Burford Capital requires investors to take a lot on faith. Those willing to stick with the litigation finance specialist through a bruising four years received the best indication yet that the pain might be worth it, after a ruling in its favour.
The $16 billion dispute over an oil company nationalised by Argentina should result in a multibillion- payout for Burford, which funded litigation brought by minority shareholders of YPF SA, the country’s biggest oil producer.
Caveats are plentiful. The judge has yet to issue a formal money judgment, says Chris Bogart, the chief executive, and the amount eventually recovered may fall short of the full award. There is also the matter of appeals and the process of collecting the cash. But the risk attached to an investment that accounted for a third of its asset value has been considerably reduced.
The figures do not account for the fair value gain to be recognised from the judgment. Analysts at Numis upgraded their forecast for third-quarter pre-tax profit to $238 million from $68 million.
The former darling of London’s Aim is still battling to prove itself four years after an attack launched by Muddy Waters, the short-seller that took umbrage with the group’s accounting and reporting practices, among other things. Bearish hedge funds are no longer a feature; there are no major bets against the shares, according to disclosures to the Financial Conduct Authority.
The shares have recovered almost 90 per cent of losses sustained when Muddy Waters broke cover in 2019. Investors are still a long way from their heady optimism pre-attack. True, the shares trade at 29 per cent above the book value forecast in twelve months’ time, but that compares with a premium of almost 350 per cent at peak valuation.
Scepticism is sensible. The group invests capital in financing legal cases, booking gains when claims are settled but also when it deems there to have been a material favourable development, such as an appeal being granted. It applies a risk premium of 65 per cent to the value of the loan at the time it issues the financing, a discount rate that can be tweaked as the litigation develops.
Favourable developments outweighed the negative during the first six months of the year, which meant the value of its investments rose to $3.5 billion, from $3.06 billion at the end of December. That doesn’t include any interest due.
Burford raised the discount rate it applies to future cashflows it expects from financing cases to a weighted average of 7.8 per cent, from 7.3 per cent at the end of December. That weighed on the value of unrealised gains over the first half. And there’s always the chance those gains do not materialise. Actual cash receipts in the first half of this year were $247 million, up from $99.5 million for the same period last year. That comes not just from litigation proceeds but also managing litigation funds on behalf of third-parties.
Burford has a good record of backing winners. Its loss rate since the inception of the company is just 9 per cent, calculated as the amount laid out in financing litigation, versus the cash eventually collected.
Profits can vary greatly, returns are naturally lumpy and they relate to a small number of cases in any period. That’s exacerbated by the fact that Burford makes about five times more money from a case that goes to trial and returns a favourable outcome than when it is settled out of court — and the fact that the business is shifting towards backing larger cases.
Burford had $441 million in cash and marketable securities at the end of June, against investments of almost the same level in the first six months of the year, so it is reliant on the realisations keeping coming.
Advice: Hold
Why: The final settlement of the YPF case could result in widfall cash receipts for the company
Hunting
The waters the oil and gas industries operate in are notoriously choppy. Hunting, a supplier of kit to the companies doing the drilling, is attempting to diversify its income stream against fluctuations in activity levels.
The equipment specialist is shooting for annual revenue of $1.3 billion by 2025, ahead of a consensus forecast of $1.1 billion. Achieving that will require the group to increase revenue at a compound rate of 21 per cent a year for the next three years. Alongside that is a 15 per cent adjusted profit margin, up from the 10 per cent to 11 per cent it thinks it will see this year, and $325 million in cumulative free cashflow.
Progress in hitting those targets is unlikely to be smooth. Its Titan business, which generated about a fifth of revenue, is still heavily into conventional oil and gas exploration activity in North America. The number of rigs stood at 632, says Baker Hughes, the oilfield services provider, down almost a quarter from the same point last year and a third compared with before the pandemic.
International activity has held up better, with the annual drop-off in rig numbers in the mid single digits. That has prompted some big orders for its business supplying pipeline connection services, which made the biggest contribution to sales over the first six months of the year.
It is trying to provide more manufacturing services to industries outside the sector, such as medical and commercial firms, but that made up just 8 per cent of the group total over the first six months of the year.
Confidence is lacking. An enterprise value of 4.6 times forecast earnings before interest, taxes and other charges is at the bottom end of the long-running range.
Capital expenditure is set to remain low by historical standards, at $40 million next year. But investing in the inventory to support large orders meant last year it reported a free cash outflow of £38 million.
It is attempting to cut working capital as a proportion of sales from 42 per cent in the first half to 35 per cent by 2025, through methods that include paying more suppliers on credit rather than up front. But any dip in exploration activity could still sap revenue and unseat any progress it makes on capital efficiency.
Advice: Hold
Why: The shares are cheap on risk of another fall in rig count
