Description

Please note the price is expressed as a unit price and not a % of face value of the claim.

Summary

While Burford has been written up several times on VIC (and we believe is an attractive investment opportunity), one of their principal assets, units in the Petersen litigation (“the units”) against Argentina and YPF related to the latter’s expropriation by the former, is tradeable and has not been the subject of a writeup.  It is currently trading for around ~17% of the value of the recent judgment which represents a >50% discount to Argentina’s sovereign bonds. 

We initially studied the situation as a component of our Burford work and concluded that the risk/return of the units was highly attractive as well. While this is a relatively obscure structure (an SPV that’s only asset is the litigation claim), it has a tradeable market cap of approximately $550 million and is fairly straightforward to trade and settle. 

Before going into the background of the investment, some comments on the structure of the units would be helpful. They represent an economic share of the receivable to the plaintiff’s stemming from the Petersen litigation.

Burford did a good job explaining this here (https://investors.burfordcapital.com/news/news-details/2023/BURFORD-CAPITAL-STATEMENT-ON-YPF-DAMAGES-RULING/default.aspx) but in summary, if you take the $16Bn total judgement, $14.3Bn is for Petersen and $1.7Bn for Eton Park (a parallel litigation from another YPF shareholder). The units are only related to the $14.3Bn. From there, you multiply by 58% to get to Petersen’s net entitlement of the units (58% * $14.3Bn = $8.3Bn). There are 40,000 units outstanding (each represents 10,000 shares). This gets you a unit face value of ≈$21,000, or $21 / shr. Burford continues to own 61.25% of the claim and is shouldering the burden of enforcement. The total market value of the 38.75% outstanding is ≈ $560M.

The units today are trading around $3.60, or ≈17% of face value. As mentioned above, Argentine sovereign debt is at ≈39%, putting the claims at a >50% discount despite some favourable characteristics relative to the sovereign.

We believe the standalone risk-reward of the units is attractive, but not for everyone given the nature of the investment. If, however, you are invested in or looking at Argentina (and don’t need to invest billions of dollars), we believe the units offer a superior risk reward to the Sovereign.

Background of the YPF Expropriation

With Judge Preska of the SDNY having already rendered her ruling on merits (March 31^st, 2023) and final judgement (September 15^th, 2023), the district court portion of the case is mostly wrapped up with the matter now pending appeal at the 2^nd Circuit Court. That said, some background on the events that precipitated the litigation as well as the course of the litigation itself are likely helpful.

In 1993 Argentina privatized YPF through an IPO on the NYSE. To increase the chances of a successful IPO, YPF’s corporate bylaws were amended to protect investors against the risk of expropriation. Notably, Sections 7 and 28 of the bylaws promised that any subsequent acquisitions of a controlling stake, explicitly including by Argentina itself, would be conditioned on the acquirer tendering for all remaining shares at a predetermined price based on a series of formulae.

In 1999, Repsol of Spain acquired 98% of YPF shares for over $15Bn. Almost a decade later, in 2008, the Petersen Group (a Spanish holding company owned by the Eskenazi family, wealthy Argentine businesspeople) acquired 15% of the shares from Repsol. In 2011, Petersen acquired additional shares bringing its stake to 25.4% (or about 100M shares out of 400M outstanding). These are the shares on which the litigation is based.

In April 2012, Argentina’s president, Cristina Kirchner, announced plans to expropriate a 51% stake in YPF controlled by Repsol but did not tender for the remaining shares held by, among others, the Petersen entity. As a result of Argentina’s plan to expropriate YPF, the shares plunged, Petersen defaulted on its debts and was forced into a Spanish insolvency proceeding.

In 2015, Burford acquired the rights to prosecute the claim against Argentina and YPF from a Spanish insolvency proceeding and filed suit in the SDNY for breach of contract against Argentina and YPF.

Case History

When Burford initially took on the Petersen case, one of the biggest risks was getting past the issues of sovereign immunity and making sure the case would be tried in a US court as opposed to Argentina. This part of the process was litigated heavily and took over 4 years to resolve. The district court ruled in Burford’s favour and Argentina appealed. The 2^nd Circuit in July 2018 upheld the district court’s order that the SDNY had jurisdiction to hear the case.

The 2^nd Circuit’s ruling, while focused on jurisdiction, indirectly addressed some of the main arguments Argentina has made in their affirmative defenses in the past and will likely use again on appeal. Some highlights from the ruling are below:

“To start, we agree with the district court that, under the bylaws, Argentina's expropriation triggered an obligation to make a tender offer for the remainder of YPF's outstanding shares.”

“Simply put, section 28(A) compels Argentina to make a tender offer in accordance with the procedures set forth in the bylaws if "by any means or instrument" it "becomes the owner [of], or exercises the control of," at least 49% of YPF's capital stock.”

