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Woodford and Barnett's big legal high
Burford Capital, the litigation finance provider backed by fund managers Neil Woodford and Mark Barnett, has smashed forecasts with its full-year results.
Shares in the AIM-listed company soared 60% last year and jumped another 6% yesterday after Burford posted a 26% increase in income to $103 million (£73 million) for 2015, with pre-tax profits 19% higher at $67.8 million.
The annual dividend was raised 14% to 8 cents a share with a current yield of 1.3%, according to Numis Securities.
The profits surge was 28% higher than analysts at RBC Capital Markets had expected. They hiked their share price target by 22% to 280p and retained an ‘outperform’ rating on the stock.
Analysts at Liberum liked what they saw too, describing the company as an ‘emerging leader’ in litigation finance. ‘2015 has seen a significant outsize gain, significantly higher cash generation, record investment commitments and improvements in the return on investment as the investment portfolio matures,’ they said.
Today the shares gained another 5% to 255p, valuing the company at £541 million.
Burford provides what it calls ‘non-recourse’, or secured, capital to big legal firms and global businesses who don’t want to tie up their balance sheets with expensive litigation claims. It receives a combination of interest payments and a share of pay-outs when legal cases are settled or are the subject of awards.
It’s a high margin business with Burford’s litigation income leaping 82% to $86.9 million last year and the company claiming a 28% internal rate of return on its legal investments.
Burford’s annual report describes the industry as a ‘slumbering giant’ as legal partners and corporate executives around the world realise the potential for using innovative financing to defray their legal liabilities.
Chief executive Christopher Bogart, a former general counsel at media group Time Warner, said litigation was an asset with its own legal status as a ‘chose in action’ or right to sue.
‘A litigation claim is no different from any other receivable,’ he said, referring to the debts owed to companies that are recorded in their accounts.
As an asset that generated cash flows, litigation claims could be securitised or converted into bonds, Bogart added, opening up a world of financial possibilities.
Big BT deal
In January the company was reported to have struck a landmark $45 million deal with BT (BT) to finance a wave of legal action facing the telecoms giant.
Bogart (pictured above) said such companies needed a third party to provide legal finance as funding their own litigation was always a ‘value destroying exercise’.
He said this was because corporate accountants would not record legal expenses as a long-term asset, nor register the windfall from a successful case as a gain. ‘You persistently reduce your Ebitda [earnings before interest, tax, depreciation and amortisation] and you’re never going to recoup your costs if you win,’ he added.
Burford also revealed it had provided $100 million in financing to a global law firm for a portfolio of different cases.
Bogart said litigation financing was moving away from backing individual actions towards supporting a pool of law suits. This was easier for groups to administer and offered investors greater protection.
‘You’re unlikely to have five aberrant witnesses letting you down in five separate cases,’ he said.
Bankrolling legal disputes is a binary bet, however, which means that while pay-offs can be big, the risk of losses is equally large, as Burford’s rival Juridica Investments (JIL ) discovered to its cost last year. Its shares have lost over half their value after a case it was backing was defeated in the US Supreme Court.
Bogart said Juridica had been more exposed to single cases than Burford. He denied Burford’s buoyant share price had been the result of investors switching from Juridica, saying it ‘had never been a meaningful competitor’.
Expensive or cheap?
Burford’s valuation is the subject of debate among analysts. The stock sometimes crops up in Citywire’s weekly 'Investment Trust Watch' column because of the apparently high premium on its shares. According to Numis, the shares closed yesterday at a staggering 93% premium to net asset value.
Bogart said it was wrong to value Burford on its NAV or book value. ‘This is an earnings-based business,’ he said, pointing out that investors who focused on its share price to earnings ratio generally considered it to be cheap.
RBC analysts, for example, estimate Burford’s share price (P) trades on eight times forecast earnings (E) for next year, compared to the average P/E multiple of 13 among other diversified financial stocks.
Liberum questioned this approach though, in light of the results showing one case had generated a quarter of the company’s income last year. ‘We believe this argument [in favour of earnings-based valuation] is weakened somewhat by the difficulty of accurately forecasting litigation returns and the fact that profits have often come from lumpy realisations from the litigation finance portfolio.’
However, it conceded that this would become less of a problem as the proportion of pooled legal business grew.
Bonds and shares
Either way leading fund managers like Burford for the way it can offer returns that are not linked to conventional assets. It's perhaps no coincidence that last year’s gains came at a difficult time for the wider stock market. Invesco Perpetual is the largest shareholder with a stake of just under 30%, followed by Fidelity at 9.5% and Woodford Investment Management at just over 7%, according to Thomson Reuters data.
The shares are not the only consideration for potential investors either. Two years ago Burford launched a retail bond paying a coupon of 6.5% for eight years. It is considering offering a new bond as it looks to raise more money to invest in the next phase of legal battles.
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