IP ANALYSIS: Burford Capital & Fair Value Accounting

Last Thursday, Burford Capital failed to provide audited FY22 financials citing ongoing discussions with the SEC around modifications to its fair value approach. BUR said that this ‘discussion’, not investigation, with the SEC is happening because it's the first year of full reporting under GAAP.

Given the 2019 Muddy Waters debacle, accounting questions are the last thing Burford needs. The stock was down nearly 20% intraday.

We published an analysis that explores how BUR currently accounts for its Level 3 litigation assets and the potential impact of the SEC's valuation methodology under GAAP.

The FV marks of litigation assets are fairly unique in that the average asset life is ~2.5 years; all FV adjustments are quickly and regularly flushed through the book. The challenge with BUR is that ~40% of the balance sheet is 1 case: YPF. And the duration of this case is >10 years. This distorts Burford's accounting as >90% of YPF's value is a fair value adjustment. Excluding YPF, only 6% of capital provision assets are FV gains.

BUR
BUR

BUR’s current valuation methodology is fairly conservative: only 25% of realized cash is fair-value adjusted upon a successful case resolution. This causes a huge uplift in FV right towards the end of the case life and undervalues younger cases marked at cost but with high expected value.

BUR CMD
BUR CMD

BUR’s current methodology starts at the deployed case cost and adjusts for certain case milestones. The SEC seems to be proposing the inverse methodology: starting at the case expected value and discounting back to a PV. This adjusts for the time value of money, something BUR doesn’t currently include.

In this analysis, we walk through how this new methodology may impact YPF and BUR’s non-YPF book. We also explore BUR’s capital structure and the risk of a credit event in 2023.

IP DIALOGUE: Valuing Constellation Software & Lumine Spin

This was a great conversation between long-term institutional shareholders of CSU discussing how to value the business and thoughts on the Lumine spin.

There are two main drivers of CSU’s intrinsic value: ROIC and the capital deployed.

This comment provides a simple framing of CSU’s forward return from here:

If you get to 25% return on capital and they reinvest 60%, over a decade, that’s 15% compounding, roughly. If they wind up reinvesting 30% or 40% of what they generate, over the next decade, then you’ve got a problem, I think. Somehow, with Mark and his team, I suspect they are going to find good things to do.

The biggest question is: how much capital can Mark and his team deploy?

If CSU can only deploy 50% of FCF, then the multiple may get chopped in half.

And then what does CSU do with the existing, slow growing portfolio? CSU arguably doesn’t have the people internally to drive organic growth.

One of the things that is embedded with them now and one of the, maybe, negatives of the system that has been built over the last five to 10 years, is that you have solved for really good acquirers and not super business managers, in terms of driving organic growth. One of the things I am a little bit less positive on is, if you did slow down the M&A engine, all of these guys, at the portfolio management level, are just going to be great at getting organic growth back up. I think some of those are different skill sets. Back to the question you just asked, I haven’t seen it and I haven’t seen any internal processes change to incentivize it, either.

With such low organic growth, the recycling of capital into new VMS companies is critical. CSU trades at ~30x FCF for a collection of ~1,000 VMS businesses that were purchased at ~5x EBIT. If they are not growing, and M&A slows down, what should the holdco trade for? It certainly shouldn’t be 30x; maybe 15x given the diversification?

This dialogue also explores the challenges with organic growth and thoughts on the Lumine spin.

Tesla Battery Manufacturing & Energy Storage

A Former Lead Battery Engineer at Tesla who also spent 5 years at Solar City building energy storage modules shares insights into TSLA battery technology.

