Burford Capital Limited

Moat: 2.5/5

Understandability: 4/5

Balance Sheet Health: 2.5/5

Burford Capital Limited is a leading global finance and asset management firm, specializing in providing litigation finance solutions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Burford Capital Limited, a key player in the legal finance sector, operates primarily in the United States, the United Kingdom and Australia.

Business Overview:

Burford Capital Limited (BUR) is a distinctive player in the financial sector, specializing in legal finance. They provide capital to companies involved in litigation and arbitration, offering a unique alternative investment class focused on high-value, complex legal disputes, which are hard to predict when they will be resolved.

The company essentially provides non-recourse funding, meaning that if a case loses, Burford doesn’t get repaid. Thus they are very exposed to litigation outcomes, and they only get payment if the case wins. This introduces a very specific risk profile. Burford receives a share of the proceeds awarded in successful cases; the return can be quite large (but not guaranteed) and its returns are correlated to the length and nature of each lawsuit. Their business model is based on the premise that companies do not get repaid for litigation expenses if a court case does not succeed.

Their operations can be classified into two primary activities:

Core legal finance: This encompasses the direct funding of legal claims, in which Burford provides capital to companies involved in legal disputes, and earns a return upon a successful outcome. They primarily target high-value, complex litigation where their expertise is best deployed. The average size of these loans has increased in recent years, reaching $53.8 million as of year-end 2022 and $54.7 in 2021. The number of deployed assets increased by a compound annual rate of 27% from 2019 to 2022, showing strong growth in demand for their services.
Asset management: This side of the business includes managing funds for other investors, allowing Burford to attract and deploy much more capital than its equity base would normally allow. Management fees are earned on the assets they have under management, and they also receive a carried interest (or a share of profits) when the funds make money. This helps them get a reliable income stream regardless of litigation outcomes.

Burford’s main competitive advantage stems from its expertise in legal finance, where it has a very long history, and a vast amount of data points.

Moat Analysis:

Moat Rating: 2.5 / 5

Burford’s moat derives primarily from several sources:

Reputation and Network: Burford has built a strong reputation and a deep network of contacts in the legal and finance sectors. They are known as a pioneer in the legal finance field and therefore other investment firms use their services to participate in this industry. They also make use of high-quality lawyers and law firms which can provide them with better claims to invest in. This reputation and network create barriers to entry for new players.
Specialized Knowledge: Evaluating complex legal claims is a unique skill that requires a deep understanding of both law and finance, something that few firms can replicate easily. Their experience in litigation financing also gives them a first-mover advantage. It would take competitors a long time to build a similar knowledge base, making it difficult for new entrants to compete directly with Burford.
Unique Data: Burford has an extensive database of case outcomes, legal precedents, lawyer quality, and legal expense data. This vast data set gives them an edge in pricing and selecting the best claims to invest in. Newcomers will have trouble competing because of the difficulty and time necessary to build similar databases.
Operational Complexity: The sheer complexity of financing litigation claims makes the operational part of the business very difficult and takes a lot of experience to master it effectively. This is especially true in the analysis of cases.

However, the moat is not as strong as it would be if it was based on a well-known product or service. The strength of the moat depends on the long-term economic prospects of the different investments they make. Their success depends not only on management skills but also on their ability to accurately predict court cases, which have multiple possible outcomes and are impossible to make truly accurate predictions on. Therefore we are not giving the business a “wide moat”.

Burford’s moat is more based on expertise and accumulated knowledge rather than hard to replicate physical characteristics.

