It’s not often that a company beats sky high market expectations, but this was certainly the case with Burford Capital (BUR:1,038p), a global finance company focused on investing in litigation cases and one of the largest companies listed on Aim. I have followed this company for just over two years now, having first spotted the investment potential when the shares were trading at a bargain basement 146p ('Legal eagles', 8 Jun 2015), and last advised banking profits on two thirds of your holdings at just shy of 900p and running the balance for free ('Top-slicing and running profits', 26 Jun 2017).
It’s just as well I maintained an interest because Burford’s results for the six months to end June 2017 were not just the best in the company’s history, exceeding the record profits recorded for the whole of last year, but they were well ahead of the run rate embedded in analysts’ full-year expectations, thus prompting some eye-catching upgrades. For instance, analyst Trevor Griffiths at broking house N+1 Singer raised his full-year pre-tax profit estimates by more than two thirds to $240m, an outcome that should deliver EPS of 110c (84p at the current exchange rate) and clearly supports forecasts of a 14 per cent hike in the dividend per share to 10.5c, or 8p.
The headline numbers tell it all: Burford’s income soared by almost $100m to $175.5m (£133m) in the six-month period to deliver a record half-year adjusted pre-tax profit of $145m and an 80 per cent rise in EPS to 64.25c (49p); cash generation of $173.7m from investments held on its balance sheet exceeded that in every previous half-year period; and the pace of investment continues to accelerate with total new commitments of $488m made of which $289m capital has already been deployed.
To date, Burford has realised $106m of capital by selling off 25 per cent of its economic interest in the multi-billion dollar legal case which relates to the 2012 expropriation by Argentina of a majority interest in YPF, the New York Stock Exchange-listed energy company formerly owned by Repsol, the Spanish energy major. The sale of participation interests to date has raised six times Burford’s original investment of $17.5m (£13.9m), and the company still retains a 75 per cent of its original economic entitlement.
Interestingly, analysts at broking house Liberum Capital point out that “64 per cent of its balance sheet commitments in the first half of this year, and 90 per cent of its commitments from its funds, do not have binary risk attached. Rather, Burford's increasing use of more complex structures means that for the majority of investment commitments, there are either multiple paths to recovery, which reduces the risk of total loss, or the company has recourse to the underlying asset which mitigates suffering a complete loss upon failure of the claim. We view this trend as positive for managing investment risk within the portfolio.”
The investment case just gets better because the company has just announced a favourable decision in an arbitration relating to the claim by Teinver S.A. and others against Argentina in connection with the country’s expropriation of two airlines. The arbitration tribunal ruled against Argentina, requiring it to pay $324m in damages, of which Burford’s entitlement is estimated to be about $140m, subject to an ongoing and compounding interest entitlement. To put this sum into perspective, it’s 10 times higher than Burford’s original investment of $13m in the case, and over 4.5 times the $30m carrying value in the half year accounts. Bearing this in mind, Liberum’s previous full-year adjusted pre-tax profit estimate of $222m does not include any uplift in the fair value for the Teinver case, so further earnings upgrades look firmly on the cards.
In the circumstances, it’s hardly surprising that Burford’s shares surged to another record high, up 13 per cent at one stage on results day to 1,165p before some inevitable profit taking set in. However, although the share price is now seven times higher than my original entry point in June 2015 ('Legal eagles', 8 Jun 2015), rated on 12.2 times N+1 Singer’s full-year EPS forecasts and with potential for further upgrades, it could go higher still. So, I would continue to run profits on what has been a wonderful investment. Run profits.
Dialling into a Spanish cash windfall
Burford is not the only investment company I follow that has been making bumper returns from its investments. The same is true of Marwyn Value Investors (MVI:165p), a closed-end investment company listed on the Specialist Fund Market of the London Stock Exchange.
The shares have been making headway since I highlighted the valuation anomaly when the price was 135p ('Five small-cap buys', 29 March 2017), but still trade on a 30 per cent discount to net asset value of 236p a share, an anomalous rating given that its largest holding by far, Zegona Communications (ZEG:162p), a £318m market cap company, has just announced a hefty cash return to shareholders following the completion of the sale of its holding in Telecable de Asturias, the leading quad-play telecommunications operator in north-west Spain, to Spanish telecoms group Euskaltel.
The €701m (£625m) consideration paid by Euskaltel values Telecable at a reasonable 10.8 times cash profits, and is being settled with €186.5m in cash and 26.8m shares in Euskaltel to give Zegona 15 per cent ownership of the listed Spanish company. Zegona’s holding in Euskaltel is currently worth €228m based on its current share price of €8.50. Importantly, there could be upside to that entry point as analysts at JP Morgan estimate that Euskaltel trades on an equity free cash yield of 10.8 per cent, or double the European cable average, and could rise to in excess of 12 per cent assuming annual cost savings of €17m are achieved.
In the meantime, Zegona’s board plan to return £140m of the cash sale proceeds, representing a cash return of 71p, to its shareholders through a tender offer. The directors have also reconfirmed their commitment to declare 5p a share in normal dividends this year, having retained a valuable interest in Telecable through the 15 per cent shareholding in Euskaltel. Euskaltel’s current dividend is 36c a year which will deliver a dividend income of around £8.6m at current exchange rates for Zegona’s shareholders. Moreover, Euskaltel’s board has committed to raising the annual payout in double-digits.