Once back at the district court, defendants put forward their affirmative defenses now focused on the merits of the case itself, rather than the forum it would be heard in. Motions for summary judgement were filed in April 2022 and the case was fully briefed a few months later

The major events came on March 31^st 2023, with Judge Preska deciding in favour of Petersen’s motion for summary judgment against Argentina (though not YPF which is off the hook for now) on merits and a minimum level of damages. She also scheduled a trial to determine the precise quantum of damages owed by Argentina.

The trial on damages was about two issues, the precise price which Argentina should have tendered for the YPF shares to comply with the bylaws and the applicable prejudgment interest rate. Last September, both were decided in favour of plaintiff’s yielding the $16Bn damages value.

While there has been some minor back and forth in the court since (given the size of the litigation, Argentina is taking every opportunity to delay the process), the district court’s role is for now mostly resolved, (though if this proceeds to enforcement Judge Preska will continue to be involved, a positive given her history with the case and our perception of her skepticism of Argentina’s scofflaw behavior)

Steps from here

Judge Preska recently ruled against an Argentina motion requesting more time before Burford can begin enforcement proceedings. Burford will likely have authority to begin enforcement against Argentina  in the near term.

Argentina is appealing to the 2^nd Circuit (though has yet to file their opening briefs) and this will likely take around a year to resolve once filed. Given the clear cut breach of contract that occurred (Argentina said they would tender for the shares if they reacquired them after the IPO, then they acquired the shares and didn’t tender), the senior judge at the District Court and highly briefed record/trial, the 2^nd Circuit’s existing impressions of the case and the low base rate of 2^nd Circuit overturning civil appeals, we think it is unlikely (though to be clear - not impossible) that Argentina prevails on appeal. Having done exhaustive diligence with two sets of Argentine counsel as well as two sets of New York Law counsel Argentina’s arguments are mostly very weak and were decided convincingly on summary judgement. This case was so extensively briefed and litigated and there were not significant disputed facts, but rather questions of law. This is unlikely to be a “rabbit out of the hat” or “smoking gun” type of appeal which surprises the plaintiffs. Additionally, we believe there is some probability (albeit relatively low) that YPF is added to the judgement which would not impact the size of the claim, but could help facilitate collection efforts.

You are likely thinking “are there really $16Bn of foreign assets available for Burford to seize?” and the answer is no, there likely are not. That is not, however, the point of enforcement actions. They are meant to cause sufficient pain, friction, and frustration to the sovereign that they decide negotiating a settlement is preferable to avoiding payment.   Also, while the $16Bn is clearly a massive judgement, to put it in context Argentina’s GDP is expected to be >$500Bn and it has ~$400B in sovereign debt.   

Experts we’ve spoken to, including one of the top lawyers in the field who has led other high-profile cases against Argentina, were optimistic, that given enough time, an enforcement strategy would bring Argentina to the table. This was before the election of Javier Milei.

Javier Milei’s electoral win (by a significant margin) is a meaningful positive for the investment. The election and subsequent moderation of Milei’s more radical views led to a rally in many Argentine assets (Argent 2030 $ bonds jumped from 29-cents to 39-cents, YPF stock from ≈$10 to $17 etc).

While Milei’s respect for free markets and the rule of law more broadly is clearly a positive, his specific commentary around the Petersen litigation at the end of December (https://www.lanacion.com.ar/politica/javier-milei-adelanto-que-planea-crear-una-tasa-kicillof-un-impuesto-para-pagar-los-us16000-millones-nid26122023/) is particularly relevant to the claim. In a smart political move, he has stated he plans to create a Kiciloff tax (named after Axel Kiciloff, the Deputy Economy Minister in 2012 who presided over the expropriation) in order to pay the litigation. An unfortunate and potent reminder to Argentines of the follies of economic populism and a politically savvy way to deflect blame for paying foreign creditors.

Despite a huge rally in Argentina assets and the commentary/focus of the administration on the Petersen litigation specifically, the units didn’t trade up much and now trade at wide discount to the sovereign. We believe this is likely due to their lower visibility and trading liquidity and timing of the announcement (right after Christmas, before New Years) and likely sets up well in the near-term as investors return to their desks in 2024.

How to think about Valuation?

Pre-judgment, the value of the claim was a function of litigation risk (would we win?), how large would the claim be (there was uncertainty as to the required tender price and prejudgment interest rate) and how much we could ultimately collect? Following the district court’s judgment, we believe the main input into claim valuation is the third question on collection, though appeal risk remains.  

At bottom, collection will not be a walk in the park and could take many years. That said, there are reasons for optimism and multiple shots on goal.

