Earnings Call Transcript - BUR Q4 2021

Operator, Operator

Hello and welcome to the Burford Capital Presentation of 2021 Full Year Results. My name is Lauren and I will be coordinating your call today. I will now hand you over to your host, Christopher Bogart, Chief Executive Officer to begin. Christopher, please go ahead.

Christopher Bogart, CEO

Thanks very much and hello everyone. Thank you all for joining us both on the telephone and via the webcast for our earnings call about our full year 2021 numbers. As usual, with me on the call are Jon Molot, Burford’s Chief Investment Officer and Ken Brause, Burford’s Chief Financial Officer, and we will walk you through the slides that you should have before you seriatim. I will start on Slide 3, which is really just an overall summary of some of the key things that happened during the course of the year. I would say that we are very pleased with our 2021 performance. This was the best year in our history for new business, not only in terms of the total amount of business that we wrote across all of Burford’s pools of capital, which translated into further growth in our now $5 plus billion portfolio of litigation assets. I’d particularly highlight the strength of the balance sheet commitments and deployments, which is of course where we maximize our returns for shareholders. We have also continued to produce strong returns along with very low losses. Before I go on in the slides, I will just comment on a couple of other things that I am seeing in the business. First of all, as we announced just yesterday, we have done the final closing now on a new fund, a $360 million fund that we call the Burford Advantage Fund. This fund is designed to fit in between the lower returning post-settlement fund activity that we have already been doing for a number of years and the traditional core high-return litigation finance matters. There was a gap in our product offering both to clients in the market and to investors, and this new fund fills this gap so that we now have really a complete end-to-end solution across the legal finance landscape. This new fund, which we raised from a number of large institutional investors, endowments and the like, comes with a structure that we quite like as well. These are assets that we anticipate returning roughly in the 12% to 20% range annually. The structure of this fund, instead of a traditional management and performance fee structure, pays the fund investors a simple 10% annual return and Burford retains any excess that we are able to generate. We do better with that economic structure than a traditional 2 and 20 style fund once we get not very far into that 12% to 20% range, somewhere around 13% or so depending on your assumptions. We are quite pleased with having that new fund available to us. We did a first close of it during the fall of 2021. You will see some activity in that during the course of the fiscal year, but the final close just occurred last Friday. I think in addition to just our happiness about having this incremental vehicle available to us, I think it also underlines the wide range of liquidity options and capital availability that we have. The other thing that’s nice to finally see is that the post-COVID world is resuming its pace. For example, we have talked for the last couple of years about the fact that we have largely not seen stall work things in the legal industry going on, like in-person conferences, which are significant marketing opportunities for us. Those are indeed resuming. I am in Europe right now and about to attend the first in-person large gathering of lawyers that I have been at since 2019. I am really excited to see the world reopening and having things come back to life. So turning to Slide 4, this again emphasizes the new business activity that we carried on in 2021. This is presented here on a Burford-only basis, in other words, just what we are doing on our balance sheet. I would really highlight for you the Burford-only deployments. This is where we make the most money. We obviously keep Burford-only profits for our balance sheet and for our shareholders as opposed to the activity that we do in our private funds. We love our private funds business, but the reality is we make a lot more profit when we invest directly from the balance sheet. To see Burford-only deployments effectively double year-over-year and reach a significant all-time high is a terrific setup for those assets to produce balance sheet shareholder-driven cash and profitability in the future. That applies to our core litigation finance assets. We are really putting our balance sheet capital behind those high-returning assets at the moment. Slide 5 talks about what’s going on in realizations. Those of you who have followed Burford for a while are fully aware that the timing of litigation resolutions is entirely uncertain. That’s not a bad thing. That’s what gives us our lack of correlation to the market and to broader economic activity. It’s also what generates the ability for us to earn the high returns that we have consistently been able to generate. If these cases were predictable both in substance and duration and timing, I don’t think that you would see the returns that you do. I think you’d see a different level of competition in this market. But instead, this is the one thing that one needs to contend with when you run a legal finance business, which is that we are in the hands of the litigation process and ultimately, the courts in driving the timing and the duration of outcomes. That’s always been present and you have seen the period-to-period unpredictability and variability in the past. There is no question that COVID has added to that uncertainty. What we hope for during the course of 2022 is to see some amelioration of that COVID-based uncertainty. When I talk about COVID delays, there are really two things going on. The first is that you are seeing delays in the litigation process itself, not in the court process, but the litigation process. When you file a piece of litigation, what happens for quite a long time is the parties engage in discovery, in the exchange of documents and witness testimony and so on, long before you ever go to trial. That process was interrupted by COVID. Sometimes legitimately, in the sense the parties truly couldn’t due to restrictions put on them because of the various lockdowns and restrictions. For example, in the Petersen case, we saw meaningful delays in the discovery schedule because literally the Argentine government offices were closed, and people could not go into them to retrieve and produce documents. Some of these delays are tactical. Defendants often seek delay and seize on any kind of reason to proffer for delay. There was probably some taking advantage of COVID that went along there as well. As the world reopens, those delays are significantly reducing. Unless we get another variant that causes more distress, you would reasonably expect those not to continue past this year. Courts are simply not going to be sympathetic to the idea any longer that witnesses can’t get on planes and sit through depositions