My personal investment trifecta: passive income, uncorrelated to stock market, good topic at a party (once we will be able to go to one).
A music royalties investment company, Hipgnosis Songs is the brainchild of Merck Mercuradis, former manager of Elton John, Guns N’ Roses and Morrissey; it was founded on the premise that hit songs are long-term predictable assets unaffected by economic cycles that will increase in value as the worldwide music streaming market grows. In addition to acquiring songs and songwriter catalogues, the company manages the playlist, cover, interpolation and synchronisation revenues of its IP. It’s market cap reached 1.25bln in December last year and its catalogue consist in more than 13.300 songs. Mercuriadis believes that a rights and song management company with substantial assets could change the existing economics of publishing for songwriters and aims of generating a 6.5% yield and 10% total return, with ongoing charges of 1.83%. The trust yields c4.17% at the moment.
The closed-end fund, listed on the London Stock Exchange with the ticker SONG, has stood out in particular due to the rapid nature of its growth: acquisitions are seemingly announced every week, unfortunately often with few financial disclosures. This has raised questions about the prices Hipgnosis is paying for the song catalogues and whether the deals can support the cash flow investors are expecting.
Is this a good investment?
The idea is quite compelling and not even that novel, the news here is that the opportunity is accessible to retail investors. Despite a constant cry from the music industry since Napster hit our pc, the sector is booming thanks to streaming services like Spotify. And it is really resilient: do you remember March last year? How many people that got laid off do you think cancelled their subscription to Spotify or Netflix? Music helps you navigate those depressing moments, I think there are lot of things people would give up to before even considering to click on the unsubscribe button. One thing is having to go to a shop to buy a new CD, another is to renounce to an habit consolidated in years, accessible from any device in your home.
The issue for the music industry is that it’s really hard to identify which song will be a success. Like books and movies, songs follow a power law: few hits brings a very big chunk of the sector revenues. After concluding the Harry Potter saga, in 2013 J.K. Rowling published a new book under a pseudonym. The book was well written, received good reviews from newspapers, critics and fellow writers…and it sold 500 copies. When a columnist discovered that JK was the real name behind the author, sales exploded 4000%. Being a good singer/songwriter does not mean you will ever reach success and we are (hopefully) ages away from a machine learning software able to find the next Gangnam Style.
Hipgnosis problem is different: the fund buys rights of songs that were proven successes in the past, would the price paid justify future revenue streams? As we said, the fund does not splurge in transparency; from publicly available information it seems rights were acquired at P/E of 13 but at current stock price, valuation is closer to 16. It is also debatable how long a success will last in the future: rights expire after 100 years but as journalist put it, do you listen to songs published 100 years ago? A P/E of 16 means that it will take a bit more that 15 years for your investment to pay itself, not a bargain but not impossible neither.
The PROs
It is good that rights are not managed by the artist; an artist focus is on the next thing while maximising their IP is so old thing. My brother is an industrial designer, once a product is out his attention moves immediately to the next project, sales (and his royalties) are an issue for the manufacturer. If you do not mis-use the product, like playing the song at a Trump rally (wink wink), it is a win-win for both parties: rights management is a burden for the artist because it consume attention that would be better employed elsewhere: creating art. For this reason the management company can acquire rights ‘at a discount’ to their full value.
As Mercuradis put it ‘We have a good team who come up with ideas and go looking for ways to implement them with the right partners. For example, it might be saying this song would be great for this movie, or that song would work in that game’. Possibilities are huge: with record investments in video productions (Netflix & co.) there is a bigger need for soundtracks; then there are musicals, videogames and streamers (yes, if you are on Twitch playing FIFA, you have to pay rights for the songs you make your audience listen to), commercials, podcasts, public spaces, sport events.
Sometimes it is about acquiring the rights at the right price, sometimes is about having the access to buy them full stop. As I said, there is a trust component in the sale because the artist is not interested in the payment alone, most probably they do not want their art to be used to promote a cream to cure haemorrhoids. The fact that Mercuradis and his team where pros in the sector is a big prop, they have connections and artists trust them because they were part of the artistic community.
Dummen Orange is a Dutch flower breeder and propagator that was bought by a Private Equity fund in 2015; the sector was fragmented with a lot of small players, the idea was to create a global player and save by scaling R&D, sales force and technology. The unseen risk of the strategy is that they replaced a CEO that knew the business with a CEO that knew finance: unfortunately his Excel sheet was good to calculate paper margins but not to tell how to stop spreading viruses in growing facilities or how the scaling strategy was actually making the company MORE dependent on one type of client, retail. Finance/MBA knowledge might help you to untap value in the company but the business that creates that yield you acquired needs specific know-how that you cannot take as a given.
The CONs
The negative aspect of having someone like Mercuradis running the show is that they are more likely to be obsessed about themselves than about extracting that last % point of value from a deal. I do not know him but I bet there is a lot of ego behind the creation of SONG. The risk is that he will turn out like one of those asset managers / CEO that are more interested in building their empire (acquiring assets) than maximising profits. So far SONG raised funds without any explicit target price for rights or any transparency on how exactly the funds will be spent. You need someone on the Board to keep that ego in check and I am not sure is there.
I am not a fan of closed-end funds, as for SPACs you can find the occasional exceptional opportunity but in general they are built to profit their sponsor instead of the investors. One of the key aspect to check is if current price reflects a premium or a discount compared to the fund NAV; right now the fund is priced at a small premium but that premium is higher if you actually value the NAV at the acquisition cost and not at the latest fair value. The devil is in the details and there are a lot of details here. The fund produces official reporting every six months, it takes quite a while to understand what is happening behind the curtains. A third party assesses the value of the music catalogue after the fund has acquired it, but this appears to have resulted in significant gains from 2018, despite the manager not having had sufficient time to add value or for underlying market assumptions to have materially changed. Fair valuation can move up or down because growth assumptions are revised or because of changes in the discount rate, the interest rate used to determine the current value of future cash flows. The higher the discount rate, the lower the current value of future cash flows. The higher fair value might have been driven more by the Bank of England than the skills of Mercuradis.
SONG assets might have indeed low correlation to the stock market but still the fund price went down in March 2020; if you need to sell for any reason, what you get is the price and not the fund NAV, so the uncorrelation part of the story is valid up to a certain point…which is true to any financial asset, when shit hits the fan you can find bargains basically everywhere.
Conclusion
I think there is a lot of potential here and the fact that the asset class is available is definitely a good news; that said there are loooooot of risks: I will probably buy some shares but I will definitely wait until there is some meaning full discount to NAV, at least low double digit. If the current uptick in long term rates has legs, a discount is probably coming in a not too distant future.
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