Investing in song rights – conveniently through the London Stock Exchange

Smartphones have fundamentally altered the music industry.

While in the olden days, music was purchased whenever you felt like spending money on CDs or downloads, consumers nowadays subscribe to streaming services such as Spotify. The monthly payments for access to music have turned parts of the music industry into more of a "utility", similar to an electricity company.

Add to that the growing number of smartphone owners, thanks to emerging markets such as China, India, and Africa. In many countries of these regions, you tend to find at least two of the following three factors: population growth, increasing smartphone penetration, or rising discretionary income. Analysts from J.P. Morgan predict global music industry revenues to achieve 10% p.a. compound growth between now and 2030.

It's these factors that made a long-time executive from the music industry set up an investment fund for song rights.

He had spotted an opportunity to generate secure, growing income from a market that hardly anyone had on their radar. Following the demise of CDs and the temporary prevalence of piracy through free music download websites such as Napster, investing in song rights had temporarily fallen out of favour. Also, the market is incredibly complex and untransparent. No one else had set up such an investment vehicle for the general public yet, but the opportunity seemed all the bigger for that reason.

The result was Hipgnosis Songs Fund (ISIN GG00BFYT9H72), a London-listed vehicle that has purchased the rights to over 13,000 of the world's best-known songs.

Anyone can easily buy and sell shares in the fund through the London market.

Here is how the fund's investing approach works, and an initial analysis whether it's something private investors should latch onto.

Why invest in song rights?

Song rights are copyrights that generally continue to exist for 70 years after the death of the songwriter or the last surviving co-writer. Of the revenues generated by a "song", the songwriter's share is usually the largest. E.g., Slade continues to receive several hundred thousand pounds every Christmas from its song "Merry Christmas Everybody".

Song rights fall under so-called "uncorrelated assets" (or at least, that's the idea). These rights are supposed to generate income that does not correlate with returns from the stock market. A falling or rising stock market should not in any significant way influence how much money consumers spend on music – ideal for investors who are looking for assets that produce an attractive return no matter what the rest of the financial markets does.

The idea behind the Hipgnosis Songs Fund is to buy up music rights that are poorly managed or offered too cheaply (or, ideally, both). The man who initiated the fund, Merck Mercuriadis, knows a thing or two about the industry. He spent 20 years of his life managing Sanctuary Management, a London-based company that looked after artists like Destiny's Child, Nelly, Tommy Lee, and the Who.

After leaving Sanctuary Management in 2006, Mercuriadis went on to personally manage artists such as Elton John, Guns N' Roses, Morrissey, Iron Maiden and Beyoncé. He also managed hit songwriters such as Diane Warren, Justin Tranter and The-Dream.

Mercuriadis was never a musician himself, but he became the world's grandmaster of music rights (and some say, he has the Bond villain looks to match). With financial backing from hedge funds and the conservative-minded, income-orientated investors such as the Church of England (!), he has already hovered up the rights to over 13,000 songs. Of those, around 1,800 had held number 1 positions in global charts, and over 7,000 songs had held a top 10 position.

Mercuriadis favours songs that have had an influence on culture. These songs have long staying power, and they usually keep generating income well beyond the initial three years during which other songs typically produce most of their income.

Hipgnosis keeps a list of its most popular songs on – unsurprisingly – Spotify! Check out the its playlist if you want to take a walk through the company's portfolio.

Hipgnosis listed on the London Stock Exchange in 2018, and it has since been included in the FTSE-250 Index. Following the customary contraction during the spring 2020 coronavirus crash, the stock is currently up 13% since the beginning of the year. The company recently declared that it was going to up its final dividend to GBp 5.5 per share, payable in quarterly instalments of GBp 1.3125 per share. Based on the current share price of GBp 122, the company yields investors a healthy 4.5%. The stock price is trading just a tad above the most recent estimated net asset value of GBp 117 per share.

Is the Church of England onto something?

The art and science of squeezing additional revenue out of song rights

The most interesting aspect of Hipgnosis' approach isn't necessarily the cheap purchase of music rights, but the higher-quality, more aggressive management of the songs' monetisation by the fund's team.

Hipgnosis is far from the only investor in the space, and the idea of buying up song rights isn't new. Major record labels that invest in buying rights to songs and entire catalogues include Universal Publishing Group, Sony / ATV Music Publishing, Warner / Chappell Music, and BMG.

Some of these large corporations have recently teamed up with private equity companies. BlackRock and Providence Equity Partners are two of the well-known private equity names that have poured money into the sector.

Hipgnosis often outbids these groups. In the past, music rights would have usually attracted bids equivalent to about ten times historical net annual income. The Hipgnosis portfolio was acquired for an average of 13.9 times historic annual income. For some rights, the fund paid multiples of up to 20.

Is Mercuriadis on a megalomaniacal acquisition spree that sees investors' money wasted on acquiring rights at inflated prices?