and clients can’t produce their documents. I am looking forward to an improvement in that. Now, I said the same thing in the fall of 2021 and then we had Omicron. I am hoping not to be proved wrong by another pesky variant, but that’s the path that we are on there. The other kind of COVID delay relates to the actual scheduling of court proceedings and trials. It’s just as logical that, that’s a catalyst for settlement. If you’re just sitting there and nothing much is happening in your litigation, there’s not any particular reason that you would go out and settle it tomorrow, whereas an impending trial focuses the minds of the parties and brings them together for negotiation and ultimately, settlement. As you know, a clear majority of our matters end in settlement; they don’t all go to trial. What we see on the trial calendar and this varies jurisdiction by jurisdiction, is that we see backlogs that have arisen because of COVID, and those backlogs are due to the absence of physical distancing in courtrooms and the unavailability of jury pools, often prioritizing criminal trials. That backlog will continue to take some time to work its way through the system and that will vary jurisdiction by jurisdiction. It’s important to emphasize that this is all just timing. This has nothing to do with the substance of these adjudications. We don’t see cases discontinuing. We see incredibly low loss rates. They are so low because nothing much is happening in the cases. What that is, is confirmation that nothing bad is happening in the cases. It’s simply that things are taking longer to make their way through the system than they were before COVID. We are optimistic about what the future holds as we begin to work our way more rapidly through some of our own existing vintages that have not yet come to fruition. Turning to Slide 6, this is a familiar chart to many of you. Fundamentally, the message is that the business is continuing to perform strongly. We continue to be able to deploy most of the capital that we committed into cases. We remain with a robust level of settlements, which takes all of the litigation and risk out of these matters and a significant level of adjudication gains. We win much more often than we lose. I think the other thing to emphasize is that we have achieved nearly $2 billion of cash recoveries. This slide reflects cash, not fair value, it’s just the sheer consistency of both turning in those settlements and wins, along with the consistency of returns that we have been able to demonstrate. Slide 7 highlights two things. One, it reminds us of the asymmetry of our portfolio. Nobody rational spends or risks $20 million in legal fees on a $20 million claim. When we lose, we tend to lose less than the money that we make when we win. This chart shows that. The other thing it shows is the repeatability of what we do. We have 26 separate matters over time that have generated returns of over 200%, more than 3x MOICs. These are not flashes in the pan. This is a consistent, repeatable part of a litigation portfolio where there will always be some losses, but we expect to continue to produce some very high returns from cases that go the distance and deliver. Turning to Slide 8, this slide accompanies some text in the management statement in the annual report about a case study that we have put together. We try to do these every year when we have something to illustrate. This case study illustrates several dynamics we have discussed in the past. First, it shows the winding path of litigation. This is a case that has been running in our portfolio since 2013. From 2013 to 2021 when it resolved right at the end of the year, this case has gone through motion practice in trial court. It’s been dismissed, been up on appeal. It’s been overturned, and gone back to trial court for summary judgment again. Finally, with a trial judge imposed mediation, it settled before going to trial. This case took 8 years, but it still generated a 23% IRR and a 231% return on capital. It is simply wrong to assume that, because cases are old, there’s necessarily something wrong with them. All that age means is that the case is winding its way through the process. To be sure, some of those cases will probably lose, just like in the rest of our portfolio. But there is value in that back book, and this is a good illustration of the ability to take that value out. This also shows the impact of COVID. The case would have resolved more rapidly if we hadn’t had COVID. It’s an example of COVID-related delay. The slide demonstrates how our fair value approach operates in these cases, sensitive to the events in the case. Even when we reach the end of a positively positioned case, we still have only a relatively small minority of the ultimate outcome booked as fair value. This case actually went to zero at one point when we had lost in the trial court before we were able to turn it around and get it back to trial. More details are in the annual report, but this illustrates several points, including the application of our fair value policy. Turning to Slide 9, I am very pleased to say that we can report completion in the YPF matter; all of the discovery deadlines have finished. Fact and expert discovery have both reached the conclusion, and now we are on to summary judgment. What does that mean? It means several things. First, the case resumes some level of court activity instead of mostly just activity between the parties, exchanging documents and witness expert statements. You will also be able to see more about this case, because the summary judgment filings and proceedings are public open court matters, unlike discovery which doesn’t happen in open court. The parties will file their summary judgment motions in April. The plaintiffs will argue we have a strong case and we should win, while the defendants will argue the plaintiffs’ case is weak and they should lose. Each side will respond to each other's motions by the end of May and get one round of further reply in the third week of June. Once that legal briefing is complete, the court will decide whether and when to schedule oral argument, then we will await a decision on the motions. It’s possible for the court to resolve the case entirely on summary judgment without holding a trial or it may go to trial. If the case isn’t resolved in summary judgment, it will go to trial relatively quickly after the release of the summary judgment decision. If we win, the judgment is enforceable while the appeal is pending, unless there’s a bond posted, which is unlikely, or unless a court grants an unusual stay. After a long period of waiting, you will see some activity in the Petersen case this year; filings will provide more detail than has been publicly available. However, it’s essential to read the legal arguments with caution, as both sides will put forward their best case. Depending on the court's speed, you might even see a decision on these motions in 2022 as well. This case is significant in Burford’s portfolio, but won’t overshadow the strong performance of the rest of our portfolio. To discuss that, here is Jon Molot.

