Burford Capital Ltd Q1 FY2023 Earnings Call

Hello, and welcome to Burford Capital's First Quarter 2023 Results Conference Call. My name is Alex, and I will be coordinating the call today. I will now hand it over to your host, Chris Bogart, CEO, to begin. Please go ahead.

Thanks very much, and hello, everybody. Thank you again for joining us. It feels like we've been talking to you a lot lately. I think this is our third call in three months. And welcome to our very first ever set of quarterly results, all part of the journey towards a full U.S. listing with the Stock Exchange. I'm joined as usual by Jon Molot, the Chief Investment Officer; and Jordan Licht, the Chief Financial Officer. We are going to adopt the process of having these calls be when we just do the quarterly numbers. Given our propensity to talk, we'll try to be more succinct for these quarterly calls than we have been for annual calls. Then happy to take whatever questions you all have. So, I'm going to start on Slide 3. I have to say the slide and our numbers in general really do speak for themselves. It was an extraordinary quarter, and it reflected exactly what we have been saying about what we're seeing out there in the court system and in the market in which we operate. We have seen a return to normalcy in the court system. Our backlog of cases is moving through the courts, generating an increase in velocity, and that's translating into revenue. We have numbers on the slide here that are consolidated numbers. As you know, those numbers get a little diluted by the fact that they include some consolidated funds. Let me, for simplicity, frame the Burford-only numbers for you, the portion of these numbers that accrues to Burford's equity shareholders like you and like me. On a Burford-only basis, our revenue went up 214% to approximately $315 million. Significantly, $125 million of that was from our portfolio, just the general operation of our portfolio, reflecting a return to normalcy. That's almost double what it was in the first quarter last year, and realized gains as part of that were up more than 250%. Setting aside YPF for a moment, just looking at the business excluding YPF, we're really pleased with what we're seeing in terms of portfolio activity and revenue generation. Of course, on March 31, the last day of the quarter, we had the additional bonus of a strongly positive liability decision from the federal court in the YPF case, that obviously caused an upward revaluation of that asset to some extent. So, in addition to that $125 million of Burford-only revenue, we've added about another $190 million from YPF, and those two numbers together resulted in that extraordinary outcome for the quarter. The portfolio at the same time is continuing to grow. We'll talk in a minute about what we're seeing in terms of new business in the market. Jordan will take you through liquidity and operating expenses. But bottom line, we couldn't be happier with how our first quarter and our first-ever reporting quarter turned out, especially since the first quarter in this business can certainly have periods of historical slowness. We're going to jump around with these slides a little bit, and with that, Jordan is going to take you through Slide 4.

Thank you, Chris. Good morning, good afternoon to everyone on the call. A bit of housekeeping since this is our first time sharing quarterly results. I want to ensure everyone understands the comparative periods. On the income statement side, we're comparing the first quarter of 2023 to the first quarter of 2022. However, with respect to the balance sheet information, we are comparing the closing balance sheet at March 31, 2023, to the year-end balance sheet of 2022. This page highlights results for Burford-only, and consolidated information can be found in the reconciliations in the appendix of the deck. Also note that all of the information for each quarter is presented under the revised fair value approach, which we've discussed previously. As Chris mentioned, this was a good first quarter, driven by significant progress across the portfolio, further bolstered by the YPF case and the related assets. Our business is episodic, but we hope to impress upon you today the momentum we're seeing in addition to the progress from YPF. From a top-line perspective, total revenues were up more than 200%, driven by higher capital provision income as well as improved asset management income. Realized gains were up more than 250%. However, when you exclude YPF, unrealized gains were up by 55%. Burford-only net income was nearly $260 million, or $1.17 per share, which is up more than $200 million, or $0.92 per share compared to the first quarter of last year. We now sit at total equity just shy of $2 billion and a book value of $9.10. That's a quick review of the numbers. We'll go deeper on some other pages, and I'll flip it back to Chris for Slide 5.