According to Mercuriadis, his fund can afford to pay higher prices because it subsequently manages to squeeze more income out of these rights than its competitors.

Songwriters can make money from three sources:

1. Mechanical royalties (sale or legal download of a song).
2. Performance royalties (each time music is heard in public, whether live gig or radio).
3. "Synch" fees (use of songs in movies, video games, commercials).

Mechanical royalties are set at fixed rates, but performance royalties and synch fees are freely negotiated. The team managing the Hipgnosis fund are going to great lengths to pitch their songs to decision-makers in the media industry, in an attempt to maximise the synch fees. They push for their songs to be used as widely as possible, and they are tough negotiators. The fund has a team of six staff members who focus on trying to effect higher revenues for each song.

As such, Hipgnosis is a combination of a rights fund and a talent management agency.

Using this approach, the income generated (and value represented) by the Hipgnosis portfolio should continue to increase.

Always assuming that Mercuriadis is telling the truth – is he?

Not everyone is a fan

Sceptics will point out that educated buyers of song rights are getting cautious. Warner Music, one of the most experienced players in the market, collaborated with Providence Private Equity on the basis of private equity investors shouldering the risk and Warner Music merely getting paid for their expertise. It does reek of industry experts wanting to make a buck off dumb money provided by the unsuspecting public.

Also, it remains to be seen if the emerging market growth story really comes together. Whether consumers in these countries will be willing to pay sufficient prices for enjoying existing music remains to be seen. They could instead prefer to listen to cheaper local talent.

The entire streaming industry is still young, and not all of the industry's data points towards stellar growth for all but a few outliers. So far, 80% of the income generated by streaming music comes from songs that were released over the past ten years. If the trend persists, the value of older music could be thrown into question which in turn sows doubt about the Hipgnosis' entire approach. As a concrete example that should be a warning, the catalogue of the Beatles is one of the world's most valuable set of song rights, but it currently generates just a minuscule amount of income from streaming.

Song rights do have many of the hallmarks of a potentially secure, reliably-growing alternative asset class. But success is not yet as secure as a cursory look may make it seem.

Alchemist or fantasist?

The jury is still out on Merck Mercuriadis.

He certainly created one impressive success story. His fund is now valued at GBP 725m (USD 950m), and made it into the FTSE-250 Index faster than any other British company after its IPO. The fund does have strong backing from reputable investors, and its management has been delivering on its promises. Longer term, Mercuriadis wants to buy up about 20% of the world's music rights. He believes the value of his music rights will increase by a factor of two to three over the coming decade, according to this 4 September 2020 interview in the Daily Telegraph. Mercuriadis put GBP 1m of his own money into the fund and keeps increasing his personal exposure with each fundraise carried out by the company.

In the meantime, the entire idea of investing in song rights has gained more attention on the stock market, through the recent IPO of Warner Music Group (ISIN US9345502036). Rumours are that Universal Music Group will be next to list, and there has been a recent flurry of speculation that New York-based Round Hill Music is also in the early stage of exploring a listing on one of the global stock exchanges.

The financial markets have come to recognise that subscription-based businesses can offer an incredibly attractive combination of recurring income based on existing customers and growth by adding new users.

There are, indeed, many reasons to believe that Hipgnosis will be an indirect beneficiary of the impending age of subscription-based music consumption.

On the other hand, some aspects of the investment thesis remain speculative. Whether these rights will continue to generate the kind of reliable and growing income that the fund's projections hinge on, depend on a number of unproven factors. There are some concrete warning signs, as shown above.

If anything, investors should not make themselves believe that song rights are as low-risk a utility as, for example, monopoly-style electricity companies.

A critical risk for investors will be the man himself. Without a doubt, Mercuriadis is one of the most knowledgeable and best-connected people in the global music industry. Were he to fall ill or die, the fund would suffer. Then again, the same is true for just about any other fund or company with a successful manager, and Hipgnosis has succession plans in place. Also, I strongly suspect the Treasurer of the Church of England to put in a good word with the Lord on a regular basis.

The likely future probably lies somewhere in the middle between these competing factors. That would make it a sensible thing to invest in Hipgonosis during periods when the stock is experiencing weakness, such as during the spring 2020 sell-off when the stock was trading significantly below the estimated portfolio value.

The London market is extremely good at providing a seeding group for new, innovative companies and funds. It generally fails at providing market liquidity. Most funds that are placed through London end up with below-average liquidity in their stock. It leads to the share prices over-shooting in either direction during volatile periods. Waiting for these volatile periods can be a bit of a bore because great buying opportunities only come along every few years. However, when it does happen, the market dislocation caused by the lack of trading liquidity can lead to spectacular bargains. For that reason, it's probably well worth keeping an eye on the stock.

In the meantime, Hipgnosis will probably continue to attract a contingent of investors who want to co-own some of their favourite songs. If you are a music fiend, you'll probably get about as much joy out of co-ownership as of dividend payments.

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