the binary and large win/loss nature of these sorts of investments. Skill here matters exponentially more than in other alternative investment classes.

 

This is why I think returns will be sustainably fairly high here. The equilibrium point at which this is no longer profitable yields massive returns with tiny adjustments in probability of success, meaning that those firms that can gain even tiny edges due to culture/data etc. will reap far higher returns than firms that can't.

[Jerry Capital]

The diversification point re 20 companies is not relevant to the outcomes in binary litigation finance.

[cameronfen]

At this valuation you can safely put the onneous of TAM size on the bear not the bull.

 

It's at least as large as the current year plus a good chunk larger than GDP given its really only operating in a few countries for the last few years... It's safe to say that it is highly likely to be significantly larger.

 

Why do some asset managers earn good returns while others don't?

 

Infinite money can flood into equities and there will always be someone that generates alpha. If that's BUR you make tremendous gains. If they just get their share of fund flows at market ROIs but the market is structurally attractive for 10 to 15 years you make tremendous gainz with little downside.

 

Not enough of the bears can paint a scenario with more than 20 to 30 downside... CG did a good job painting it down to 12 ish...

 

And CG was full of crap.

 

On returns and valuation, I think people miss the interplay.

 

Today, Burford earns ~40% ROE's, conservatively. Book value as of the last statement is 4.89GBP. It's worth noting that last year's 30% ROE was an abnormality:

 

"the FTSE 250 average) needs a word of explanation. Our ROE is of course affected not only by earnings, which increased materially, but also by the rate of growth in our net assets. Thus, because we deployed a record-breaking amount of new investment capital in 2018, we pushed down our ROE for the year".

 

If we get 40% ROE, then BV/Share at the end fo the year will be 6.85.

 

If next year returns compress to 25% ROE's (almost a 50% decline!), book value will  be 8.56.

 

If the year after that returns compress to 20% ROE's (which equates to ~15% ROIC's on their portfolio, down from 30% ROIC's today), then ending book value is 10.27.

 

Let's say BUR stops there and decides to pay out 100% of its earnings, reinvest nothing in the business, and has no asset management business generating any earnings. At 20% ROE's, and 10% WACC the justified P/B of this company is, with 0 growth (because they pay out 100% of earnings): (ROE - g)/(r - g). 20%/10% = 2x.

 

This gives us on 10.27 of book value x 2 = 20.54/share. This is with 0 value given to the fee stream from an asset management business, it assumes BUR pays out 100% of earnings in a dividend and does not grow. Were BUR to reinvest 10% of its earnings @ 20% ROE's, that gives you 2% growth, which means the justified P/B would be 2.25x (18%/8%). Even a little growth gets you to over 23GBP even if returns compress almost 50% from today over a mere 3 year period. Good for mid teens returns.

 

Now, what happens if returns DON'T compress?

 

If BUR compounds at 40% for 3 years, BV/S will be 13.41 share. What's the valuation of a business that can earn 40% ROE's, reinvest significant parts of their earnings and grow? Well, lets say you assume 30% ROE's is more normal, and they reinvest only 10% of earnings (growth is 3%): justified P/BV @ 10% WACC = 2.7x. That gives you 36 GBP price target on just book value, leaving alone any asset management business they have.

 

For the AM business, if you manage $3bn @ 1.5%/20% carry with an 8% hurdle and returns are 20%/year, you get a fee stream of $60mn in mgmt fees @ a ~50% operating margin, maybe 40% after tax (note that margins are high because BUR bears much of the costs of investing already, so there are a lot of synergies to doing your own BS investing and having a fund management business). At a 12x multiple, that's worth $288mn.

 

Your carry is another ~$70mn a year, say at another 50% margin. Capitalize that at 5x, another $180mn in value. So the AM business gives you another ~$470mn or so in value (~1.70GBP per share).

 

So if this goes poorly, you're looking at maybe 37GBP, 32% annualized.

 

For you to be a bear at today's prices, you need to prove that returns will compress immediately, and that Burford will be able to reinvest very little back into the business and that the asset management business will not do well.

 

I think you will do well in Burford.  But I think you are missing the point.  People aren't saying that ROIs aren't high, our argument is you can't look backwards in terms of ROI as they compounded capital in enviroments with less competition.  If they maintain 40% ROIs no way you can lose money.  The question is with so much money flowing in, everyone is IPOing, everyone is starting funds, and everyone is evaluating if paying an external fund to finance your litigation at 40% ROIs for them is worth it when you have the money yourself.  Just on the back of how much assets they are raising by themselves, at some point they are going to run out of things to finance. 

 

If you invest 3 billion in your fund and 3 billion of your own capital, maybe the market is 60 billion dollars and 50% of that you can't invest in because its 1 million dollar cases, then you are already 20% of your TAM.  Being such a large percentage of TAM unless you have some really compelling value add, which litigation finance sort of does even at that scale due to public company accounting advantages for example, maybe you can make money.  But most of the companies you finance aren't going to have liquidity issues.  At some point many are going to get better deals for themselves and ROI will go down (and it has again compared to companies that are much smaller). 

 

To @deserelts, I think the bigger size more diversification argument is more marketing than actual substance for the company.  In the public markets there is little return to diversification after the 20th asset.  This is with assets that are correlated.  With legal financing, the assets are not only uncorrelated, but IRRs are in the 50+% range.  If you have a portfolio of 10 to 20 million dollars, no one is even close to a permanent loss of capital even at that size.  Cream of corp may be more valid, but this is asset management.  If I have a lawsuit, I don't care that a big name is financing me or not (as long as they aren't going insolvent), I just want the best deal I can get. 

