In a letter published to its website, Muddy Waters explained it would be shorting the litigation finance firm after discovering it had been manipulating metrics in its financial accounts to convince investors it is producing meaningful returns across a broad spectrum of cases.
It said that for years Burford had been the “ultimate ‘trust me’ stock”. By using “a light disclosure regime, the esoteric nature of its business and unethical behaviour by its largest shareholder Invesco it turned Enron-esque mark-to-model accounting into the biggest stock promotion on the Aim.”
Muddy Waters not impressed by non-IFRS metrics
But this illusion was shattered when the litigation firm began publishing more detailed investment data this year which proved it had been “egregiously misrepresenting” the state of the overall business by relying on “misleading” non-IFRS metrics like return on invested capital (ROIC) and internal rates of return (IRR).
“Burford is a perfect storm for an accounting fiasco,” the short seller said. “It is a fund that invests in an illiquid and esoteric asset class, which few investors can understand well. By remaining listed on Aim despite being a midcap company, the company’s disclosure requirements are lighter than they would be for the main board – and far lighter than they should be. By choosing to account for its litigation investments as financial assets, Burford utilises fair value accounting for a balance sheet largely comprised of Level 3 fair value assets (i.e., “mark to model” accounting of Enron fame). Burford disingenuously blames IFRS for needing to take (outsized) fair value gains when in fact, it was Burford’s choice to adopt this accounting.”
Muddy Waters also criticised the lack of independent oversight at the litigation finance firm, noting that the current CFO Elizabeth O’Connell is the wife of the founder and CEO Christopher Bogart.
“Under the best of circumstances, this should alarm investors; however, with a company that consistently books non-cash accounting profits, it is unforgivable,” it said.
Burford denied the short seller’s claims about the company’s liquidity, returns and accounting standards.
“Burford has never been contacted by Muddy Waters and has not had any prior sight of its work. We will review the report thoroughly and respond to it as rapidly as possible,” the firm said.
Barnett bail out
Muddy Waters singled out Invesco UK equities head Mark Barnett by name in its exposition of Burford.
After doing a deep dive into the company’s accounts the short seller found the bulk of the group’s net realised returns have come from a very small number of cases which stands in “stark contrast to the impression many investors seem to have that the portfolio produces meaningful returns across its breadth.”
It found that just four cases have produced 66% of Burford’s net realised gains between 2012 through H1 2019. One of these outsized contributors was a loss at trial, the US research house said, and was bailed out by Invesco “at the direction of Neil Woodford protégé Mark Barnett.”
“Absent the bailout, the case almost certainly would have been a total loss,” the firm said.
Invesco has also disputed Muddy Waters’ version of events. “We categorically refute any accusation of improper or unethical behaviour on behalf of Invesco or fund manager Mark Barnett,” a spokesperson for the company said.
“Invesco has been a long term shareholder of Burford Capital and held investments in Napo since 2006. These investments were made and overseen in line with our robust investment and independent oversight processes. Invesco’s legal advisers are reviewing the accusations and we expect we will be able to make a broader statement in due course.”
Bad news for Woodford
The explosive note from the California-headquartered investor sent Burford’s shares crashing 52% lower to 535p on Wednesday.
The downward move in shares will bring more pain for Neil Woodford, the second largest stakeholder in the business, who is trying to reconfigure his frozen equity income fund, which is set to reopen come Christmas.
Records from the company’s website show him owning a 9.48% stake, while his former employer Invesco is the largest shareholder with 13.9% of the issued share capital.
Woodford Investment Management declined to comment on the note from Muddy Waters.