Sponsored Deep Dive #8: Burford $BUR (part #2: returns over time and YPF collectability)
This is part #2 of my deep dive into Burford. You can see part #1 (which included an overview and discussed Burford’s culture and credibility) here.
Today’s post will discuss two key questions:
How does the business evolve over time / what do returns look like going forward
Before I get too far ahead of myself, I should note that Tegus has made the three calls I did that formed the basis of this post free to check out for the next year:
Former Senior Executive at Burford Capital (this focused on how much they could recover from their Argentina judgement)
Former Executive at Burford Capital (this focused on Burford’s underwriting and funding of new cases)
Former Employee at Burford Capital (this focused on why a lawyer would chose to join Burford and how the industry will evolve over time)
That out the way, let’s dive into our questions:
Section #2: How does the business evolve over time / what do returns look like going forward?
Burford’s historical returns have been incredible. They’ve realized ~29% IRR on the ~$1.2B they’ve deployed since inception (this return excludes overhead, but as noted on BUR’s Q1’23 earnings call they’ve generally done >20% ROE).
Impressively, this number does not include the insane windfall they’ve gotten from the YPF case, where they deployed just $17m and now seem set to realize over $1B in value on top of the ~$236m they’ve already monetized for.
In large part, these historical returns were driven because of a lack of competition. As one expert put it:
going back to the early days, litigation finance as an industry was filling a niche that was not being satisfied by traditional banks that didn't have a way of diligencing legal outcome risk….. How are these returns possible? Because funders, at least back in the day before there was so much competition, they were able to address a need that others weren't addressing. And when you only had a few funders in the market, they were able to command high prices. I think there's more price pressure now with so many competitors.
That statement is the history of “alpha driven” finance in a nut shell: there’s some niche that offers incredible returns because most market players can’t or won’t tough it. This niche could be “junk bonds” in the 80s or credit card lending in the 90s. Some smart investors come along and realize that the area is presenting massive returns versus the risk taken (for junk bonds, that was Michael Milken and Drexel Burnham; for credit cards, that was Capital One) and generates insane returns by focusing exclusively on that segment…. but, over time, the returns to that strategy dissipate as copy cat investors flood the market or the market simply can’t absorb any more capital.
So there’s no doubting the historical returns for Burford are insanely impressive, but the question for investors today is if Burford will be able to realize anything approaching those historical returns going forward or if the combination of Burford’s increased size and competitive money coming into the market will drive returns down.
Let’s start by talking about the bull case that says returns will stay high over time. I think the bull case would point to three things:
The market is huge: Burford would argue that we’re just starting to scratch the surface of all the cases litigation finance can fund, so their size is no where close to as big as it can get before returns will start to come down. The basic argument is that there have been a lot of cases that have historically not been pursued because the aggrieved party was too small (think a little 2 person company that gets wronged by a giant tech company but doesn’t have the money to take the tech company to court) or because the aggrieved party wasn’t interested (most large companies view their legal team as a cost center, and it might not be in anyone’s interest for the legal team to invest $10m in expenses for multiple years to pursue a case, even if the case is NPV positive). Litigation funding can solve these problems, and it’s just starting to open up some of these cases.
On the earlier example (a case where the aggrieved part traditionally wouldn’t have had the money to pursue a case), I think Burford would point out that the YPF case they are on the verge of realizing billions of dollars of proceeds for came out of bankruptcy and was considered a long shot. Without litigation financing, this case would likely never have been brought!
On the later example (large companies generally don’t want to fund a legal department as a profit center), BUR’s CEO likes to give this example: “Why are companies taking our capital instead of simply writing checks to their own law firms? There's really 2 reasons for that. One of them is the P&L side of the company's business. I used to be, for example, the Global General Counsel of Time Warner, the media group. I never could get enough budget out of the CFO. It wasn't that Time Warner didn't have the money. It's that Time Warner wanted to spend the money on its movies and television shows instead of on my litigation cases. And the reason for that was perfectly sensible on the part of the CFO. If I spent money on litigation, that money would flow through the corporate P&L, it would hit the operating expense line, it would reduce earnings and because Time Warner trades on a multiple of earnings, it would have an untoward impact on overall valuation. Especially since investors don't value litigation outcomes very much.”