This has very positive implications for Marywn Value Investors which has a 25.8 per cent interest in Zegona’s equity, including 21.3 per cent held indirectly through other Marwyn Funds, an investment accounting for 37 per cent of its own net asset value, according to analysts at Liberum Capital. They calculate that Marywn’s share of the tender offer will be around £29.6m to realise a 15 per cent uplift on the 141p a share average cost of the company’s investment in Zegona.
In my opinion, Marywn’s shares should not be trading 30 per cent below net asset value when the company is set to receive a bumper cash windfall equating to 25 per cent of its own market value, and will still retain a valuable stake in Zegona and one underpinned by that company’s investment in Euskaltel. There is also decent investment upside on Marywn’s holding in BCA Marketplace (BCA:197p), Europe's largest car auction operator, shares of which my colleague Mark Robinson rated a buy at the time of the last results.
I would also flag up that Marwyn’s distribution policy is to deliver a minimum of 8.255p per share each year, a sum equating to 5 per cent of its current share price, with potential for further distributions if 50 per cent of net realised capital gains have not already been returned through ongoing quarterly dividends.
So, having highlighted the current valuation anomaly when Marwyn’s share price was 135p ('Five small-cap buys', 29 March 2017), and reiterated that advice at 162p ('Five small-cap opportunities', 23 May 2017), I believe my fair value price range of between 180p to 200p is a realistic target. Buy.
BP Marsh’s hidden value
Shares in cash-rich insurance sector investment company BP Marsh & Partners (BPM:230p) are making good headway towards my upgraded target price of 250p ('On the money', 7 Jun 2017). It's a business I know incredibly well, having initiated coverage at 88p ('Hyper value small-cap buy', 22 Jan 2012).
The company’s investment team has wasted no time in setting about investing the £22m it raised by selling its stake in Besso Insurance, a top 20 independent Lloyd's broking group, a deal I commented on at the time ('Four undervalued growth plays', 24 Apr 2017). For instance, it has just acquired a further 17.84 per cent shareholding in LEBC, an independent financial advisory firm that has been making hay in the post Retail Distribution Review (RDR) environment. Boosted by investment in technology, success in targeting the ‘at-retirement market’ and following the introduction of the RDR at the end of 2012, LEBC’s revenues have surged by over a third to £15.4m in the three years to end September 2016 and its trading profits have almost trebled to £2.1m.
BP Marsh paid £7.138m for the 17.84 per cent stake to value LEBC’s entire equity at £40m, buying out retiring employee shareholders, members of management through share ownership plans, and a part sell-down by founder and chief executive, Jack McVitie. This takes BP Marsh’s holding in LEBC to 60.87 per cent, while the balance of the equity continues to be held by founder and chief executive, Jack McVitie and LEBC’s management.
It’s an interesting deal because when I covered BP Marsh’s full-year results a couple of months ago ('On the money', 7 Jun 2017), I noted that BP Marsh’s 43 per cent stake in LEBC “looks undervalued at £13m, even after being revalued upwards by 11 per cent since July 2016. The valuation implies a value for LEBC’s equity of only £30.2m, or 15 times trading profit.” To put that valuation into some perspective, the equity of Mattioli Woods (MTW:819p) is rated on 20 times cash profits for the year just ended. Mr Marsh also revealed during our results call that “every now and again we are passed an enquiry to buy LEBC” and the current valuation “is a long way below these approaches.”
The point being that the implied equity value of £40m for LEBC following BP Marsh’s latest investment equates to a 33 per cent upgrade on the carrying value of its previous 43 per cent investment, suggesting a £4.2m uplift, worth 14p a share, to the company’s last reported net asset value of £79.7m. In other words, pro-forma net asset value is now closer to 290p a share. Furthermore, there is scope for further upside given LEBC is still being valued on a lower rating than Mattioli Woods.
There are very real prospects for further valuation gains elsewhere in BP Marsh’s portfolio too, and in particular, on its 18.6 per cent holding in Nexus Underwriting, an independent speciality Managing General Agency. This investment was last valued in BP Marsh’s accounts at £13.9m, placing a value of £74m on Nexus’ equity, the equivalent of 15 times last year’s cash profits, falling to only 10 times previous guidance based on Nexus’ cash profits rising to £7.3m. However, earlier this year Hyperion Insurance sold its majority stake in CFC Underwriting to a consortium of private investors and the management team on a multiple of 22 times cash profits, suggesting a conservative valuation approach being adopted by BP March’s investment committee.
Moreover, Nexus has just announced the acquisition of Zon Re Accident Reinsurance, a U.S. based Reinsurance Underwriting Agency. In 2016, Zon Re produced a gross written premium of $14.3m, revenue of $3.77m and cash profits of $2.69m (£2m). This acquisition has been funded by tapping a previously announced £30m loan facility, and follows two other acquisitions: marine cargo specialist Vectura Underwriting, and trade credit specialist Equinox Global. Factoring in these three acquisitions and strong organic growth in the business, the latest upgraded financial guidance from Nexus’ board points towards this year’s gross written premium rising to £160m to generate commission income of £30m and cash profits in excess of £11m, suggesting cash profits will double year on year.
In other words, the carrying value of BP Marsh’s holding which values Nexus’ equity at only £74.7m is looking very conservative indeed, so expect valuation upgrades on here too. I would also flag up that BP Marsh still some way to go to invest the rest of the £29m cash pile on its balance sheet, and expect further news on the investment front in coming months.
In the circumstances, I am upgrading my target price from 250p to a range between 260p to 275p to reflect the likely portfolio valuation uplifts I have outlined above. Buy.