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The company is particularly appealing to investors seeking assets with low correlation to markets

AIM-quoted Burford Capital (BUR:AIM) may interest investors seeking assets with low correlation to markets.

It is a leading operator in the nascent area of litigation finance. Essentially it provides cash to help fund lawsuits and then takes a proportion of any resulting compensation award.

It invests its own money in this activity (from cash raised in debt and equity issues as well as recycling funds secured from successful lawsuits).

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Burford also acts as an asset manager investing on behalf of third parties. Rapid growth has been recognised by the market such that the shares are up more than eight-fold in the last three years and five-and-a-half times in the last two years.

WHY WE HAVE TURNED BULLISH

We turned cautious on the stock in December 2017 on valuation grounds but after a period of weakness during the market correction, we now believe investors should give the shares another look.

The company trades on a price to earnings ratio of 14.7 and yields 1.6%, based on forecasts from stockbroker Numis.

Its ability to deliver substantial returns which are not linked to either the performance of other asset classes or the economic backdrop could find favour in the current environment.

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A FAST-GROWING INDUSTRY

Lawyers appear to be increasingly comfortable with the concept of third party financing.

The potential of this market is reflected in the $1.34bn worth
of investment Burford committed to its different areas of activity
in 2017.

This is nearly as much as it had put up since its inception in 2009 through to June 2017 and, in addition, reflects a change to its business model since it acquired Gerchen Keller, a deal announced in December 2016.

This deal helped the company establish its asset management arm and as chief executive Chris Bogart tells Shares ‘added access to a deep pool of capital’ to help grow Burford.

In the future this part of the business could also deliver significant management and performance fees which could help smooth out the
less predictable returns from court payments.

Numis analyst Jonathan Goslin reckons fees could total $40m a year based on the firm’s current returns on capital.

EXCEPTIONAL RETURNS

Goslin calculates a return on invested capital (ROIC) of 52%; for context a firm delivering consistent returns on capital above 15% is usually considered a good quality business.

Burford has expanded into legal insurance and loans to law firms as well as investing in lawsuit defences in return for a pre-determined fee if successful.

For now, the company still derives most of its profit from investing its own cash. It recently raised $180m of new funds in the first dollar-denominated bond issue on London’s retail bond platform ORB.

Bogart rejects the concerns over a lack of earnings visibility and limited transparency on live cases, arguing Burford is no different to any large provider of commercial finance.

The confidentiality agreements which are a standard feature in legal settlements prevent it detailing returns from every individual case. Yet the company can point to several examples to show how historic investments have played out and the average duration of cases the firm invests in is fairly limited at less than two years.

Some insight has also been provided by sales of interests in its Petersen V Argentina case. This concerns Spanish investment group Petersen which faced insolvency after the Argentine government summarily renationalised oil company YPF.

The sums received for these stakes to date imply the asset could be worth several multiples of Burford’s initial investment of $18m.

BARRIERS TO ENTRY

The barriers to entry into this market, namely scale and reputation, are, according to Bogart, reflected in the fact that Burford’s competition comes principally from established players rather than new entrants. According to Goslin at Numis, ‘demand for additional capital appears to more than outstrip supply’.

Expansion into new markets like Singapore and Hong Kong offers another leg to the growth story, although Bogart explains the focus will be on English language, common law jurisdictions. ‘You’re not going to find us providing litigation finance in Indonesia, for example,’ he says.

A key risk faced by the company is funding a lawsuit that is eventually unsuccessful, which means the time and money it invests will have gone to waste. This risk will be mitigated as Burford puts money in a greater number of cases.

Although he admits making ‘bad investment decisions’ is a potential hazard, Bogart says the team of 90 people adopts a selective approach, closing on just 10% of enquiries which come in. His main concern is cyber security given the company holds a lot of sensitive data in its files.

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