Before it came under attack by US hedge fund Muddy Waters, Burford Capital (LSE: BUR) could claim to be one of the most successful stocks on London’s AIM market.
At the beginning of August, the company had a market capitalisation of £3bn, but this has since crumbled to £1.8bn following Muddy Waters’ attack.
Muddy Waters initially claimed that Burford’s accounting and governance practices are all wrong, and the company could be insolvent based on its analysis of the accounts. Soon after the report was released, Burford fired back. The litigation finance provider issued a rebuttal document disputing all of the claims against the hedge fund and threatening legal action.
In the days since, Burford has intensified its attack against Muddy Waters. On August 12, the firm issued a news release saying that after conducting a “forensic examination” of trading data from August 6 and 7 — the days when Muddy Waters published its dossier — there was evidence of “trading activity consistent with material illegal activity.” Muddy Waters immediately refuted these claims.
Posting on Twitter, the hedge fund wrote that it has “absolutely no trading capability” to make the kind of market manipulating trades alleged. It also called the accusations “preposterous” and promised to “smack” Burford down hard if the firm brings this evidence to court.
With Burford and Muddy Waters both digging in, it doesn’t look as if this spat is going to end any time soon.
The way I see it, investors have two options here. They can either stick with Burford or sell the shares. The question is, if you stick with the firm, how low can the stock go before staging a recovery?
The answer to this question isn’t simple. In reality, any share can fall to zero if the underlying company goes bankrupt. Muddy Waters claims that Burford is insolvent, but the company disputes this.
Burford might claim to be solvent, but the company has historically relied heavily on third-party finance to fund its operations and provide capital. For example, during the first half of 2019, the company recorded $751m of new investment commitments from investors, and this is where problems could now emerge.
Third party confidence
Muddy Waters’ attack on the company has undoubtedly shaken investor confidence, which might make it harder for Burford to raise capital going forward.
Unfortunately, the longer the fight between the two parties continues, the more likely it is that investors will avoid the firm. The one thing the market hates is uncertainty, and if Burford does take Muddy Waters to court, I think investors will sit back and wait for an outcome before committing new capital to the business.
This could have a severe impact on Burford, but at this point, it is impossible to tell how much of an impact.
So overall, while it seems unlikely that the firm is insolvent right now, the company’s operations are likely to be hurt substantially by the short attack.
Only time will tell if the business will be able to recover from this reputational damage. With so much uncertainty surrounding the business, I think it is probably best for investors to sit on the sidelines here and watch the battle between Burford and Muddy Waters play out.
There are a number of small-cap stocks that could be worth buying right now, and our investing analysts have written a FREE guide called "1 Top Small-Cap Stock From The Motley Fool".
The company in question may have flown under your investment radar until now, but could help you to build a great income from your investments and retire early, pay off the mortgage, or simply enjoy a more abundant lifestyle. Click here to find out all about it — it's completely free to do so.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.