TSLA was growing too fast for its original battery suppliers that it took battery production inhouse:

When Tesla was growing even faster than the suppliers, indicating they would ramp up their battery factories, Tesla decided to go into their own manufacturing. Because Tesla wants to make the best decisions and asks, how do you get the battery cost down the fastest? You probably can't do it if you do the same as anybody else. If you took a Panasonic and copied it exactly, you would end up having the exact same line as a Panasonic line. That is not the way Elon operates. He wanted to put in all the innovation he could, to make a cheaper battery. For the 4680, it was about the form factor, and the module changes. It was about the dry battery development. All of these are fairly big deviations from the established manufacturing process. If it all works, it's going to be cheaper than what the other companies are doing. - Former Lead Engineer, TSLA

Tesla mines the data from its battery to continually improve performance. This is very difficult for competing OEM’s who don’t produce and own the battery and battery system technology.

The software on the cars is super important. The software on the battery management system is important. The data mining, I see as super important. Tesla knows how every car in the world is charged, and how the batteries behave. All this data is being mined. Tesla knows better than anybody else in the world how the batteries behave in their cars. - Former Lead Engineer, TSLA

Adyen: Pricing, Culture & Talent

Adyen has maintained impressive growth rates with high profitability. This former Adyen Director describes the company’s unique culture in attracting and retaining talent with lower compensation relative to competitors:

That is one challenge from a hiring perspective, but they have a superior product platform and still have a culture where they want to have fun while changing the payments landscape. They will not pay you the best in the market as they don't want you simply work for them based on the pay they offer you; they want you to help them revolutionize and improve the product, platform and payment space. If you become a top performer, they will compensate you for what you are worth, but that might still not be as much as you would have got from Visa or PayPal, who pay top dollar to attract the talent because they don't have the same culture Adyen does. - Former VP, Adyen

Atlassian: Confluence Strategy & Competition

Atlassian is leaning on Confluence to address work management within enterprises. Besides Asana, Notion, and Monday.com, Atlassian has to compete against the Microsoft bundle. This former Manager at Atlassian describes how Microsoft and Google are a bigger worry than other competitors to Confluence:

Feature differentiation was definitely the all-in-ones but Microsoft and the enterprise was way more scarier than Notion and Asana because of Exchange and Google Gmail. They can tell large enterprises that they can do it all for significantly less. - Former Manager at Atlassian

Cytek Biosciences: Flow Cytometry Competition

Cytek Biosciences has developed an innovative and cost-effective flow cytometry analysis instrument. Since going public, the company has managed to achieve an installed base of over 1,500 instruments and are now looking to sell their own reagents to gain a profitable revenue stream. This Cytek Customer explains the opportunity for Cytek to supply reagents:

Let’s say the Aurora system can do, in theory, 63 fluorescent dyes; you’d imagine that would be pretty expensive. You buy 63 different antibodies and you have to add one test of all those antibodies to one tube and one sample. If you’re doing 100 samples a week in that setting – it could happen – it is going to add up and you have to ask yourself if we do the right thing with the reagents. Of those 63, it might well be half of those are unique dyes that Cytek provide and actually even if they’re not unique dyes, if Cytek provide them in a nice pre-titrated prearranged backbone foundational panel that I then build on with other antibodies, easy. That’s my point, I think they’re playing the smart game here; it’s not a lock-in, it shouldn’t be a lock-in. People get very upset about that in basic research, but what will happen is that people will just go with it and I reckon about half of the reagents in anyone’s large panel will just be Cytek reagents. - Current Cytek Customer

Costco's Cultural DNA: Working with Jim Sinegal

Great stories about what it was like to work with Jim Sinegal from a 30-year COST veteran:

[Jim] would go to every single warehouse at least once a year. When I had the opportunity to be in his presence for warehouse walks, he would shake hands and talk to as many people as he could and he would remember their names, like I said, and he would have remembered something about them and ask them how this was going or how that was going. When there was trash on the floor – because in an environment where there's so many customers going through, and they do sampling and all the things, there's always some sort of trash on the floor – he would stoop and pick it up. People would rush to get it from him, out of his hands, or make sure they were first to pick things up. He just was the example. He walked and did everything he asked others to do. - Former Senior Manager at Costco