Legitimate Risks that Could Harm the Moat and Business Resilience:

Legal and Regulatory Risk: Changes in law and regulation are one of the biggest risks in the industry, and these can have a drastic impact on the legal finance market. In particular, changes in rules regarding the permissibility and enforcement of claims, could directly negatively affect Burford. Other than that, new government policies and sanctions as seen with Russia and Ukraine can severely affect their business.
Increased Competition: The market for legal finance is growing, attracting both specialized firms and new hedge funds, who all want a piece of the pie, which can compress margins for existing players like Burford. Also, if competitors start to replicate their data assets or knowledge base, then this will definitely hurt their competitive advantage.
Credit and counterparty risk: As they are essentially a lender, their business depends on the creditworthiness of their counterparties. Also, the failure of their counterparties to pay their dues can negatively impact them. Since they are so heavily involved in litigation they are also affected by the success of said litigation, and if there are repeated adverse litigation outcomes, Burford may have difficulties in obtaining funding or even surviving.
Market sentiment and liquidity: When markets are down, risk appetite diminishes and investors are less likely to fund such companies, and investors are also less likely to buy the stock if it is listed on public markets. Also, litigation investing does not have much liquidity, which may be concerning to some investors.

The company has taken steps to mitigate these risks. They have built a comprehensive credit and risk management framework, and they have a diversified portfolio. Also, they operate in multiple geographic areas, which mitigates the risk of a change in law or regulation in one jurisdiction. However, their business is inherently difficult to understand and hard to predict.

Even though they have steps to mitigate the risks, due to the inherent nature of this business, it is very difficult for the company to truly remove or control all the risks, and their success still primarily hinges on accurate prediction of complex court cases and their outcomes.

Detailed Explanation of the Business:

Revenue Distribution:
- Burford’s revenue model is complex. They derive their revenue from three sources. The majority of their profits comes from Realizations, which is money they get when their financed cases win and the assets are sold to different parties. Then they get profits from Asset Management Fees, which are management fees that are based on the assets under management (the legal claims they finance, in this case). Finally, they also get profits from Other Income which can vary year to year.
In 2022, the revenue distribution broke down as follows: Realizations 89%, Asset Management Fees 8%, Other Income 3%. Historically, Realizations are usually the largest contributor, and they have accounted for as much as 94% of the revenue, and a minimum of 75% of revenue. This means that their financial health is dependent on predicting future litigation outcomes.
Industry Trends: *The legal finance market has been showing strong growth, partially because of increased demand from companies to use a different form of funding, and partially due to an increase in litigation overall. It is becoming a common way of funding cases, and many big players are looking to join the party as it is a very unique and uncorrelated asset class. The industry is consolidating into a smaller number of large players. However, there is uncertainty regarding how this business model will behave during the next crises.
Margins: Burford’s profit margins are volatile because the profits are reliant on the number of litigation cases that get completed and their corresponding payouts. For the most part, they have maintained gross profit margins of well over 70%, but their net profit margins have varied considerably from year to year, and have even been negative in certain years. There is also substantial variation across segments. While there is the potential to have high returns, the costs are also substantial.
Competitive Landscape: The competitive landscape is changing, and there is no single, very dominant player in the sector. Companies like Fortress Capital and Longford Capital are Burford’s biggest competitors; however, there are also a number of smaller players and hedge funds trying to enter the business. These players are all trying to increase their reach and expertise in this space, meaning the battle for talent is very competitive.
What Makes Burford Different: Burford is the largest player in litigation financing, with a long history in the sector and extensive data assets. They focus on very large deals, and on the asset management side they are very big, which allows them to bring in capital from institutional investors. They have been able to build out a global business model which also gives them an edge over other competitors.

The company has a strong history of providing high returns but is dependent on the outcomes of litigation cases and, as such, profitability can fluctuate from year to year. This makes forecasting much more difficult.

Financials (in-depth analysis based on the 2022 annual report and latest earnings call):

