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Market's painful sentence for Burford

In less than a day, a short-seller's report has wiped more than two-thirds off the value of one of Aim's largest companies
August 7, 2019

Shares in Burford Capital (BUR) were crushed this week, after a hotly-trailed report from short-seller Muddy Waters accused the litigation financier of “egregiously misrepresenting” its financial metrics. The 25-page report, published on Wednesday morning but widely anticipated to be the subject of a tweet sent on Tuesday, crystallised months of growing scepticism and bearish sentiment towards the group, outlining numerous ways in which Muddy Waters claims Burford manipulates its return on invested capital and its internal rate of return.

IC TIP: Hold at 591.5p

The report argues that top management is “primarily compensated for aggressively marking cases in order to generate non-cash fair value gains” and “actively misleads investors” about the way its accounting for realized gains works. In turn, Muddy Waters argues Burford’s “real” invested capital – that is, less third party interests and fair value gains – is $880m. That’s half the $1.77bn carried on the balance sheet at the end of June, and below the level Muddy Waters reckons is needed to meet debt and funding requirements.

Burford’s corporate governance was also singled out for criticism, including directors’ length of tenure, heavy turnover among senior finance managers, and the 2017 appointment of Elizabeth O’Connell – the wife of founder and CEO Chris Bogart – to chief financial officer in 2017.

Before the account was even published, Burford took to the wires to acknowledge its likely need for additional external capital, but called this “a cause for celebration, not for alarm, because it means the business is growing rapidly”. It also sought to reassure investors of its liquidity and funding, stating it had “over $400m of cash and cash equivalents on hand” as of this week, up from $232.5m at the end of June. 

It later described the report as "meritless", having issued a veiled legal threat against what it referred to as a “bear raid” and market manipulation, which it blamed on its initial share price fall. When asked for evidence of misconduct, a Burford spokesperson said the information was “confidential”.

The report’s impact was nonetheless spectacular. By Wednesday afternoon, the shares had fallen to 460p, down two-thirds since the initial tweet. Still, several of Muddy Waters’ critiques will be familiar to followers of the stock. Earlier this year, analysts at Canaccord Genuity argued the group inflates its past returns on partially realised investments, prematurely books unrealised gains and faces lower future returns. The brokerage also said it expected a capital raise before the end of 2019.

Key to answering these concerns has been the opinion of Burford’s auditor EY, which has backed Burford’s valuation of its investments, while acknowledging their subjective nature and the “significant and complex” judgements involved. In its report to Burford’s board, EY says it thoroughly tested these values, and performs “external research on the status of litigation, obtained supporting documentation, considered any relevant secondary market trading and challenged management’s judgments”.