1. Milei willingly settles:

Most importantly, we believe the election of Javier Milei is a gamechanger. While we certainly don’t think it means he will pay in full tomorrow (or perhaps ever), just the fact that we are contemplating them willingly paying this without enforcement action is a 180 degree turn from dealing with Kirchner and the more radical faction of the Peronists. We believe that as (if?) Argentina’s economy stabilizes, there is a significant likelihood that he will negotiate a settlement with Burford regarding the claim, on its own or part of a broader debt restructuring. This route, which might not have existed before the November election, is in our opinion the most likely outcome. As mentioned above, he has already publicly stated his willingness to pay as well as discussed the outlines of a tax that would raise that revenue. His finance minister, Luis Caputo, was part of the team that settled with the holdout creditors in 2016.

2. Burford pressures Argentina via enforcement actions:

If Milei changes his political convictions on free markets (unlikely) or the economy is so poor it restricts his ability to negotiate a satisfactory settlement (which is possible) with the plaintiffs, Burford can begin enforcement proceedings to apply more pressure. Collection is a core competency of Burford and their team is considered one of the best in the world (recently collected $100M+ from a Russian oligarch, which many didn’t think was possible). This is a huge position for Burford, so they will be highly motivated to pursue all possible options. While the Foreign Sovereign Immunities Act (FSIA) puts some significant limitations on Burford’s ability to seize assets in the US, there is still a lot they can do domestically (disrupt capital flows, subpoena Argentine leadership about hidden assets abroad to cause personal embarrassment, raise cost of capital, limit imports and exports) and these FSIA rules do not apply to many other jurisdictions in which Argentina has assets and trade/capital flows across Europe and Latin America.

It is well known that Argentina fights judgments tooth and nail. What is less well known is that across many circumstances, they actually settle and pay them. These include Repsol ($5Bn), 8 resolved ICSID awards, other judgements (Total, NML, various treaty claims) at anywhere from 50-75-cents on the dollar.

Each of these settlements has unique circumstances rendering them helpful, but not perfect case studies. Some of were settled during a better economic situation. They were all smaller (though NML and Repsol were huge too). Some were during Peronists administration, others Cambienos. ICSID awards have different enforcement rules. Repsol involved Spanish-Argentine government relations. Burford doesn’t have access to the pari passu clause of sovereign debt that Elliott had etc…

But in certain key aspects, we believe the claim is a superior instrument to sovereign debt. Importantly, Judgements have no expiration date, so we have a perpetual option on more favorable economic or political circumstances. While Milei may be fighting an Omnibus bill through Congress in a moribund Argentine economy today, things could look quite different in a few years. We are not macro experts, but there are numerous positive tailwinds if Argentina can get through this reform period (lithium, energy reserves, more competitive official exchange rate, YoY improvement in crop exports following a historic drought). The lack of collective action clauses in the claim means that unlike sovereign debt, we cannot be dragged into a collective restructuring on terms we disagree with and can control our own destiny. Argentina also needs access to foreign capital, and doesn’t want to become a pariah state like Venezuela.

While the claim might be settled as part of a broader debt restructuring (see #3 below), it is also possible that much larger parts of Argentine’s debt (sovereign, multilateral) are restructured first. This could give Argentina fiscal breathing room while the claim remains outstanding against a far more solvent Argentina. While this would push out recoveries, it could also lead to a higher % of face value being recovered and a significant boost to the multiple of money returned.

3. IMF pressures Argentina into a comprehensive restructuring

The IMF has released several working papers indicating that going forward, they want debt resolutions for sovereigns to be more all-encompassing than just sovereign debt. This could include ICSID awards, litigation and importantly debt from other nations or multilaterals. While we don’t know today how each claimant would be treated, it is unlikely Burford would agree to a deal that they did not consider fair and the IMF cannot force Burford to release their claims

While we wait, the judgement is accruing interest at a rate of 5.42% per annum, or >$1 per share which is >25% of the market value of the claim.

We think the mispricing of this asset likely has less to do with its economics than its obscure structure, historically small float (before the court victories, the tradeable market cap was <$150M), and the recentness of the positive fundamental developments and simplification of the story.

In summary, we believe there is a decent chance these claims payout closer to 35-65 cents on the dollar in the next few years. Using 4-years as a midpoint, this would equate to a 2.5x to 4.7x multiple of money over that period. Alternatively, if one is already long the sovereign bonds, we think these represent a superior risk return given the >50% discount.

DISCLAIMER: THIS IS NOT A RECOMMENDATION. The securities described are neither a recommendation nor a solicitation. There are no assurances that securities identified in this note will be profitable investments. The stated opinions are for general information only and not meant to be predictions or an offer of individual or personalized investment advice. This information and these opinions are subject to change without notice. Security information is being obtained from resources I believe to be accurate, but no warrant is made as to the accuracy or completeness of the information. Any type of investing involves risk and there are no guarantees. 

Catalyst

More awareness of security and the recent positive developments, Argentina economy stabilizes, Argentina government takes steps to settle