Income Statement:
The company saw revenues surge in 2022 due to high realizations. There was also a substantial reduction in expenses. As a result, Burford was able to produce very strong Net Income numbers ($487.4 million in total) which helped it to become more profitable overall.
The gross profit margin has remained consistently high, but net profit margin is highly volatile because it is dependent on outcomes and time of litigation, and they can even be negative. * A big contributor to earnings was the release of reserves due to the fact that many cases had been successfully settled, and therefore were not as high risk anymore. This may not be sustainable.
Looking through their 2022 annual report, the majority of earnings were from realizations, and the income from those was substantially higher compared to the other segments. * In the latest earnings call, the management stressed that they are trying to make the earnings mix better by increasing stable fee income from asset management. Their goal is to be able to have income that is not dependent on litigation results, so the company is trying to be less cyclical.
Balance Sheet:
- While at face value their assets are mostly assets related to investment in ongoing cases, the company is required to provide for future losses, which is calculated based on historical performance in court. Their total assets have increased to over $5 billion, with most of that amount in investment in legal assets and cash, with the rest being in intangible assets, goodwill, and other minor assets.
Their total debt has significantly increased as well, to over $1.1 billion, which has resulted in a higher risk profile, which will be discussed in more detail in capital structure.
- A good percentage of their capital is composed of shareholder equity. Total equity has increased a great deal in 2022 due to strong profits and positive results from their litigation investments.
- Burford has very significant long-term liabilities related to nonrecourse investments (mostly in the range of $2 to $3 billion on average for past few years, but has fallen to $1.9 billion in 2022) and a large amount of debt.
Cash Flows:
- Their cash flows are highly volatile, depending on the outcomes and time of settlement for litigation cases. Because of that, it is extremely hard to predict their future cash flows. As a long-term trend though they usually have very positive cash flow from operating activities.
- As they make new litigation investments, they tend to spend significant cash, and that coupled with high debt leads to a volatile business.
Capital Structure and Debt:
- Burford has a complex capital structure, involving debt, equity, and non-recourse financing arrangements. A concerning point of note is that long-term debt has risen sharply, and represents a large fraction of their capital structure. Due to the volatile nature of the business, this might pose a substantial risk to shareholders, and they will not be able to rely on the capital if their forecasts turn out to be wrong. They have also indicated on the latest earnings call that this level of debt is a point of focus for management and that they have begun taking steps to reduce it.
- A large proportion of Burford’s assets are tied to specific litigation cases. They can not easily get out of these investments, as they are contractually obligated to fund those cases, and that would hurt their liquidity in the short term. As a result, their ability to react quickly to problems is somewhat hampered by this kind of operation.

Burford has a complex structure and this combined with their unique business model makes valuation difficult.

Understandability Rating: 4 / 5

The business model is fairly easy to understand at a high level: Burford finances court cases, and makes money when they win. However, understanding the details of the legal finance sector, the complexities of how returns are created, and also the accounting and financial metrics of this business requires above-average effort from investors. Due to the intricacies of litigation, and its unpredictable nature, forecasting Burford is exceptionally difficult. As such, it might be hard for most investors to truly grasp how their business model works under the hood.

Balance Sheet Health Rating: 2.5 / 5

Burford has a very strong asset base, including the underlying value of their legal investments, and their investments are also producing profits for them, along with significant amounts of cash. However, their debt has risen drastically in recent years, and their operations are very sensitive to the direction of the markets. Their operations are also hard to predict, and that means their balance sheet is also very dependent on the outcomes of litigation cases. Finally, there is limited information on the quality of their assets, so investors need to make their own decisions when judging the overall health of the company.

The balance sheet is more complex than other companies and presents certain risks for investors, so it must be treated with caution.

Recent Concerns/Controversies and Management Response:

There has been some concern about the large amount of debt that they have taken out, and about the complex accounting methods employed by the company. Management has addressed the issue by saying that they are aware of the risks, and are planning to deleverage the business and improve their debt-to-capital ratio. They also say that they are working on making the reporting more transparent.
There have also been concerns about the effect of a recession and geopolitical risks on their financial results. Management has stated that their business is resilient to a recession and that it would likely not be affected by most geopolitical problems, though the conflict between Russia and Ukraine was a major issue for them in 2022.
There has also been substantial discussion of the stock price and its extreme volatility, with significant gains and losses in short periods of time. Management has stressed that they are aware of the volatility and will continue to improve the fundamentals of the business.
While their earnings in 2022 were strong, the earnings mix did not improve substantially and they are still heavily reliant on profits from realized legal gains, meaning a substantial part of their earnings is dependent on chance.
On the positive side, their new fund structures have been showing early success, and they are planning on launching more in the coming years, and that will help to improve their stability.

Burford’s management is aware of the challenges and are actively working to improve results.