After crashing to a three-year low of 380p earlier this week, the Burford Capital (LSE: BUR) share price is motoring higher. As I write this on Friday morning, the stock is up 8% at 820p.
The shares are still more than 50% below last year’s record high of 2,075p, but the company’s response to last week’s shorting attack seems to have reassured many investors.
In today’s article, I want to give my view on last week’s events and explain what I’d do with BUR stock now.
Aggressive accounting?
I’ve now had a chance to go through the Muddy Waters shorting report on Burford and the company’s own rebuttal document.
There isn’t time or space here to go through every item in detail. But overall, I think both sides make some good points, while also having areas of weakness.
Broadly speaking, I agree with Muddy Waters’ view that Burford is quite aggressive in the way it reports profits from valuation gains on cases that are still in progress.
I’d prefer a more conservative approach, where legal cases were valued based on the money invested until a final settlement was reached. But without commenting on individual cases highlighted by Muddy Waters, I think it’s fair to say that Burford’s accounting treatment is within the scope of accounting rules for financial assets.
“Arguably insolvent”
The Muddy Waters report suggests that Burford is “arguably insolvent” and “frequently raises capital”. In my opinion, this is a weak and contrived argument.
I agree that Burford has debt and raises funds from outside investors for new litigation investments. But in my view, this is consistent with its business model and historic growth rate. I wouldn’t describe Burford as insolvent.
I’d also say that my reading of the firm’s accounts suggests that it does generate plenty of cash from its litigation investments.
For example, in 2018, the company reported cash proceeds from investments of £629m. However, all of this cash and more was swallowed up by new investments of £738m. As far as I can see, the company’s rapid growth is the main reason why it doesn’t generate any free cash flow.
I’m worried about these things
I don’t want to sound too positive about Burford, as there are a lot of things that worry me about this business.
The Muddy Waters report suggests that 66% of Burford’s net realised gains since 2012 have come from just four cases. If that’s correct, then it suggests that most of the firm’s other cases are far less profitable.
In some ways, I’d expect this. Not every case can be a blockbuster and as more money flows into litigation financing, economic theory suggests average returns will fall. But I think there’s a real risk that profit margins could be lower in the future.
I am also uncomfortable with the increasingly complex financial structure of Burford’s investments. In my view, some of these arrangements may be designed to magnify the value of wins, while risking larger losses.
As a rule, I think complexity is a bad idea in investments. My experience suggests that it increases the risk of misunderstandings, errors and surprise meltdowns.
Buy, sell or hold? For me, Burford is too complex and too much of a black box. I’m not prepared to put blind trust in management. I’m going to continue avoiding the shares.