[BUR/LN – Burford Capital] Part 2: Investment returns and valuation

For those of you who are intimately familiar with Burford (there seem to be a lot of you!), bear with me for a few paragraphs as I run through some preliminary concepts for newcomers.   

Here is how Burford represents the returns it has generated on its portfolio:

ROIC is simply the profits realized on concluded investments divided into the capital deployed into those investments.  If Burford deploys $10mn into a case and recovers $20mn on it in one lump sum a decade later, ROIC is reported as 100%.  The portfolio’s IRR is computed by pooling all 92 of Burford’s concluded litigation finance deals and measuring the cash inflows vs. outflows.  This is a more conservative approach than the averaging method taken by the industry, which can really skew the number higher given the dramatic gains realized by successful investments. 

There is often an inverse relationship between an investment’s ROIC and its IRR.  Settlements, which account for 2/3 of Burford’s cases, result in lower payouts than successful adjudications but resolve much faster, resulting in lower ROICs but higher IRRs.  Adjudicated cases, on the other hand, can take a very long time to conclude but result in massive payouts when they do. 

That’s why we shouldn’t be so quick to conclude, as some skeptics apparently have, that Burford’s reported IRRs and book value are being artificially inflated by ongoing cases from older vintage years that management should have written off.  Just look at the Teinver’s case¹, in which Burford’s $13mn investment was sold for $107mn (a 700%+ ROIC), 8 years after its 2010 investment.  Of course, it’s unlikely that Burford’s ongoing cases will generate anywhere near those returns…but even if you were to zero out all investments from all ongoing cases prior to 2016, management claims that its investment portfolio would still report a 41% ROIC and a 15% IRR.  

We shouldn’t get too caught up in the IRR or ROIC of any single investment since downside exposure and duration also matter a greater deal to generating value.  Principal investing generates lower ROICs than litigation investing but, as previously discussed, also carries lower downside risk and much shorter duration.  The latter is especially important because it means the company can more rapidly recycle recoveries into new investments, producing more dollar profits over the same length of time².

Downside risk is harder to appreciate because it isn’t explicitly captured in reported returns.  We might readily see one financier with 50% IRRs and another with 20% IRRs, but it might take a little more digging to realize that former’s returns come from a small sample of binary bets; the latter’s from a diversified portfolio of investments, each one supported by tangible asset value.  Of course, the problem with short duration investments is that there may not be anywhere to reinvest the recoveries.  Given the robust demand and market size, this risk is not foremost on my mind.  The more central point is that Burford has many ways to optimize along the risk/return continuum.

The amalgamation of diverse investment payoffs, durations, downside risks, and categories in Burford’s portfolio makes it hard to really place one’s finger on what kind of returns we should expect.  That peers report such radically different ROICs and IRRs – LCM reports a cumulative IRR of 83% from 2011 to 2018 and computes IRRs the same way as Burford (on a much smaller sample size) – only confounds the issue.  We might benchmark off Burford’s reported returns, but can those be trusted at face value?

Perhaps not, according to Canaccord Genuity.  In a research report published in April 2019, CG believes that the 85% ROIC reported by the company is “confusing and significantly above reality”.

Let me try to break this down.