Jon Molot, CIO

Thank you, Chris, and thanks to all of you for joining. If we turn to Slide 10, that’s what I am going to talk about regarding the portfolio. We have a very large portfolio that has continued to grow; it's 15% larger at the end of '21 than at the end of '20, based in large part on a significant increase in our capital provision direct new commitments, which were up 80% from last year. The capital commitments have continued to increase over the last 5 years, with a compound annual growth rate of 43%. The diversity of what we have built is incredible. We still turn down many matters that come our way. We have a rigorous investment process. However, we have the internal expertise and market reach that prevents us from being limited to any one type of litigation or jurisdiction. Whether it’s intellectual property, contract disputes, business torts, or investor state disputes under an investment treaty, we handle it all. We want to serve law firms with diverse practices and companies with varied litigation portfolios. This diverse portfolio is what makes me optimistic about our future because it delivers future returns. If you turn to Slide 11, I’ll discuss one way we have grown our portfolio—monetizations and claim families. We’ve talked about this before. We build a diverse portfolio as we're able to take on all types of claims where there is legal risk. Once we invest in a matter and get to know it, we monitor its progression and see the risk/reward change. Sometimes it’s the same counterparty that comes to us to finance litigation expenses, then decides to monetize a portion of the receivable. Other times, it involves different companies sharing overlapping claims. We can take what we’ve learned and build our position. We have done this profitably; we double-down on investments we like. There are three distinct advantages to this strategy. One, if you like the investments, putting out more capital as the risk/reward improves is attractive. Two, our expertise adds value because we understand the risk more than the claimant. This means we can be a provider of smart capital. Companies choose us not based on price competition but based on the strategic value we can add. Thirdly, this strategy provides operating leverage; it's more efficient to invest more capital on risks we understand. This part of our strategy has grown our book without sacrificing diversification. Turning to Slide 12, I’ll briefly touch on our portfolio history and vintages by age. Recent vintages have a significant potential with many matters remaining to resolve. The older vintages from 2009 to 2013 have mostly resolved. There is only $39 million of deployed capital remaining among pre-2013 vintages, which represents just 3% of total costs of ongoing matters. Most of the capital is out in recent vintages where we've scaled up. While older vintages have profitable matters, real value lies in recent investments, enhanced by COVID-related delays, adding to the value of our portfolio. This leads me to be optimistic for the future. If you turn to Slide 13, we introduced probabilistic modeling last November. We use sophisticated probabilistic modeling as part of our underwriting process; every matter is modeled before we deploy capital. This powerful tool helps us allocate resources among the various matters in our portfolio. We have been using it for a long time but have only recently started sharing results publicly. Our modeling shows a more valuable portfolio than before, projecting a 137% return on invested capital and $3.8 billion in recoveries on $1.6 billion invested. This reflects a roughly 10% increase from previous modeling, showcasing the attractive opportunities as we allocate capital and advance our matters, even if COVID had slowed progress. This gives me a bullish outlook for our future and our portfolio.

