Burford Capital: YPF, Book Value, & Valuation

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Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

The recent update is probably a good place to start, in terms of the asset management versus the balance sheet. It depends how you interpret the update, but it seemed as if they suggested they weren't going to raise much more third-party money and they were going to focus more on the balance sheet. What did you make of that, given your experience in these businesses?

Analyst 1: It looked as if deployment was a little harder, a little slower and that, perhaps, this is not as scalable as they think. Yet, they were putting a lot on the balance sheet last year; a lot more than one would have expected, given that there were fewer cases going on. On one side, they were getting a lot more on the balance sheet and, on the other side, they are saying they can't get the funds out of the door. It certainly seems it's not as scalable as we would have thought.

Analyst 2: Aren't they saying, we don't want to scale it for the high-returning stuff? We are okay scaling it in the smaller stuff, but the smaller, post-settlement stuff just churns really fast, so that doesn't seem scalable. Is there a middle ground where there is potentially more scalability, or are they just saying, none of it is scalable; none of it makes sense?

If you go back and read Bogart's comments, he would be upfront and say, we optimize the balance sheet for the highest yielding assets. They have to, because they are spending $150 million in just running the business. They need to have those 30% IRR and higher yielding assets on the balance sheet to cover that cost base. The fact that they've come out and said they are going to keep all those on the balance sheet – and they were doing that anyway, so it doesn't really change much – it does suggest that there are not that many of these cases out there. Especially as they get bigger, they have to start allocating minimum $10 million a case, on average. If you go through the investment table again, you can see that the average case deployed has gone up, over the last decade and it has to.

How many cases are there out there that you can allocate 20 million to regularly? When I first saw the update, my thought was that the market isn't ready for that amount of deployment at scale, at the size that Burford is required to keep up the growth and deployment. But it doesn't necessarily mean that they can't launch different products that are 10% or 15% IRRs; which is still a solid product.

Analyst 1: I was going to say to add to that, they would get no end of asset management AUM available to them because of the non-correlated nature of this asset class. The reality is they are not raising it. I think that is just another data point they have to grow into the strategy. They will create some of the market over time, they've gone into portfolio cases, they've gone more direct to corporate and it will just take time to grow into it. At the moment I think they've decided the easiest way to grow into it is via their balance sheet, and then possibly, it makes more sense for them to have a lot more on the balance sheet in case YPF goes against them or it gets dragged out or they win but can't collect. YPF being so big as a percentage of the book value of the balance sheet today is just a problem for them, and one way to deal with that problem is just to get more stuff on the balance sheet as quickly as possible, and that will move the needle more for Burford than getting more stuff into funds, and it can grow their way into the funds and expand their product suite, over time for that.

It's pretty clear these balance sheet assets generate 30% IRRs. They also mentioned the 2 and 20 fee structure doesn't make sense. What fee structure do you think would make sense, given the non-correlated nature of the assets?

Analyst 1: I'm not sure that I fully buy this whole fee structure sense, versus not making sense narrative. If that was the case, that's a negative for operating leverage as well. They're essentially admitting this is actually quite a cost intensive business. Maybe they are alluding to the last structuring that they did, where they gave the investors 10% and they take everything else, which is a variation on the theme. I suspect you could deal with the fee structure element but I think the bigger issue is simply the lack of deployment opportunities.

Analyst 2: How well hooked are they into the LP world? Do they know every single LP in the world, in every category and they're connected with everybody and they just know who the market is? Or do they just have a few relationships and they just don't know a lot of different pockets of people who will be interested? How connected are they?

They’ve got to be connected at this point. Surely, they would be aware of the major LPs.

Analyst 1: Yes, I mean there are so many LPs who won't allocate because of the reputation risk. I had an example, recently, of somebody in the life settlements space where a Canadian wanted to allocate two billion to them and they couldn't take that kind of capital at all. I think some of these non-correlated asset classes are just simply access products, and I would say they could double their AUM tomorrow if they had the deal flow. I don't think it's lack of relationships is the gate there.

Do you think that the LP demand is there, in terms of someone wanted to allocate two billion but they couldn't deploy quick enough?

Analyst 1: I've seen that in other non-correlated assets. I talked to some of the people in the bigger institution allocators and their clients – particularly where the 60/40 portfolio is no longer giving balance, where bonds can't hedge you any more – people would love to allocate to that in a distant way where they don't have to take the reputation risk of potentially sueing your clients somewhere. When I went out talking to people in the space, it's harder than one thinks to allocate capital here, so I just think there's an opportunity supply side issue rather than a demand side, that's what it feels like to me.

Do you think the market isn't big enough already, or the cost and operational challenge of getting access to the deals is the bottleneck?

Analyst 1: I don't know; I think they're tied in together perhaps. If Burford hired a lot more people, they could probably originate more. There are plenty areas, particularly tax for example, where they haven't really gone after it, because it's very specialist, and again it gets to be the nature of the business model. Maybe the summary here is, don't get too excited about the value of the asset manager right now, in your sum of the parts. Focus on this as a book value compounder and look at it from that perspective.

Analyst 2: I have marginal understanding of the world of LPs, and obviously, this is a relatively new market. There's been funds for a while, they don't scale large, I'm guessing some of the “sophisticated” people have been more involved than the “non-sophisticated” people. There's a lot of memetic dynamics in that world and they can spill over from the smartest family offices down to the endowments, down to sovereign wealth funds down to pensions, and so I'm not really sure where the market is from that perspective, that's kind of my question on how hooked are they to all these layers.

I'm just not sure where that memetic process is. They're obviously partly creating the market, and so I don't know where they are in the market creation such that they can keep structuring these products such that they can really target the returns to whatever different LP’s want. It's obviously a recursive process and I'm not sure where they are in that recursive process. My guess is that there's a long, long way to go, and obviously, it has to be a bit organic. I'm guessing they're marginally smart about that and they don't try to push it too hard. They're just trying to optimize for what's best for them. You know what the deals out there are, the cost structure, but also what LPs fund, so all those hypotheses may make sense, and it would be interesting to dig deeper with them to see where they think they are in that recursive process.

And the other thing is that we don't know how much time, effort and manpower they're spending on YPF. It's hard to see them making cases because of the Covid challenges, but I also think the YPF, when that does close, regardless of the outcome, is that it would be a lot of energy wrapped up in that case that would be released into sourcing new deals and working on other stuff, which could help in building the market up.

Analyst 2: My question is, if it's not economic to do this via funds and there is not a lot of deals out there - which would be the two hypotheses of why they can’t do this – doesn't this suck way more for all competitors, and so the competitive dynamics are actually better?

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