Thanks, Jordan. So, Slide 5 talks about new business. Just to emphasize, the first quarter for us is often very, very slow in terms of new business. There is no good reason, frankly, for this business to be seasonal. But sometimes, I joke that in the fourth quarter, it feels somewhat like I'm running a retailer. The simple fact of the matter is that lawyers are driven by deadlines. Many law firms have their fiscal year ending at the end of December. Since we've been in this business, December has historically been remarkably busy for us. After that, following the close of multiple deals, lawyers tend to take a break. I am quite pleased with these trajectories we are seeing here. So, in terms of new commitments, overall, on a group-wide basis, we almost doubled new commitments first quarter over first quarter. More significantly, Burford-only new commitments went up significantly more than that by about 130%. This is because the balance sheet is now taking 75% of the high-octane deals, while BOF-C is taking 25%. Previously, the balance sheet was at lower numbers, sometimes 42%, sometimes 50%. So, we are pleased both with the overall trajectory and with the relative share of that new business that the balance sheet was taking, which ultimately accrues to equity shareholders. A fundamental factor that we are seeing in play is economic stress and anxiety in the market. We've discussed this before, but to recap, businesses tend to engage in questionable conduct when they are under economic stress. That economic stress is caused by high-interest rates and uncertain economic environments. This questionable conduct tends to result in both litigation and insolvency, both of which we benefit from. So, while we do not wish for a recession or significant economic downturn, our business certainly performs well in these kinds of times. That’s where we are on the new business front. Jon will now discuss the portfolio activity on Slide 6.

Sure. Thanks, Chris, and thanks to everyone for joining. On Slide 6, you can see supporting what I've been saying over the last few calls, the portfolio is quite active. We had a sleepy period during COVID after having grown the book significantly. We are beginning to see progress reflected in the numbers. Growth is evident in all metrics. In addition to, as Chris mentioned, the YPF success at the end of the first quarter, we are seeing growth in unrealized gains in the rest of the portfolio too, and realized gains are triple what they were in the first quarter of '22. There is an impact from how we walked you through the approach under the SEC's valuation of litigation assets, where interest rates and discount rates factor in. There was a decline in interest rates or in the discount rate by 52 basis points in the first quarter of '22, followed by a more modest decline of 28 basis points in the first quarter of '23. These changes would have had an upward effect on fair value, though it would have been more muted in the first quarter of this year due to a less significant movement in interest rates. Additionally, I want to mention that on the asset management income side, you are beginning to see the benefits of the relationship. Management fees and performance fees from other funds have not moved much due to the European waterfall structure, which postpones earnings performance fees. But, with BOF-C, as the portfolio performs and BOF-C generates profits, we are seeing a significant increase in our asset management income from the BOF-C relationship. With that, I will hand it over to Jordan Licht on Slide 7.

Thanks, Jon. On Slide 7, I will walk through our operating expenses for the year. An important point that we've discussed before, but I want to reemphasize, is that we pay people based on cash profits. However, we do take accounting charges when capital provision asset values increase as they did this period. But none of those charges are paid in cash until we have the cash profit in hand. Therefore, while looking at the income statement, we thought it would be helpful to put some of the line items in context and discuss the reasons for differences quarter-over-quarter. First, our deferred compensation plan expense is compensation that employees had previously elected to defer and invest in Burford's stock. We routinely buy shares in the market to offset employee dilution. However, this has varying degrees of P&L impact on the underlying programs. Second, there is the asset recovery business, which includes two remaining assets in which the original owners had a contingent interest tied to our purchase of the business. Back in 2021, we had an outsized expense related to the conclusion of a case, and only two assets remain from that deal. This line only increases when positive developments occur with the underlying asset we own, and we only pay in cash when we receive the proceeds. The third item is our carry expense that appears in the long-term incentive compensation line, driven by fair value movements in our assets. Again, it is not paid to employees until we actually see the cash realizations. While we are seeing broad-based growth in the portfolio, the majority of this change was driven by the markup of YPF-related assets and is formulaic. Lastly, I want to point out the annual incentive compensation line, which represents traditional discretionary corporate bonuses. These are determined in the fourth quarter based on qualitative and quantitative targets for our employees. Thus, the quarterly expense is driven by an accrual percentage based on last year, and we will finalize that expense at year-end. Overall, while the total operating expenses may appear significantly higher, adjusting for some of the less routine items, particularly strong unrealized gains, is in line with how we anticipated it, mapping to the Q1 2022 expense total. I will now flip to Slide 8. We previously discussed our liquidity position at the end of the first quarter during our recent call just a few weeks ago. On the top left-hand side of the slide, we show $183 million of cash and marketable securities, which consists of $53 million of cash and cash equivalents and $130 million of securities. Additionally, we mentioned $99 million of receivables due from case conclusions. Our group-wide realizations were $147 million compared to $34 million in the same period last year. On a Burford-only basis, realizations more than tripled from $20 million to $62 million. Realizations in Q1 2023 stemmed predominantly from our 2019 vintage. Finally, on the covenant level, we're well within the major covenants for both our U.K. and 144(a) bond issuances and continue to maintain significant debt capacity. As always, we will balance our liquidity, anticipated realizations, and debt issuance with demand for our capital to fund new business. With that, I will turn it over to Chris for Slide 9.

