Nice work, also enjoyed your framework surrounding oysters and horses!
New to BUR which I found thanks to you, but applying the mental model of expected value (EV in this post, as opposed to the usual Enterprise Value) here could be useful. We know the size of claim to BUR (6.2bn usd) and we know the number of outstanding shares (223.56mm). So let's play around!
Assume we have three scenarios:
1 - full recovery and payment, lets say its probability: p=10%
2 - partial recovery and payment, p=30%
3 - no recovery, no payment, p=60%
Assume that any payment they receive have a probability distribution
after 1yr, p=10%
after 2 yrs, p=12.5%
after 3 yrs, p=15%
after 4 yrs, p=17.5%
after 5 yrs, p=20%
after 10yrs, p=25%
I personally use a 25% hurdle/discount rate, so have applied it here:
EV for the claim is +1.085bnusd ($4.85/share - adding the full EV would move the stock +37%)
Discounted EV is +435musd ($1.95/share- adding the full DEV would move the stock +57%)
*this is without factoring in additional costs they may have in enforcement/legal
Congrats on the new venture! I've been following you on twitter and I'm really excited about what's coming up here.
The idea looks really interesting in the current market environment where I find shortage of good counter-cyclical investments. This can be one to be used to add on weakness or when other cyclical parts of the portfolio over-perform.
What's your thought process on positioning in the idea given the possibility of lumpy/disapointing earnings?
You're right, the legal finance industry has a counter-cyclical nature to it. Litigation doesn't stop because of a recession, quite the contrary, corporate clients will be even more inclined to seek liquidity from their legal assets. On top of that, you have more bankruptcies in a recession which is a big segment within legal finance. The awards from successful cases are also not impacted by recessions nor are they correlated to the stock market in any way. Legal finance firms have performed well in the aftermath of the great financial crisis in 2008/2009.
In terms of positioning, the most important thing is to be patient and think long term. This is not a trade that I'm positioning for because of the current market environment or because I think that the share price will do well over the next 6-12 months. This is an investment in a great company that - in my view - will compound value at way above broad market rate over a long time and that the market underappreciates for non-fundamental reasons. I would suggest to think about it like a private investment, or in the Terry Smith way of, "Buy great companies. Don't overpay. Do nothing."
If I'm right about the direction of the two main value drivers, ROIC and deployments, then the answer is a lot. I try to be directionally right rather than precisely wrong, so I can't give you a concrete number, but here's an illustrative example for you:
If you can generate 30% IRR on your whole capital,
you're financed at 2/3 equity and 1/3 debt,
the income from your asset management business covers your operating expenses and
you pay 6% interest on the debt and 15% taxes,
then your equity should compound at just over 40% per year as long as you can find enough opportunities to invest your whole capital at 30% IRR.
Now, there are a lot of assumptions underlying that math, the main ones being:
a) IRR can be sustained at 30%
b) you have enough opportunities to reinvest your whole capital
c) your asset management income covers your operating expenses
a) and b) is what I try to argue in the write-up and
c) is not ambitious in the long run (in my opinion) but it's definitely not true right now.
And this compounding will not happen in a straight line of course due to the lumpiness of realizations.
Right now the ROE is >20% per year which is still plenty for a company that trades at roughly book value.
On top of intrinsic value compounding at high rates, you could get significant additional share price performance from multiple expansion once the sentiment about the company changes, which will only happen/matter, if I'm correct about the direction of the main value drivers over the long term.
Hi Zeljko,
Nice work, also enjoyed your framework surrounding oysters and horses!
New to BUR which I found thanks to you, but applying the mental model of expected value (EV in this post, as opposed to the usual Enterprise Value) here could be useful. We know the size of claim to BUR (6.2bn usd) and we know the number of outstanding shares (223.56mm). So let's play around!
Assume we have three scenarios:
1 - full recovery and payment, lets say its probability: p=10%
2 - partial recovery and payment, p=30%
3 - no recovery, no payment, p=60%
Assume that any payment they receive have a probability distribution
after 1yr, p=10%
after 2 yrs, p=12.5%
after 3 yrs, p=15%
after 4 yrs, p=17.5%
after 5 yrs, p=20%
after 10yrs, p=25%
I personally use a 25% hurdle/discount rate, so have applied it here:
EV for the claim is +1.085bnusd ($4.85/share - adding the full EV would move the stock +37%)
Discounted EV is +435musd ($1.95/share- adding the full DEV would move the stock +57%)
*this is without factoring in additional costs they may have in enforcement/legal
** I took the probabilities OMA (Out of My Ass)
So basically, the EV of the YPF claim = net debt.
Probably decent risk reward, good spot!
Congrats on the new venture! I've been following you on twitter and I'm really excited about what's coming up here.
The idea looks really interesting in the current market environment where I find shortage of good counter-cyclical investments. This can be one to be used to add on weakness or when other cyclical parts of the portfolio over-perform.
What's your thought process on positioning in the idea given the possibility of lumpy/disapointing earnings?
Thank you!
You're right, the legal finance industry has a counter-cyclical nature to it. Litigation doesn't stop because of a recession, quite the contrary, corporate clients will be even more inclined to seek liquidity from their legal assets. On top of that, you have more bankruptcies in a recession which is a big segment within legal finance. The awards from successful cases are also not impacted by recessions nor are they correlated to the stock market in any way. Legal finance firms have performed well in the aftermath of the great financial crisis in 2008/2009.
In terms of positioning, the most important thing is to be patient and think long term. This is not a trade that I'm positioning for because of the current market environment or because I think that the share price will do well over the next 6-12 months. This is an investment in a great company that - in my view - will compound value at way above broad market rate over a long time and that the market underappreciates for non-fundamental reasons. I would suggest to think about it like a private investment, or in the Terry Smith way of, "Buy great companies. Don't overpay. Do nothing."
Thanks, any rough idea at what rate you expect intrinsic value to compound?
If I'm right about the direction of the two main value drivers, ROIC and deployments, then the answer is a lot. I try to be directionally right rather than precisely wrong, so I can't give you a concrete number, but here's an illustrative example for you:
If you can generate 30% IRR on your whole capital,
you're financed at 2/3 equity and 1/3 debt,
the income from your asset management business covers your operating expenses and
you pay 6% interest on the debt and 15% taxes,
then your equity should compound at just over 40% per year as long as you can find enough opportunities to invest your whole capital at 30% IRR.
Now, there are a lot of assumptions underlying that math, the main ones being:
a) IRR can be sustained at 30%
b) you have enough opportunities to reinvest your whole capital
c) your asset management income covers your operating expenses
a) and b) is what I try to argue in the write-up and
c) is not ambitious in the long run (in my opinion) but it's definitely not true right now.
And this compounding will not happen in a straight line of course due to the lumpiness of realizations.
Right now the ROE is >20% per year which is still plenty for a company that trades at roughly book value.
On top of intrinsic value compounding at high rates, you could get significant additional share price performance from multiple expansion once the sentiment about the company changes, which will only happen/matter, if I'm correct about the direction of the main value drivers over the long term.
Again, none of this will happen over night.