Seller sensitivity creates advantaged processes: the more bidders there are in an auction, the more efficient it will be. The argument here is that the sensitive nature of legal claims limits each process to only a handful of bidders (at most), and that allows for some “alpha” for the bidders. The example I like to use is this: say you’re selling a local business for $5m. You can basically hold a “bake off” where you invite every credible bidder to come look at your business and lob in a bid; anyone who can write a $5m check can diligence you, and you can sell to the highest bidder. In contrast, say you’ve got a legal claim that you want to sell. You can’t just open that up to the highest bidder; a lot of the information in a legal case is privileged or sensitive, and if it leaks out you could destroy your case or risk jail time. To limit leaks, you’ll probably only shop that case to two or three people, and you’re going to make sure that those two or three people are very trustworthy. Burford’s position as the largest litigation financer ensures they’ll be one of those handful of people that gets a call, and being involved in processes with only a handful of buyers tends to create good economics.
Burford’s proprietary database gives them an advantage: Burford has funded hundreds of cases over the years, and they’ve likely seen thousands more. The data and record from these cases are not like public company M&A where the high level financials are available for everyone to see; almost everything about these cases are private. Burford’s database gives them access to historical case profiles, returns, and results that no one else has, which makes them a better and smarter bidder on future cases. This creates a compounding knowledge effect, and one that frankly would be extremely difficult for Burford to lose (if a Burford lawyer leaves Burford to start up a new shop, they’d lose all of that historical data base, and Burford’s data base will only grow over time, so every year their lead and moat gets a little wider).
To be frank, I’m of mixed mind of these claims. I do think Burford has a knowledge advantage, I do think there’s likely to be some inefficiency in the bidding process given a limited pool of buyers, and I do think litigation funding is likely just beginning to open up a whole host of cases that would previously not have been pursued that can be profitable.
But, that said, I’m very skeptical that returns won’t come done over time. 30% IRRs / 20%+ returns on equity are just too lucrative to exist for decades as money pours into a space.
The experts seemed to agree with me here. They noted returns in the funder space are coming down
the market is a lot more crowded and a lot more competitive, and there has been compression on pricing and the sort of pricing that Burford could do in the earlier days will not fly now because there are so many other people looking to invest.
And so yes I think that, that is bound to affect future returns versus past returns because a lot of the funders are looking for the same sorts of cases, very large competition cases, follow-on damages cases, sort of multiparty litigation class actions or all of that stuff where you have extremely large potential damages and large amounts of funding. But these days, looking for a $5 million or even $10 million ticket is not just the preserve of Burford.
And that’s in large part driven by a lot more competition for cases
the industry has become more saturated with funders, there's more people that saw the returns on places like Burford in past years and decided they wanted a piece of that, too.
So I think over time, that competition does drive down the return they can command if a potential counterparty says, "Well, this other funder will give me X." And I think it means there are more funders out there chasing the same deals. So it's more likely that counterparties will have other options and Burford won't even see deals because other funders will have gotten to them first.
And that as the competition increases, exclusive processes are getting rarer.
Historically, there were more exclusive things. And more recently, there's more of a shopping process… in my experience, a counterparty wouldn't shop it around more than like two or three funders, just because it's too time consuming
Even in cases where a case has sensitive information, sellers have gotten better at doing a quick check of pricing on high level before limiting the time consuming diligence piece two or three parties:
sometimes a law firm or something in the bankruptcy there, they will design a process like a bidding process. And so they'll give a certain amount of information upfront and they'll send that to however many people they want, and they'll say, here is the high level, are you interested?
And give us some guidance on what your terms might look like. And then they'll whittle it down to maybe a second round where they get more information and they have to firm up with terms and then a runoff between two or three.
The experts were also generally skeptical of confidentiality as a moat
the whole industry is built on confidentiality. And so I have not seen clients expressing concerns about sharing the data with too many people.
And, in terms of competition, the experts were clear that larger law firms are increasingly willingly to fund the cases themselves and bet on their own upside:
there are tons of plaintiff firms that are making tons of upside on settlements.
So for example, Motley Rice, this is public, they'll be entitled to hundreds of millions of dollars in legal fees just from the opioid litigation. There's huge pieces of litigation like that, that aren't being funded because the law firms are keeping it to themselves. So if you're a Burford or a Parabellum or someone, they would love to get their hands on deals like that where they get to be part of the upside on a huge litigation like opioids.
But the law firms like Motley Rice kind of think like funders and they're comfortable taking risk and they don't want to share. So that's an example of why there are realistic limits to the growth potential of funders given that there are so many law firms on the plaintiff side that are making a ton of money and keeping it to themselves and not wanting to give away the upside.
Again, none of this is to say that Burford doesn’t have advantages in those areas, or that Burford can’t generate alpha going forward. They obviously have in the past, and they’ll likely continue to do so! But I think the experts were really expressing doubt that these returns / competitive advantage would exist at the scale and level that they did when the industry was more nascent.