Thanks. This is a slide you’ve seen before, and I’m not going to go through it again since I did that just a few weeks ago. However, it’s a nice way to close out the presentation and remind people that the business, from our perspective, is really firing on all cylinders. The core portfolio now exceeds $6.5 billion, continues to increase in velocity, and generates cash at desirable returns. The origination platform is doing its job, our asset management business is growing in terms of its fee load, and we’ve had a successful period with YPF. With that, we are delighted to take your questions. Operator, we’re ready for you.

Our first question for today comes from James Hamilton of Numis. James, your line is now open, please go ahead.

Thank you for the presentation. You mentioned portfolio activity, and obviously, Q1 was very busy. On Slide 3, you talked about milestone events that occurred up to the 9th of June. I was just wondering if you could split that out, how many of those were actually in Q1, and how many dropped into Q2? Following on from that, in the pipeline and milestone events, how many more do you have lined up for 2023? And finally, how much deployed capital has been allocated to cases that have milestone events this year?

A number of questions there. I'll try to address some of them. Thank you. First, we are not going to comment on the previous methodology. We've adopted the new approach, and I think it would be inappropriate for us to continue referencing numbers from the old methodology. With respect to the milestone question, in Q1, we had approximately 25 milestone factors that occurred. I understand why that information would be nice to have, but I don't think we will start tying specific milestones to projections on a vintage basis. We do provide vintage information and an aggregate table, which outlines incremental deployed costs and realizations by vintage. But I don’t think we will be tracking or projecting future milestones at that level.

I think it's worth pointing out that table on Page 48 of the 6-K, which shows vintage by vintage what the deployed costs and realized proceeds were with respect to our realized gains. That may be of interest, James.

Thank you. And the pipeline of milestone events for the rest of '23, how many more do you have coming up?

Without wanting to commit to this number, I think our estimate is north of 50, possibly even larger. However, I should mention something about the concept of milestones. We provided this data when trying to convey to everyone the short-term information about the current dynamics of the court system returning to velocity. Just to clarify, these milestone factors are not a financial metric, and I don't intend to continue providing them. This approach was simply a way to illustrate the extreme difference we are feeling in 2023 compared to the previous two years. It is not something we track as a KPI.

Our next question comes from Julian Roberts of Jefferies. Your line is now open. Please go ahead.

Thanks very much. James asked a few of mine, and I might just be putting one of his another way, so apologies if so. But can you split the gain on the YPF assets between the time value of money effect and litigation risk reduction? I have a couple more questions, which seem to be tied to the remaining assets we have in the due from settlement line. Do we still expect a substantial amount of that to be collected in 2023? How much of what has been realized this year has been a settlement versus results of adjudication?

Sure. Let me address those and then Jon and Jordan can fill in. Firstly, regarding the due from settlement question, it's somewhat unusual for us. Historically, when a case concludes, payments are immediate. Settlements almost always pay right at the time of conclusion. However, there are exceptions where clients may agree to structured settlements with payments made over time. Typically, we observe that most receivables turn over quickly due to timing, with the exception of one item in the due from settlement, which is being held up by collateral litigation not related to our portion. We're optimistic that will be paid this year, but there are uncertainties due to court processes. To answer your question regarding splitting time value of money and litigation risk reduction: while we can differentiate between them, it is not our practice to disclose that detail. I can say that the realized proceeds from the 2019 vintage were mostly a mix of adjudication and resolution. We don't categorize those clearly as one or the other, as it involves a combination of factors.

