Litigation finance: can growth continue?

It's little wonder that UK investors have warmed to the shares – and Burford’s peers have taken note. December saw the admission of two litigation finance specialists to the Alternative Investment Market (Aim), with Manolete Partners (MANO) and Litigation Capital Management (LIT) raising £15m and £20m, respectively. Those providers have pegged themselves as 'counter-cyclical', meaning they would benefit from a market or economic downturn.

Like Burford, Litigation Capital Management funds legal claims by individuals and companies, recovering the amount invested plus a share of the financial rewards in the case of a positive outcome. But its history stretches back further. After being founded in Australia in 1998 to finance insolvency claims, chief executive Patrick Moloney hopes to use the group’s experience underwriting claims in the Southern hemisphere to expand into the rapidly growing UK and US markets.   

"[Litigation finance] has gone very quickly from being a dark art that lawyers didn’t talk about to being one of the tools of arbitration," says Nick Rowles-Davies, executive director of Litigation Capital Management’s recently formed UK business and former Burford managing director outside the Americas.

However, Manolete – which deals only with insolvency cases – buys cases from insolvency practitioners, becoming the claimant. That helps the group avoid going to court, says chief executive Steven Cooklin. "If you’re funding someone else, the decision to settle is that party’s decision," he says. HMRC accounts for a large chunk of cases the group takes on. "The ability of these organisations to run those complex cases is very stretched," Mr Cooklin says.

Indeed, litigation financiers argue there is a greater chance of avoiding court, with the opposition encouraged to settle by the presence of patient capital backing a claim. Both Manolete and Litigation Capital Management are committing capital to new cases at an impressive rate, with investments by the former up by three-quarters during the first half of the financial year and the amount of capital deployed at Litigation Capital Management more than doubling last year.

"The interesting thing is, because they’re smaller, some of these companies are below the radars of a lot of other institutions," said one major shareholder in Manolete and Litigation Capital Management. "The growth opportunities are so much greater when you’re small."

Valuation conundrum

However, converting those capital commitments into cash is far from assured. Guernsey-based litigation finance specialist Juridica halted new investments in 2015, after suffering a $34.2m loss from one US Supreme Court case. The group was then wound up and de-listed its shares from Aim in December 2018. Meanwhile, Vannin Capital, which suspended its IPO plans in October last year citing equity market volatility, had been forced to delay sending its prospectus to investors after losing a $6.6m investor-state arbitration case after the claimant it was backing lost.   

Cash returns for all three of the UK-listed players look robust, but assessing potential returns that could be unlocked from ongoing cases is more difficult. Both Burford and Manolete calculate unrealised gains using fair value accounting methods, which encouragingly accounted for a lower proportion of the income both groups recognised in their most recent reporting periods.

How the litigation finance companies compare (cash receipt)

That means Burford – which generated 62 per cent of income via investment realisations during the first half – only alters the fair value of ongoing cases in the event of a secondary market transaction, whereas it sells part of an interest in a matter to third parties, or if there is a significant development in the legal process of a case. "Because we are looking for those kind of objective events, these tend to happen later rather than earlier in the life cycle of litigation," Mr Bogart said.

The danger of incurring losses means Burford is highly selective in the cases it finances. In 2017, the group reviewed more than 1,500 cases, but chose to invest in just 56. "We are essentially a buy-and-hold investor – there is not an easy way to exit an investment once we've made it," he said.

Meanwhile, Manolete points to the short duration of its investments – most are concluded over an average term of 11 months – which means the group is never carrying too much 'tail risk'. That compares with an average duration of around two years for its two listed peers, which typically commit a higher level of capital to cases. Litigation Capital Management goes one step further, only accounting for the initial cost of the investment, which means it would only have to write down those costs if the claim it backs loses.

Given the high level of demand and potential returns on offer, the arrival of more litigation finance providers onto public markets – which throws up potential for further fundraising – is unsurprising. Yet, high-growth Burford only tapped investors for further capital in October this year, raising nearly £200m via an oversubscribed share placing. That cash was raised to finance geographical expansion, including into Australia and Germany. Up until 2016, the group had financed new investments using cash receipts from existing business. However, Mr Bogart said: "We were seeing a level of growth that wasn’t serviceable just by private balance sheet," said Mr Bogart. In April that year the group raised $144m via a retail bond.   

Burford has been "quite thoughtful and innovative" in using diverse and alternative sources of financing, particularly in issuing a retail bond, said one top 15 shareholder. "What bank would lend and what price would they charge for a new industry?", they asked.  

That was followed by an additional $1.6bn-worth of funding secured in December, which included $667m from an unnamed sovereign wealth fund. Under the agreement, a $1bn pool of capital will be invested on a 2:1 basis, with Burford providing the remaining $333m in exchange for 60 per cent of profits generated once the initial investment has been recovered.