Speaking of enduring alpha, the experts were generally bullish on the “institutional knowledge” alpha:
part of the reason why Burford has done well is what I mentioned before, just intelligence and experience. I mean as far as they know, they've looked at more potential deals and they've closed more deals than any other funder, at least bigger deals. So that means that they have more institutional knowledge than others.
And when you're looking at a deal, you're able to compare it to past deals. So if you're out on your own, you're kind of more working in the wilderness, where you're just basing it more on your own past experience rather than having sort of a whole, the collective institutional knowledge of a big company with a lot of people who've done a lot of deals…..
a new player, all else being equal, compared to Burford is not going to have as good returns
There is some precedent for this; the largest private equity firms of today (KKR, BX, Apollo) are generally the same giant firms of 20-30 years ago. Those firms built institutional processes, relationships, and brands that have endured even as the industry got flooded with capital. Yes, returns have come down from the insane levels of the early days, but they’ve still managed to generate some alpha on a much, much larger capital base with a lot more competition.
I think you could see something similar (or actually, better) with Burford. Returns for the space overall come down over time….. but Burford’s status as first mover, relationships and brands, and proprietary historical database gives them an edge that allows them to continue to realize some alpha / best in class returns even as they take on a much larger capital pool and a lot more competition.
Section #3: YPF collectability
Burford won the YPF case in late March, but there are still plenty of questions around the case. We still don’t know what damages Burford is entitled to, nor do we know the interest rate that will accrue on those damages. Those questions will get settled in a “quick” case later this year (I believe the case is set for late July, so we should know the results sometime in the back half of the year), and the answer will result in hugely different face values of the damage awards (for example, depending on when the damages get calculated, the Petersen side of the case will either be worth $7.5B (before interest) or $4.5B!).
But the biggest question for Burford (and Burford shareholders!) these days is the collectability of the decision against Argentine. It’s not exactly a secret that Argentina is in distress; as I write this article (mid-June 2023), Argentina bonds are trading for ~30% of par. Argentina’s GDP is <$500B/year, and their tax revenues run ~10% of GDP. With interest, even the lowest end of the YPF award will be ~$10B, so the YPF ruling will represent a substantial portion of Argentina’s annual tax revenue, and it’ll be against a country that’s already distressed and has a history of default.
So the question I wanted to answer here is what avenues does Burford have for debt collection once this case is locked down.
It’s important to note here that Burford has certainly been thinking about this. Burford has a global asset recovery business that specialize in collecting on cases like these. My expert may be biased (he used to work there!), but he described Burford as having “probably the best judgment enforcement team in-house of anyone in the world in terms of capability, access to funds, experience, et cetera. And the team there have done similar cases before.” In other words, there’s probably no company in the world that’s better positioned to collect on an award here (or to know the trade off between taking the certainty of a settlement or pursuing the time and cost of collecting an award).
For this portion of the segment, you’re going to want to pay most attention to the “Former Senior Executive” expert interview; this interview is with a Burford former who was in their asset recovery group and the main focus of our interview was on how Burford would recover their judgement.
The first thing the expert noted is that he thought it made sense for both sides to wait for the judge to make a final ruling on damages, interest rate, etc., and then after that a settlement would make sense for both sides. For Argentina, a settlement would let them put this all behind them and avoid the headaches that come along with enforcement (which we’ll discuss), and for Burford it would let them crystalize a huge win will avoiding the costly and time consuming process of seizing assets.
However, that’s not to say Burford couldn’t seize assets if they wanted to. The expert was very clear that Burford would have multiple avenues to go after Argentina if that went that route, and that Burford enforcing a judgement would be much more painful for Argentina than dealing with bondholders is. That’s an important point; plenty of people look at Argentina’s bonds trading at ~30% of face value and wonder why that wouldn’t be the number to settle at (i.e. if the award comes in at $10B, the settlement comes in at $3B). I specifically asked the expert this question, and he stressed that enforcing a judgement is much stronger than enforcing bonds. Per the expert,
Every man and his dog in the enforcement world, every good enforcement lawyer has had a crack at enforcing sovereign interest payments on sovereign bonds over the past, goodness knows, how many years. And I don't think there's ever been a successful episode.
Burford has been very clear on this as well: a judgement against a country is in a much better position than a defaulted sovereign. From Burford’s H1’22 call:
So I suppose I'd say a couple of things in response to that. One is -- and this is really quite important, and we get this question a lot. There is a distinction between sovereign debt and the enforcement of defaulted sovereign debt on the one hand and stand-alone court or arbitral tribunal decisions on the other. When you're a sovereign debt holder, you are subject to not only the whole set of terms, which usually include enforcement-related terms, in the documents that you've agreed to as part of the loan, but you're also not, generally speaking, an independent actor.
