Shares in litigation finance provider Burford Capital (LSE: BUR) are plunging today after US research firm Muddy Waters published a damning report on the business.
The report accuses Burford’s management of manipulating the figures, misleading investors and colluding with Neil Woodford’s protégé Mark Barnett to juice the returns on its litigation investments. Muddy Waters concludes that, based on its research, the firm is facing liquidity problems and could be insolvent.
A tower of cards
Yesterday, Muddy Waters revealed that it was planning to publish a short report on a UK-listed business this morning. Rumours quickly spread through the market that the target was Burford and the stock started to slide.
Management decided to preempt the report by issuing their own statement this morning. In the statement, the company declared “Burford’s cash position and access to liquidity is strong” and “our litigation finance returns rose to their highest-ever levels as of 30 June 2019.“
Burford’s update also noted that the company “uses the same IFRS accounting that is used widely across the financial services industry and has used consistent accounting policies for many years.”
Muddy Waters disputes all of these claims. In its report, the research outfit claims that Burford is “a poor business masquerading as a great one,” and the firm “woos” investors with “non-IFRS metrics,” which are “meaningless.” The report goes on to state:
“We have identified seven techniques through which Burford manipulates its metrics to create what we believe is an egregiously misleading picture of its investment returns. These manipulations usually involve Burford either giving itself credit for a recovery when one is uncertain (or even highly unlikely) or ignoring cases that are likely to be failures.”
Furthermore, Muddy Waters has reviewed Burford’s published financial metrics and believes it is “financially fragile.” The company’s “operating expenses, financing costs, debt, and funding commitments,” put the business at “a high risk of a liquidity crunch,” it states. The report goes on to speculate it is possible the enterprise is already insolvent.
Time to catch a falling knife?
Considering all of the above, it is no surprise that investors have rushed to sell Burford following the report from Muddy Waters. If the allegations turn out to be correct, then the stock could be worth nothing.
At this stage, we do not know if there is any truth to these allegations of insolvency and accounting manipulation. However, Muddy Waters has presented compelling evidence suggesting that Burford has been manipulating recovery figures, in particular. This is enough, in my opinion, to sell the shares.
The problem is, as investors, we have only have a limited view of a company’s financials and operating performance. We have no choice but to take what management says at face value. If we cannot trust management, then that is a big red flag in my mind. With this being the case, I think Burford needs to prove that the accusations are incorrect before trust is restored and it is better for investors to err on the side of caution here.
All in all, I think it is best to avoid the shares even though they might look undervalued after falling 60% in two days.