Ken Brause, CFO

Thank you, Jon, and good morning and afternoon to everyone. I want to take a few minutes before discussing our financial results to mention the updates and enhancements we’ve made to our financial reporting. This is our first financial report prepared under U.S. GAAP. The U.S. GAAP rules are similar to IFRS rules, including issues like revenue recognition and fair valuing our capital revision assets. One change applied to past periods in IFRS is that we are now consolidating a subsidiary called Colorado Investments where the third-party interest in the Petersen claims we sold reside. This results in an increase of assets at period end of $383 million, but there is also a corresponding liability reflecting the 38.75% of the Petersen claim that was sold. As a result, there is no impact on Burford-only shareholders’ equity from this change. Third-party interest in consolidated assets reported as a liability under IFRS are now included in shareholders’ equity as a non-controlling interest. In our financial metrics for the year, we reported a net loss attributable to ordinary shares of $72 million or $0.33 per diluted share, which was at the low end of the range provided in our business update last month. Despite a strong year for new business, the slower case progress limited realizations, thereby affecting fair value adjustments and capital provision income for the year. We still recorded solid realized gains in line with 2019 levels, including gains related to Petersen sales. Other highlights include operating expenses generally aligned with previous years, apart from performance-related asset recovery items. Our tangible book value at year-end stood at $6.47 per diluted share, while Burford-only liquidity, comprising cash and equivalents, and marketable securities, remained at $315 million. Moving to Slide 15, Burford-only asset management income increased 6% year-over-year to $26 million, reflecting income from BOF-C, our arrangement with a sovereign wealth fund, as core litigation finance assets in that fund continue to season. We earn management fees for most of our managed funds during their investment periods. Performance fee income of $6 million remained unchanged from last year. Looking ahead, we expect to continue earning asset management income from BOF-C and performance fees from partners, Funds 2 and 3, BAIF, and BOF. Our models suggest these fees could amount to $400 million on a Burford-only basis going forward. We also closed on the Burford Advantage Fund, a $360 million fund that includes $300 million of third-party investments. Burford’s balance sheet deployments into the Advantage Fund will be considered capital provision indirect assets going forward. Turning to expenses, we have changed how we report operating expenses, particularly for compensation and benefits. Salaries and benefits should increase in line with headcount, while annual incentive compensation should move according to overall performance. Over time, we expect this percentage to continue to decrease as we make larger investments and emphasize monetizations and claim families. On our liquidity slide, Burford-only liquidity remains at $315 million. Marketable securities now represent a larger proportion of our liquidity, consisting predominantly of high-quality and liquid money market and fixed-income assets managed by one of the top fixed-income managers in the U.S. This approach allows us to earn an incremental yield on our liquid assets without taking undue risk. Although deployments exceeded cash receipts in 2021, our receipts covered operating expenses and financing costs and supported our growth due to a $400 million bond offering in April. Our liquidity position remains strong to capitalize on new opportunities as they arise. We see a slight uptick in our due from settlement receivables, with expectations for collection in the current year. Now to Slide 18, we have over $1 billion of debt outstanding. A £62 million note ($80 million) is maturing in August, for which we have ample liquidity for repayment. After that, our next maturity is in 2024, and our debt is well laddered. Our debt-to-equity ratio was 21% at year-end, well below covenants. We will actively manage our liabilities and continue to be opportunistic in issuing debt. We maintain our position that while this business should leverage, it should remain relatively low. I will turn it back to Chris for concluding remarks.

Christopher Bogart, CEO

Thanks, Ken. Turning to Slide 19, we were very pleased with the growth of new business in 2021, both across the business and particularly on a Burford-only basis, which sets those assets up to maximize future shareholder benefit. Despite some of the delays discussed, we had a strong year for cash generation, generating more than enough cash to cover all our operating expenses and financing needs. We have robust balance sheet liquidity and good access to capital from multiple sources. 2022 should be the year where something significant happens with YPF. We’re very bullish about where we sit today and what the future holds. I invite your questions.

David Chiaverini, Analyst

Hi. Thanks and thanks for all the details, very helpful. It’s great to see the strong rebound in new commitments and deployments. Any commentary on the outlook for additional commitments and deployments?

