Author Topic: BUR.L - Burford Capital  (Read 40390 times)

Jerry Capital

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Re: BUR.L - Burford Capital
« Reply #10 on: July 05, 2019, 08:50:25 AM »
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...


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peterHK

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Re: BUR.L - Burford Capital
« Reply #11 on: July 05, 2019, 09:26:42 AM »
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

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Re: BUR.L - Burford Capital
« Reply #12 on: July 05, 2019, 09:30:12 AM »
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

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Re: BUR.L - Burford Capital
« Reply #13 on: July 05, 2019, 09:35:23 AM »
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?

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Jerry Capital

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Re: BUR.L - Burford Capital
« Reply #14 on: July 05, 2019, 09:46:11 AM »
Downside 30% upside 10 year compounder, hit the bid
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Jerry Capital

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Re: BUR.L - Burford Capital
« Reply #15 on: July 05, 2019, 09:47:29 AM »
Don't focus on the upside focus on the downside
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peterHK

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Re: BUR.L - Burford Capital
« Reply #16 on: July 05, 2019, 09:49:43 AM »
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

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Re: BUR.L - Burford Capital
« Reply #17 on: July 05, 2019, 09:50:52 AM »
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

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Re: BUR.L - Burford Capital
« Reply #18 on: July 05, 2019, 09:51:19 AM »
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

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Re: BUR.L - Burford Capital
« Reply #19 on: July 05, 2019, 10:14:04 AM »
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. 
« Last Edit: July 05, 2019, 10:19:22 AM by cameronfen »