Burford Capital (BRFRF/BRFRY) – leader in litigation finance with attractive economics
This is a shorter than normal post. I’m not really doing a deep dive on the business, but I wanted to share some surface-level notes after studying the company for a few weeks. For those that want to dive deeper, I can point you to Artem Fokin’s excellent write-ups from MOI Best Ideas, and would also suggest reading Burford’s letters and reports. They are incredibly in-depth and explain each facet of the business in incredible detail.
At first glance, Burford Capital (BRFRY – dollar denominated ADRs) appears to be a high quality business with outstanding economics run by solid managers (owner/operators) with a long runway for growth at a fair price.
The company is the leading provider of litigation finance, and has two main business segments; balance sheet investing (their own capital) and a newly formed (or acquired) asset management business where they invest outside capital for fees using their legal expertise. Burford focuses primarily on financing corporate claims, steering clear of individual lawsuits and keeping the class action portion of their business to less than 3%. They’ve developed a tremendous data set and expertise over the years, and coupled with their selectivity in choosing cases to finance, Burford has been earning returns on invested capital above 60% (that’s correct, 60%) in the litigation finance portfolio over the last four years, with 24-30% IRRs each year. What’s even more impressive are the 85% operating margins (yes, 85%), and inherent operating leverage in the business, with Opex declining from 30% of revenues in 2013 to 14% today.
While its difficult to calculate the size of the industry as well as the TAM given the lack of public data, the litigation finance industry is massive and growing, giving the impression that Burford is just scratching the surface of their TAM. I’d estimate the industry size to be around $400-600 billion using the amount of litigation awards issued each year as well as global legal fees charged around the world.
What’s more is that the litigation finance industry is in its infancy, as the industry (from a large scale standpoint) was formed about a decade ago. Today, Burford is the largest litigation finance business in an industry with very low penetration, with nearly $4B in assets under management.
As a finance business/asset manager earning monstrous returns, many have pointed out that increases in capital into the space (once institutions figure out how lucrative the returns are) will drive down ROICs and become a pricing race to the bottom. Here are a few reasons why I don’t believe that will happen on a large scale, starting with the fact that capital on its own is not a commodity here.
Litigation finance is looked upon as sleazy and unpopular – profiting from lawsuits? Traditional firms with a large installed base of clients may struggle to enter – especially given conflicts of interest
Burford works with 90% of the AmLaw Top 100 – 75% of those clients who came in on a single case basis bring them repeat business – there is less risk for CIOs to use the market leader in litigation financing. Winning cases is important and costly – you’re not going to go with an upstart just because they have money to back you, even if their take rate is lower
Lawsuits propose a binary risk of loss and are illiquid and lumpy – tough space for new firms to enter
Without asset management fees to smooth earnings, can startups go years without seeing any cash flows?
Because of the high risk/high reward nature of the cases and binary risk of loss, pricing can’t come down that much – wouldn’t make sense for firms to underwrite the risk
Diligence and privilege limitations prohibit auction style pricing
How many startups can deal with the illiquidity?
So why does this opportunity exist? Businesses of this quality don’t trade at market-like multiples of earnings, nor do they hide in plain sight without some serious hair. In Burford’s case, one may be able to attribute it to the following:
Trades on the AIM
Accounting is subject to management estimates which may turn some off (track record to date and risk controls indicate no impropriety)
In line with the above, accounting earnings are a combination of realized and unrealized gains from the core litigation finance portfolio
Litigation finance as a business may turn some off – there is a misconception that one has to have an opinion regarding the outcome of a case – i.e. – know how to value the outcome
The company gives no guidance and just recently started doing conference calls
Earnings based on the outcome of legal cases tend to be lumpy therefore difficult to predict
For investors that aren’t concerned with any of the above, Burford represents a high quality long-term investment similar to a Blackstone or Brookfield, where its best to step out of the way and let management do their thing.
Lastly, in terms of a long term holding, I tried to assess the business in a few different areas. These are my ramblings, and the opposite of a high-level analysis.
Will litigation finance be around in 10 years?
It’s very likely. Given the amount of legal fees charged in the US each year and the amount of legal settlements paid out, weighed against the rising cost of legal representation (and favorable state/governments rules supporting litigation funding), companies may seek to finance all or a portion of their legal expenses at higher rates moving forward. Burford has deployed ever-increasing amounts of capital on a yearly basis into new investments, indicating massive demand for litigation finance.
Is the company building or widening their competitive advantage?
Burford’s size, scale, experience and data (based on funding many cases over the past decade) puts them far ahead of industry competition. To date, no other litigation finance firms have been achieved Burford’s scale, despite similar starting points and access to capital. Relationships matter in legal funding, and high barriers prevent competition from raising capital to compete (if you are a CFO dealing with a legal case, do you want to take funding from a startup or the market leader?). In addition, the binary nature of legal outcomes (lose a case, and the funder receives nothing) don’t allow pricing competition or discounting. Adequate compensation has to be set for taking on risk. Burford runs this business extremely well, showing discipline about which cases to fund (of 1,561 request for funding last year, Burford funded 59), and with each additional case completed, adds to their growing data set the metrics that allow them to cherry pick the best potential outcomes in future cases/investments. My guess is that it would be incredibly difficult to replicate this process within a short period of time.
How does the management team operate?
The two founders/operators (CEO and CFO) each own 5% of the business. The next 20 employees own $80mm in shares. Every single employee owns shares as well, representing around 13% of the business according to the 2017 annual report. As we all know, companies that allow all employees to become owners are pretty rare. This long term vision results in no managing of earnings, and the management team refuses to give guidance, issuing a 1H year report and a full report at the conclusion of their year. They are some of the best reports I’ve read, with extreme insight and transparency into the business. This is also rare, as the management team wants shareholders to understand the company in a candid, straightforward way.
Is the price attractive?
Although I don’t believe alternative asset managers may ever trade at premium multiples, paying mid to high teens earnings for Burford given their growth runway, management team, economics and returns on capital seems very fair. Although its a difficult business to model, the market doesn’t seem to be pricing in how this business might look years down the road given their economics. I believe Burford can continue to grow their revenues, earnings and book value at attractive rates for years.
In terms of risk factors, I read the following italicized note on Reddit. I thought it was interesting enough to share.
I have no idea what future returns will be but think they will be lower than historical because there is a lot of money pouring into this space.
For example when many institutions such as university endowments noticed that owning timber/forests has returns uncorrelated to stock markets many opted to allocate more money to this space. Because it is very difficult to create new forests, and impossible to do so (grow them) at the rate of new money poured in, all it did was raise the price of existing forests. Paying a higher price for an asset with the same dividend stream results in lower returns.
The question becomes thus, what is the ‘capacity’ for litigation finance? How much more unnecessarily litigious can ambulance chaser law firms make the US? I’m not sure – but my reasoning is that the capacity to grow the strategy will be lower than the current buzz around this strategy. I mention ‘buzz’ meaning that many institutional investors I have spoken with mentioning it, articles in Barrons, etc.
I own a small position, and am in the process of further due diligence and completing my channel checks, but have been intrigued so far to say the least. Of note, Burford just filed their 2018 results. A record year.
I’ll post any updates/new findings as they come.