Litigation finance provider Burford Capital (LON: BUR) has an impressive share price record since flotation a decade ago, and it is still around six times the original placing price, but it has fallen sharply over the past month. A report by a short seller has knocked the share price of the AIM-quoted company.

The share price slumped 516p to 605p having fallen the day before, and this is barely much more than one-third of the price less than a month ago. The stated NAV is $7.17 a share, so the share price is still trading at a small premium, even after the fall.

Muddy Waters published a 25 page report. It questions the way gains are set out in the accounts and it argues that most of the realised gains come from four cases. It also points out that Burford has sold parts of its share in claims at the end of trading period – providing a reason to upgrade the value of the case and thereby increasing reported gains in the period.

Ironically, the fact that Burford is providing more information has made it easier to compile the criticism.

Problems

If a short seller goes after a company there will be some weaknesses, because they are not going to go for a company with unquestionable figures and a realistic share price.

The four main weaknesses of Burford are (or were) a high share price, a large Woodford stake that may need to be sold, valuation of cases and poor cash generation.

Cash

The poor cash generation has been highlighted by others, so it is not a shock. Financial company accounts can be difficult to get to grips with which does not help.

In 2018, there was a $40.8m cash outflow, compared with an operating profit of $178m, and in the first half of this year there was a cash inflow of $6.7m, compared with a reported interim operating profit of $246m.

There have been cash inflows from operations in the past, but the outflows have been much more significant.

During this 18 month period, Burford paid nearly $36m in dividends. So, it has not even generated enough cash to pay the dividend. A further interim of 4.17 cents a share has been announced. Burford has paid dividends since 2011 and there has been a large overall outflow from operations in that time.

The reported profit is predominantly generated from investment income, but that includes movements in value of the litigation cases. This is not a cash movement it is based on the values assigned to the litigation in terms of the likely outcome.

Valuations

The NAV is $1.57bn and the value of investments is $1.77bn – that does not include additional amounts due from settlement of cases.

There is $637.8m of loan capital in the balance sheet at the end of June 2019, while cash was $276.3m. Burford says cash is currently more than $400m. Even so, the value of the business is based on the value assigned to the cases.

It is difficult to say for sure how much these investments are worth. The recent slump in the share price shows that belief in a valuation and prospects can decline rapidly.

Woodford

In Burford’s case, the Woodford stock overhang may be the greatest weakness, for the time being at least. Burford was the largest investment in the Woodford Equity Income Fund, which is closed to withdrawals at the moment. Burford was one of the more liquid shares in the portfolio, so it is an obvious investment to sell in order to payback investors.

An obvious seller will hamper the share price anyway and it provides a soft target for short sellers – even if a share price appears undervalued at the time.

Not over

The chief executive and chief information officer of Burford say that they will buy Burford shares once the company has published its detailed response. It has already released three statements today.

Burford accounted for 7% of the FTSE AIM 100 index, so it has dragged the index down.

The dividend yield is 1.9%, so that des not provide much of a floor to the share price, which is likely to continue to be volatile over the coming weeks.