SONG 2

More than three years ago I wrote this post about SONG, a closed-end fund listed in London that invests in music royalties. I would not explain again why I think investing in music royalties is a good idea, if you are curious, read that post. Many things happened in these three years (see the graph below) and it is a good opportunity to summarise some lessons, on this particular fund but also on investing in general.

It is also a great moment to trick you into thinking how prescient I was:

“The negative aspect of having someone like Mercuriadis 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.“

In fact, all the (bad) things that occurred are related to Mr Mercuriadis and his acquiring asset frenzy. Music royalties are not that different from any other investment, the price you pay heavily influences the final return. There might be a moment when you can be in a rush to buy assets, but that moment should be when everyone else is shitting in their pants. The proverbial blood in the street. Go and check what Howard Marks did after 2008 as a great example (and what he did not in 2020). Mercuradis frenzy was ill-timed and more so considering who he was buying from…not exactly the most money-savvy guys in the world.

I understand he wasn’t the sole potential buyer for this asset. It’s worth considering that purchasing rights directly from Justin Bieber, even at the height of his success, could be a more beneficial approach than acquiring them from a Private Equity shop in the future. But still…

He used all the funds he had as soon as he could; even more, since SONG could go up to 1.3x leverage. The leverage was in the form of a revolving credit facility with floating interest rate. When rates were at zero, leveraging up to acquire assets that could generate 5% to 6% recurring profits seemed like a no-brainer. Unfortunately, it is a no-brainer if you use fixed debt (at least until you have to refinance). SONG decline started when rates shot up: Mr Market was suddenly not at ease anymore with the prospect of having to deal with almost 6% borrowing costs instead of 1%.

Inflation and the cost of debt

Using leverage myself, I was not that surprised about the market reaction but I found it mislaid. Sure, it might be temporarily bad to have to deal with higher cost of funding but after the initial shock, revenues should increase and re-align with the new reality. If the quality of the assets matches expectations. Music royalties should be a good inflation hedge because they have pricing power (again, subject to asset quality): how many of you have cancelled your Spotify subscription in the last three years? Spotify indeed increased their sub prices and if you are selling to them and they would not want to renounce Bieber songs, you should increase your revenues too.

SONG revenues did not increase that much in the last three years (if I recall correctly), which means the acquired assets were not 100% worth the price.

Allegedly, a royalty fund should generate more revenues from the same rights because the fund’s management is concentrated on that: maximise profits. An artist might be reluctant to see their song used to boost haemorrhoid cream sales but the fund does not care. Music is everywhere, Netflix shows, musical gigs, radio, elevators and the fund is set to monetise by pushing their songs instead of others.

Well, turns out that Mercuriadis didn’t give a damn about it. That would be a quality over quantity reasoning. Merck was so focused on asset gathering that he partnered with Blackstone, a Private Equity shop, and opened another fund with them, this time for Blackstone clients only. Conflict of interest anyone?

At the height of the crisis, Mercuriadis even tried to sell some assets from SONG to the Blackstone fund: imagine the process of setting the price on that sale; on one side, as a shareholder, you have one of the biggest, most resourced PE fund in the world, on the other a bunch of retarded retail investors like me.

In hindsight, Mercuriadis management ticked all the boxes of the worst possible fiduciary act: hidden and not-so-hidden fees for himself, overvalued assets, and a golden parachute in case he was fired. Because in the end, he was indeed fired by the shareholders (closed-end funds have at least this control mechanism in place, I save you the technicalities of it).

I was a spectator in this crazy show. A spectator with an interest. A decade ago I learned how to build a position in a stock: you divide the ideal allocation by 4, buy 1/4 of the position, use a second 1/4 to average the price if the market goes against you and the last 1/2 is for short-term trading to buy the dips and adjust the carrying price. No worries if you did not understand, it’s been a while since I stopped investing in single names (the fact that I cannot articulate the strategy well enough is not uncorrelated to that decision), it was just to say that I first bought a small SONG bite of what might have been the final allocation.

I knew that the first purchase was at a premium but it did not matter: I needed to have skin in the game to start to care and do the homework (I am like this, what can I say…) and I could adjust the price later anyway. Ultimately, we are talking about fun money here, with a sprinkle of bragging points of having a weird investment while being a “content creator”.

At least I was aware enough of the issues of the investment that I did not jump to buy another clip when in 2022, the market started to offer me discount after discount. As time passed, the bad news was piling up but not to the point that I considered divesting: in a classical fashion, the fund price moved from premium to discount. At that point, I really wanted to buy more but I wanted to apply another lesson: I needed a catalyst to trigger the buying and avoid the proverbial falling knife. For an investment of this type, where you have even less information than normal, the only valid indicator is price: if the situation changes, insiders will start to buy aggressively because the assets would be clearly undervalued (to them). In order to avoid a dead cat bounce, I wanted to see the price stay convincingly above the 200 MA; what does it mean “convincingly” and why the 200 MA? There is no written rule but at this point of my life I trust a bit my eye (I easily spent more than 50k hours watching price graphs, so much for the 10k rule).

Here comes the cavalry

Turns out the fund’s assets are indeed of a higher value, so much so that in the last few weeks a bidding war started between two other funds to OUMPH! the whole cake. The war started before SONG price reached my trigger point, so from a “resulting” POV my strategy didn’t work. But I am happy about it: I did not have any particular insight that would have meant I could have been more aggressive…only my cockiness.

It is still a Pyrrhic victory, even if the final bid might be higher than my purchase price. I was interested in the long-term value of the asset and whatever I do, I would not realise that. Unfortunately, in a world that is still awash with liquidity, this would happen more and more. It is the same curse of small-cap value: if you really find value, some big whale would pull the chair under your ass; and if you do not, welcome to the value-trap world. Plenty of downside with limited upside.

While I am still positive about these “weird” asset classes, I do not think there will ever be circumstances where retail investors could achieve a real, passive-like, long-term beta. Unless blockchain would provide a different solution? The market is not big enough: once a real opportunity emerge, big institutional capital would follow. It might never convince all investment committees but it would allure enough to make the opportunity disappear.

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