Christopher Bogart, CEO

We don’t really guide going forward, as you know. But it’s fair to say that we see activity in the pipeline of the legal industry. We provided some statistics about new litigation filings in U.S. courts showing both civil and bankruptcy cases fell to 5-year lows in 2021. That does not mean there’s a scarcity of litigation; it just suggests some pent-up demand in the system. There’s likely active litigation pending as people have been slow to file during COVID. It’s interesting to see how this pent-up demand plays out. As for insolvencies, they’ve historically provided us with decent business. With the stimulus withdrawal, the downward trend in insolvencies stands to reverse.

David Chiaverini, Analyst

Great. That’s helpful. Can you talk about your liquidity, $300 million in cash, and the $84 million debt maturity coming up? Can you discuss your capacity to take on additional opportunities?

Christopher Bogart, CEO

It’s not something we would anticipate doing. We think our liquidity is strong and adequate for the business we want to do. We have multiple alternative paths available to us. In 2021, one of the larger deals we did wasn't liquidity constrained; it was a risk management matter. For example, we took on an extra $100 million of exposure in a sidecar arrangement with our sovereign wealth fund partner. We have many options on the liquidity front that help us avoid needing to turn away business.

David Chiaverini, Analyst

Awesome. Last one is regarding changes in the competitive landscape, any new entrants or existing competitors becoming more aggressive?

Christopher Bogart, CEO

We discussed competition in the management statement as well. There has always been competition in this business, which is positive. A rising tide lifts all boats. No significant seismic changes have occurred in traditional commercial litigation financing. New entries and exits are common as they discover how challenging this business can be. Hedge fund capital is flowing into areas we don't focus on, mostly into the U.S. mass market and consumer litigation finance. In our niche, the commercial end of the market, there haven’t been dramatic changes.

Julian Roberts, Analyst

Will the duration of assets in the Advantage Fund be shorter than for the average balance sheet asset?

Christopher Bogart, CEO

Not necessarily. We have a wide range of asset durations on the balance sheet. You will see a similar range of durations in the Advantage Fund. Some matters will indeed be shorter than traditional funded standalone litigation claims, but we also have shorter duration matters on the balance sheet.

Julian Roberts, Analyst

Can you talk about claim families? The North American food and beverage antitrust claims seem to be making progress with recoveries on three assets, two being portfolios. How do these relate to the other claims in the family?

Jon Molot, CIO

It’s not surprising that in a large claim family with multiple lawsuits, settlements would occur at different times. It’s premature to predict ROICs based solely on early activity. The first settlements might lead to attractive IRRs, but lower ROICs as they save costs associated with uncertainties. Ultimately, it depends on the facts of the individual cases and risk appetites of the parties. We do see that settlement activity often indicates progression, but should rely on hindsight to evaluate the success of litigation.

James Hamilton, Analyst

Thank you for the presentation. On Slide 13, you highlighted your projected ROIC at 137%, historically 93%. Is there a major duration difference between the two?

Christopher Bogart, CEO

It’s not just about avoiding profit guidance; our modeling is historically accurate at predicting outcomes. However, we cannot reliably predict duration. The modeling aggregates multiple durations, and while we aim to share valuable metrics, it’s tough to separate IRR from ROIC projections.

James Hamilton, Analyst

On the Advantage Fund, the top end of your IRR guidance is 20%. Does this correspond to a 50-50 split with clients? Can you clarify the super normal returns and their implications?

Christopher Bogart, CEO

The economics depend on negotiations, and the 10% is a simple, non-compounding number. The super normal provision ensures we are not incentivized to take on excessive risk. Regarding the timing, we don’t project, but we’re not trying to finish in one year. This fund has a 3-year investment period, and we’ve already deployed around $60 million.

Trevor Griffiths, Analyst

Do you have any Russian exposure subject to sanctions or reputational risk?

Christopher Bogart, CEO

No. Burford has never done business requiring enforcement against assets in Russia or Ukraine. We don't take on cases where we doubt the integrity of underlying court systems. There have been instances of enforcing outside Russia, but that's not a significant part of our business.

Richard Howlett, Analyst

On the YPF case, can you outline various scenarios and related timetables for receiving cash settlements?

Christopher Bogart, CEO

The most bearish scenario is a loss, which we don’t see as likely. If that happens, it would be because the judge favors Argentina's legal arguments. In terms of cash payment, specific plans for enforcement and settlement are strategic and case-specific; we're not discussing them before public developments. Argentina, in the past, has paid judgments, but negotiations after losses are common.

Jon Molot, CIO

Thanks everyone.

Operator, Operator

This concludes today’s call. Thank you for joining. You may now disconnect your lines.