 

To @peterHK Again nothing suggests Burford is unnaturally good at underwriting.  Everyone earns IRRs in 30% of higher.  They just perfected the financial engineering side before anyone else. 

 

my edit: @spartan to address one of your points, although Burford has a large North American presence, many other firms (which were all started in Australia and often listed in London) focus on markets with less regulatory risk and so you can always avoid that risk by picking firms.

 

Look at IMF Bentham. I feel like Burford has shown its underwriting is better.

 

My argument is not that returns won't decline, it's that the rate of decline priced in by the market today is, in my opinion, far too fast. I don't believe the argument that just because there's more competition, returns must decline immediately. As I said before, there are trillions of dollars chasing various private assets, yet some firms are continually able to eke out good returns from a combination of factors. Similarly, there are mutual fund firms who's only advantage is they interpret filings better than other people, yet that is enough to keep them compounding in the teens for many years. Increased competition is a necessary, but insufficient condition for a very rapid decline in returns.

 

It's also worth noting that as BUR takes on different types of investments, their returns will fall naturally, as they indicated at a number of investor days. For example, if you have an investment in a mediated case that settles quickly with lower IRR's, but you can increase asset turns, then your "returns" fall, but you can compound capital at comparable rates because of increased asset turns.

 

As for risk, lets say you have a random 50/50 flip of heads and tails. Heads you win 200%, tails you lose 100%. Yes, your expected value is positive, but there is still a non-zero chance that you lose absolutely everything because of the binary outcome. 2 points to this. First, a firm with a greater number of cases, more capital, and therefore more coin flips, is going to have a lower level of risk. So diversifying beyond your 20th asset DOES matter.

 

Second, in order for the expected value to make sense in the above, you have to have 101% win, 100% losses and over time with enough coin flips you can make money. Now, let's say you were very skilled in evaluating opportunities so you could tilt the odds instead of 50/50 to 60/40. Expected returns there would be 20%, up from 0.5% with 50/50 odds. Thus, even very tiny shifts in the ability to judge outcomes skews expected returns massively because of the binary and large win/loss nature of these sorts of investments. Skill here matters exponentially more than in other alternative investment classes.

 

This is why I think returns will be sustainably fairly high here. The equilibrium point at which this is no longer profitable yields massive returns with tiny adjustments in probability of success, meaning that those firms that can gain even tiny edges due to culture/data etc. will reap far higher returns than firms that can't.

 

So yes.  I may invest in Burford to diversfy my portfolio in this space, but lets discuss this point.  This is a result of a misunderstanding of how financial litigation firms report IRRs.  The problem with IMF Bentham is not that they cannot generate IRRs, their IRRs are great, but when companies report IRRs they report it gross of DD costs.  So the only costs that go into IRRs is calculated only by the amount of money put in as direct investment (and money returned) and not overhead.  With IMF Bentham, historical returns are even negative because they have such a small asset base even though they generate IRRs of 75%, overhead turns these IRRs into negative earnings.  The way to make more money is to have a larger asset base. 

 

You can calculate this. LIT.L has overhead costs of 4 million pounds this year.  The eaked out maybe 2-3 million in profit (I'm not sure).  However, their equity jumped from something like 12 million to 40 million.  If you assume a return of 75% IRR on the capital, the return is 30 million pounds.  Assume overhead increase by 50% to 6 million pounds and now you have an ROE of 50-60% (net of taxes).  Again this is very conservative, as Burford has what 100 or 200 odd people at a 3 billion market cap, and LIT has 20 at a 100 million MC and so to manage more capital you don't need many more people.  The problem with IMF Bentham, is that historically they were too small.  Even though their IRRs are at the same level as Burford, because they are small, they cannot earn much money.  When a company raises money in the public markets, it can scale up so overhead is moderately spread out. 

 

To address your diversification questions you don't invest your entire portfolio in one case.  With a portfolio of 20 cases, you invest in 20 cases evenly distributed so each case gets 5% of your assets.  Just doing math.  You have a random variable which has prob 2/3 of being 3 and 1/3 being zero.  You invest 1 and the expected return is 100% (as 2/3*3 +1/3*0 = 2) for simple math.  This is 3 times a Bernoulli random variable with p=2/3.  The standard deviation of Bernoulli rv is sqrt(p*(1-p)) = \sqrt(2)/3, multiply by 3 to get \sqrt(2).  Thus your standard deviation of the mean of 20 3*Bernoulli RV is 1/\sqrt(10) = approx 1/3.  Thus it would require a 3 standard deviation event just to lose money which using the normal approximation has a .13% chance of happening.  So mathematically speaking, with a portfolio of 20 cases, has only a .13% chance of losing money, not to mention the astronomically small chance of going bankrupt.  I understand that more diversification = better.  But my point is after 20 or so cases, the benefits are astronomically small. 

 

edit: The other thing to think about especially in the case of IMF Bentham, is when you are expanding your portfolio, you tend to show losses as your overhead has to increase first in the DD phase, and then 1 or 2 years later the return rolls forward.  So all the little players who look like they are losing money and terrible businesses, are just being masked by the fact that a.) they have small overhead, and b.) they are rapidly expanding. 

[SHDL]

Regarding diversification, don’t forget about the role of leverage.  One key benefit of greater diversification in businesses like this is that it enables you to earn greater returns on equity via leverage without taking on excessive risk.

 

Thanks for the idea by the way.  This certainly merits investigation.