The sovereign debt holders are acting as a group of creditors. That just isn't the same dynamic when you reach -- when you have a court judgment. If you're an independent actor, you have an immediate set of remedies available to you, and you are free to go and begin using those remedies as soon as you have an enforceable judgment. And there's not the opportunity for the judgment debtor to basically use a collection of sovereign debt style roadblocks to block that. That doesn't mean to say that enforcement against recalcitrant sovereigns is easy. But it's something that we do and that we have significant experience in doing. And it's also obviously a key part of our underwriting ability when we take on these cases.
It's notable that Argentina has in the past consistently paid arbitration and judicial awards, consistently meaning ever since Argentina rejoined the capital markets. And so we're not going to comment publicly on the specific dynamics of how to enforce against Argentina or what our strategy would be. But we're not subject to the same macro forces that you might see in play with sovereign debt. Jon, anything to add to that before we close?
The expert gave a nice anecdote / historical example of how a judgement can muck up the workings of a country and eventually lead to a nice settlement:
you get to a situation where Burford are of the opinion that actually enforcement is going to be the best way forward. They start freezing some commercial assets around the world.
They start applying some diplomatic and other leverage to the point that Argentina has to settle because this has now become such an albatross around your neck that it's affecting the day-to-day business because it doesn't just affect Argentina, PLC, it affects how everybody else views Argentina, PLC. But it also affects their relationships with people like the World Bank, the IMF, the development banks, all the other sources of funding that make the world go around. And the World Bank, in particular, get really upset about these things.
We had a situation a few years ago where Egypt was in a similar situation as Argentina is now. Multiple commercial parties with multiple outstanding judgments and awards, not quite the crazy billions that Argentina is facing and has faced, but hundreds of millions of dollars' worth of judgments and awards as a result of commercial disputes going back a decade. And they were piling up.
And in the end, with Egypt, it was the World Bank who cut Egypt a check for, I think it was something like $500 million or $800 million and said, look, pay them, settle these debts because Egypt can't continue like this. And actually, you're killing yourself because nobody is investing in Egypt, nobody want to transact with Egypt.
Nobody wants to trade with Egypt because you default on every contract and then you have to pay the award. So now you have no money because of those things to pay the awards. So here's a blank check, pay the awards and then we'll figure it out. So the influence that bodies like the World Bank has in these circumstances shouldn't be played down.
The “magic” settlement number the expert kept coming back to in our call was ~50% of face value. Any less than that, and it made more sense for Burford to try to enforce. Any higher than that, and it made more sense for Argentine to dare Burford to try to find and seize the assets.
I don’t think there’s magic or scientific precision to that number, but I do think it makes sense. If Argentina sovereigns are trading at ~30% of par, and a judgement has better enforcement mechanisms than a sovereign, then it should trade at some premium. Whether that’s a 10 or 20 or 30% premium is anyone’s guess, but based on this expert call (and similar ones I’ve done / talked to) I think a 50% settlement is a good baseline.
There is a lot about Burford we haven’t talked about. It’s a fascinating company with a lot of angles. We didn’t dive into the actual damages and interest number for the YPF case. We didn’t really discuss valuing their core business, how their core business is likely to see a wave of realizations this year, or the value of their asset management business. We ignored the capital allocation questions they’ll face once they get the proceeds from YPF, or if the YPF case is a complete one off or if we can expect a litigation funder to catch lightening in a bottle and realize a grand-grand-grand slam every now and then if they’re good and funding a lot of cases.
Unfortunately, I can’t do all of that here. I have covered some of those points elsewhere (in the podcasts, on the premium side, etc), but this series was designed to address questions with expert calls, and I think I did about as good a job covering these points as I could in an expert call series. Answering any other questions would have diluted the current crop of questions or required a whole new set of expert calls!
So I’m going to wrap up this post (and series!) here; I’m of course happy to engage any questions in the comments!
PS- One thing I didn’t mention is the recent case of Burford suing its own client (Sysco). I don’t think it’s crazy relevant, but it is interesting because Burford wrote a massive check into the case and there are now WSJ articles that include the quote “We’d imagine the company regrets the entire exercise at this point” (with exercise being getting legal funding). Burford responded pretty strongly against the WSJ piece, and think they do have a good claim against Sysco…. but I can’t help but wonder if the whole thing could impact Burford’s reputation or the corporate appetite for litigation funding in the medium term.