Just to clarify, the $37 million was actually group-wide, with Burford-only due from settlement at $23 million relating to the example Chris just mentioned. We feel confident about collecting the rest.

Understood. Thank you very much. Regarding those cases that are a mix of settlements and adjudication, could it be that there's a family of cases and price discovery occurring because of one adjudicated case?

No. Jon, did you want to add to that?

Yes. As Chris indicated, the line between settlement and adjudication can involve scenarios where a settlement follows a judgment that has been rendered. In such cases, parties may settle alleviating the risk that appeals could arise. Thus, it can be challenging to differentiate between a settlement and an adjudication.

We have a webcast question before moving to the next question on the phone. The question is, when do we anticipate a full New York Stock Exchange listing? Currently, we are what's termed a form private issuer because over 50% of our shares are held by non-U.S. investors. We assess that 50% threshold every June 30. We will be conducting another assessment in 17 days. If U.S. shareholders increase above 50%, that will finalize the process to become a full U.S. 10-K filer. While there will be no change on the New York Stock Exchange, this is an SEC dynamic. We are not certain if this will occur this year until we complete the testing. We previously looked at our data and found that we are in the 40s in terms of U.S. holders, so we’re getting close to that milestone.

Our next question comes from Matthew Howlett of B. Riley Securities. Matthew, your line is now open. Please go ahead.

Can you hear me now?

Yes.

Yes. Apologies. My first question regards return on equity. Your return on equity appears to be in the high teens, normalizing for YPF and some expenses. Historically, pre-COVID, you have been in that range. How do you see the return profile for this quarter versus normalized expectations? What do you think is reasonable for fully deployed capital? You have discussed IRRs and other returns, but I would like to focus specifically on return on equity.

It is challenging to look at return on tangible equity on a quarterly basis. We have stated, in past statements, that we target a return on equity above 20%. We continue to see that, although it will be episodic or slightly bumpy. It is essential to view this on an annualized or rolling average basis rather than as a single snapshot.

Yes, exactly. We believe that this reflects the earnings power of the business over a multi-year rolling basis.

Additionally, our underwriters take this into consideration. When evaluating potential deals, we do not solely examine the gross IRR but also consider the expense load, which the team is very mindful of.

Thank you. The other question pertains to the case types and industries you are focusing on for new business; have you noticed any shifts in categories or sectors?

What I want to emphasize is our opportunistic approach. Our team can evaluate diverse case types due to our expertise in various areas, including patent, international arbitration, and commercial litigation. This diversity allows us to capitalize on a broad range of opportunities. When we identify a particular segment suffering from similar legal issues or claims, we may expand our investments in that area. However, that may not necessarily align with current economic conditions; we also spur geographic expansion. New businesses have been emerging beyond North America and Europe due to our increased resources allocated there.

Got it. Thanks for taking my question.

We have a couple of questions from the webcast. To begin with, Alistair Lindsay asks about the continued strong flow of milestone events through June 9. Were any of the milestone events noteworthy in terms of significant wins or unexpected losses? Nothing notable comes to my mind; I would characterize it as business as usual. However, since we are moving toward quarterly reporting, we won't be providing pre-reports on ongoing events. We anticipate discussing Q2 in our forthcoming quarterly report as this report was slightly delayed by our full-year results.

Another question from Miguel Gonzalo: Are we involved in the litigation claims relating to the Credit Suisse subordinated debt write-off? Do we have a legal view about that? Jon, do you have any comments?

Yes. We refrain from commenting on specific litigation matters, whether we are involved in them or not, unless they become public through other means.

It’s certainly a complicated situation. One must closely examine the underlying documents. Another question: at what point would our stock be considered for index inclusion? We are already included in relevant U.K. indices. For U.S. indices, the criteria combine trading volumes and share characteristics. As we build U.S. liquidity and trading volume, we hope to see progression toward U.S. index inclusion, but this is a gradual process. The next key step is the test at June 30. We will keep our plan to ensure this does not take too much of your time each quarter. We hope you found our quarterly data useful and informative. We will return soon to share Q2 results. Thank you all for your support; we are thrilled with how Q1 turned out and the opportunity to report these truly extraordinary numbers. We look forward to speaking again soon.

Thank you.