Based in New York and London, the company's team of investment advisers and legal eagles have been doing rather well since the company was formed in 2009, growing operating profit fourfold to $60.7m in the past four financial years and delivering decent cash returns to shareholders. In fact, the progressive dividend was raised by a third last year to around 4.5p a share, covered more than three times over by EPS of about 14.5p. On this basis, the shares offer a dividend yield of 3 per cent and are rated on 10 times historic earnings.
Expect another robust financial performance this year, too. That's because the company has just announced the successful resolution of one of its US litigation finance portfolio investments, which has generated gross cash proceeds of $61m (£39.6m) and a profit of $36m on a $25m investment funded over a period of time starting in 2012. This represents a 144 per cent return on invested capital and a hefty 60 per cent internal rate of return.
Burford had previously recognised $10.1m in unrealised gains from this investment, so it will book $25.9m in additional income in the six months to end-June 2015. That's a chunky sum considering that the company had income of $82m in 2014, of which litigation case settlements accounted for $48m. What this also means is that the company's book value of $382m (£250m) at the end of 2014 is set for a decent hike. Analyst Rob Jones at brokerage Liberum Capital calculates that the disposal adds 8.3p a share to net assets, lifting the December 2014 book value of 122.5p to almost 131p. The disposal is also a good example of what the litigation finance sector offers both in terms of high returns on successful cases, and low correlation to the general equity market.
Impressive track record
This was not a one-off legal case, either. Since 2009, the company has committed $500m to litigation cases, of which it has now recovered $270m from investments of $156m. That represents a return on investment capital north of 70 per cent. Of course, there is no guarantee that future cases will be as lucrative, but it's clear to me that Burford has a decent track record and one worth following for the $242m-worth of litigation-related investments it has outstanding. The company is also due settlement on a further $57m of litigation investments that have successfully concluded and where there is no longer any litigation risk remaining. The settlement terms and duration vary case by case.
It's worth noting, too, that Burford had cash of $189m on its balance sheet at the end of 2014, so when this is combined with the $61m cash windfall announced last week, and the settlement of the $57m-worth of concluded litigation investments, then I reckon the company will shortly have cash available for future investments of $307m. The only debt the company has is a £90m retail bond issue which listed on the London Stock Exchange last August and which matures in August 2022. The bond was priced on a 6.5 per cent yield at launch and is currently trading on a 4 per cent premium to par.
It made sound commercial sense to tap the capital markets in this way as Burford generated a return on equity of 17 per cent in the last fiscal year, and with its litigation cases generating such a high return on capital employed, and operating expenses about a quarter of operating income of $82m, then there is a decent return to be made for shareholders by recycling the cash raised from the bond issue into new litigation-related cases. And with around $300m-plus to invest the company is well funded to do so.
That's important because the key for value creation for shareholders is not only the potential profits to be earned from ongoing litigation cases, but the potential for new business taken on. In effect, what we are seeing now is the result of decisions the company made several years ago due to the medium duration nature of Burford's business. This doesn't give much insight into what is actually happening in the business today - and the short answer is that the market for litigation finance is exploding.
From alternative to mainstream
When Burford was launched in 2009 and began institutionalising the provision of litigation finance, the concept was largely unknown in the legal profession and the company spent much of its time educating and developing the market. Today, the situation is far different.
For instance, The Lawyer, a leading legal publication, recently published a special report on litigation funding in which it concluded that litigation finance has moved “from alternative to mainstream”, and it continues to grow in popularity, as the market diversifies. Traditional blue-chips along with smaller businesses are now pursuing litigation funding, and lawyers from leading litigation firms are witnessing growing demand for financing from their clients.
In other words, The Lawyer's investigation highlighted that litigation funding has rapidly become a normal course, and widely considered alternative form of corporate finance for businesses addressing litigation expense. It makes financial sense for large companies to use this type of funding as a way of managing the costs of high-value claims that expose the business to substantial legal costs. These are reputation-conscious clients who have previously seen funding as a bit of an unknown, but as the market becomes more established they are starting to consider it a realistic proposition. The explosive growth in this niche market helps explain why Burford made $150m of new commitments to new litigation-related cases in 2014, or more than three times the amount in 2013. Importantly, with the benefit of a cash-rich balance sheet, the company is ideally placed to continue to benefit from the growing demand for its services.
A conservative balance sheet
Factoring in the cash windfall last week, Burford’s market value of £300m is around 11 per cent higher than its spot net asset value of £269m. But it’s worth pointing out that the company continues to adopt a conservative approach to investment valuation. For instance, in the 2014 accounts only 11 per cent of assets consisted of unrealised gains, the same percentage as in 2013. This is an important economic point that is often lost amid IFRS accounting complexity.
One school of thought suggests that litigation investments should be marked up (and thus unrealised income created) as time passes and the investment goes through the litigation process, so that by the end of the investment all of its potential gain will have already been recognised. But Burford’s board does not endorse that approach and instead increase (or decrease) investment values solely based on objective events in the progress of the litigation, and then only moderately.
As a result, when the company experiences investment successes, as was the case last week, typically there is a large incremental income to book. This conservative approach does not maximise current income, but defers the income to the future. So, if you have confidence in the quality of Burford’s investment portfolio, as I clearly do, then it’s only reasonable to expect portfolio growth to underpin a ramp-up in the company’s income as investments continue to mature. In turn, cash receipts from settlement of litigation cases will rise, delivering a significant boost to book value per share over time and offering scope for the board to maintain their progressive dividend policy.
Decent share price upside
And that’s why I see potential for Burford’s shares to outperform over the next 12 to 18 months as the portfolio of older legal cases reaches a conclusion in the courts. I am not alone, as analyst Peter Lenardos at brokerage RBC Capital points out that this month’s cash windfall accounts for more than two-thirds of his current-year pre-tax profit estimate, adding that the “strong momentum in the business and a valuation that is the cheapest of any company in our coverage universe, continue to support our positive investment thesis”.
Mr Lenardos notes that Burford’s shares trade on only 7.7 times his EPS estimates of around 18p for fiscal 2016 or half the rating of the diversified financial sector average, and also offer a prospective dividend yield of 3.4 per cent for fiscal 2015. That represents value to me, especially as the company is set to release an upbeat pre-close trading update next month ahead of interim results in late summer.
Mr Lenardos has a target price of 191p, a valuation I see as reasonable. That’s because if the company delivers total post-tax earnings of around 33p a share over the next couple of financial years, and pays out around 9.5p a share in dividends, then book value per share would still rise to around 154p by the end of 2016. This would not only support a decent rise in the share price over the next 12 months, but with the company enhancing its track record then investors are more likely to pay a higher premium to book value to gain a slice of the action.
For good measure, Burford’s share price is tantalisingly close to signalling a major chart breakout. Having stalled at the 148p level in March 2012, and at exactly the same level in September 2013, the share price is pressurising this key resistance level once again. And with the company set to report at least a doubling of first-half pre-tax profits in next month’s pre-close trading update, there will shortly be a very favourable tailwind to push the share price through the 148p glass ceiling into blue-sky territory. Priced on a bid-offer spread of 145p-146p, I rate Burford’s shares a value buy and have a 12-month target price of 190p.
MORE FROM SIMON THOMPSON...
At the end of April, I published an article with all the share recommendations I have made this year. Since then I have published articles on the following companies:
■ Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)
■ Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'