Hipgnosis Songs Fund (SONG) currently has net assets of c. £700m, and aims to achieve income and capital growth by owning songwriters’ music royalties. In particular, the manager targets songs expected to be beneficiaries of the global rise of music streaming.
SONG now owns 54 catalogues, comprised of multiple writers, performers and genres. In total, the portfolio has over 13,000 songs, featuring 1,810 number-one hits (in at least one country). 49 have been awarded a Grammy. At current valuations, the portfolio is generating gross income of c. 6.7%.
The manager hopes to grow both the capital value and income from the portfolio in a number of ways. A secular tailwind is provided by the growth in global streaming, which is showing no signs of slowing. Additionally, the 2018 US Copyright Royalty Board ruling will increase the US royalty pot by 44% by 2022.
Manager-led initiatives include having a dedicated resource behind each song the trust owns, ensuring that revenues are maximised. Efficiencies in collecting revenue are expected as the portfolio administration is transitioned to Kobalt Music over the next two to three years. Kobalt is the preferred administrator, which claims to be able to recover 20% more income on a like-for-like basis relative to other administrators.
Over the past year, the portfolio’s earnings have covered this year’s 5p dividend two times over. The manager seems optimistic for the near-term prospects for income generation, and the board has reiterated its dividend target.
We think the uncorrelated nature of the NAV and the high income the portfolio provides are key attractions of SONG. The next year or so will see more tangible evidence of the portfolio performance, which on its own could help reassure investors about this relatively unknown asset class.
Recent corporate activity in the wider music-publishing sector suggests that SONG’s historical valuation multiple of 13.9x (and current valuation of 15x) compares favourably to corporate valuations elsewhere. With the report and accounts due to be published next month, we hope more granularity on the portfolio will be provided, and further illustrate SONG’s unique proposition.
Further potential upside comes in the form of the independent valuer’s discount rate, which has so far stayed static since IPO. Within the renewable-energy infrastructure universe discount rates have come in significantly, driving NAVs upwards. Whilst SONG might not follow suit, there is certainly potential given the 9% discount rate currently used.
Market sentiment knocked SONG’s share price; in rating terms it therefore has some way to go to recover the previous double-digit premium. However, on a yield of 4.4% the dividend is attractive and differentiated. With the potential tailwinds from the industry trends and management initiatives, the current discount might be viewed as an opportunity.
The uncorrelated returns potential, and the fact that this is the only UK-listed share giving exposure to music royalties, means we think that SONG deserves a premium rating again.
|Attractive yield, with prospect of income and capital growth||Unfamiliar asset class, with no direct comparators listed (although Spotify, Warner Music and Vivendi have some of the same dynamics)|
|NAV returns likely to be uncorrelated with equity and bond markets||Difficult portfolio to analyse, even if disclosure improved|
|Opportunity for capital growth from industry trends as well as active management||Possibility that the current trend of rising royalty payments will reverse|
Hipgnosis Songs Fund (SONG) is the only London-listed fund that invests in music royalties, a relatively new asset class for most investors. SONG launched in 2018 and is listed on the main market of the London Stock Exchange, having raised further capital so that it has net assets of £707m. SONG has announced that it is contemplating a further capital raise, as well as an extension of the gearing limits, to take advantage of the manager’s strong pipeline of potential investments. SONG’s manager is aiming for total returns over the medium to long term of greater than 10%, with a high dividend yield and the prospect of capital growth.
We delved into the detail of what songwriting royalties are in our initiation note published last year, which can be found here. However, in summary, SONG’s manager and advisory board of music industry insiders aim to use their network to access copyrights of a portfolio of evergreen hits which will prove durable over many years and provide a stream of music royalties to the fund for a long time into the future. The manager believes that royalty incomes are at the beginning of a secular uptrend (for reasons we will come to later), and that it will be able to add significant value through focussed and dedicated management of these assets. In its view, the long period in which piracy led to a significant decline in traditional (hard format) music sales has enabled them to invest at an opportune time in the cycle.
The manager aims to buy catalogues which include songs with the following characteristics:
- those that are proven hits, delivering royalty income for numerous years
- those that are culturally influential and therefore likely to be continually played and/or covered by new recording artists
- those that are underexploited and for which the manager is able to identify potential sync or cover opportunities
- those offering upside from the improved administration of collecting royalty income
The manager has a stated aim to diversify the portfolio through genres, with a preference for those that should benefit from strong and rising appeal, such as hip hop, pop and rap – and most especially those which will benefit from increased streaming.
As SONG has grown, the manager has deployed the capital raised into 54 catalogues, with multiple writers, performers and genres. In total, the portfolio has over 13,000 songs. Of this long list of songs, 1,810 have been number-one hits, and over half have been in the top ten (in at least one country). 49 have been awarded a Grammy. We believe this points to the high quality of the portfolio, recognising that within catalogues, much of the value (and expected income) is sometimes attributed to only a few songs within each catalogue. We understand that the US is the largest source of revenue for SONG. The trust does not hedge currency exposure, which means that investors will benefit from dollar strength but will suffer when there is dollar weakness relative to the GBP.
The management team’s main target for investment is songwriters’ royalties, the owner of which is entitled to the publishing and writer’s share of copyrights (68.84% of the portfolio by value). The manager believes that, aside from being able to buy these royalties directly from songwriters on an attractive running yield, investors should benefit from trends and active management which will increase the level of income (and capital value) over time. The manager has invested SONG’s assets on an average multiple of 13.9x three-year historical income, equivalent to a running yield (before costs) of 7.2%. As we discuss in the Dividend section, SONG expects to generate a dividend of 5p, with several drivers behind what the manager hopes will be growth in income over the next few years.
A big tailwind that the manager believes will drive revenues for SONG is the secular theme of increased music streaming worldwide, but most especially in emerging markets. Streaming not only opens up the potential market (by reducing distribution barriers to zero), but also significantly increases and extends the length of a song’s earning potential. This is simply because the streaming model is so different to the physical-format music business of selling records. Streaming means that songs can stay with consumers for longer (they can’t be broken, scratched or lost), but more importantly will continue to earn royalties each and every time a song is played. This gives the owners of these rights much more surety that an income will be generated into the future.
As we discuss above, SONG’s revenues are derived from all over the world. However, the US is the largest music market globally, but also for SONG. In this regard, it is significant that in 2018 the US’s Copyright Royalty Board (which sets US industry-wide royalty rates) ruled that it would be increasing the share of revenues for songwriters from the overall royalty pot by 44% over the ensuing four years. As such, every $1 of revenue that SONG earns from the US in 2019 will be worth $1.44 in 2022.
SONG’s manager also aims to improve the efficiency of revenue collection. In this regard, SONG hopes to be signing up an increasing proportion of the portfolio to its preferred administrative publisher: Kobalt Music. Kobalt has a number of proprietary collection systems which the manager believes will be able to increase the ‘nuts and bolts’ revenue collection, as well as speeding up the process of being paid. We understand that Kobalt is able to collect up to around 20% more revenue than other administrators for the same song, and as such when Kobalt is fully integrated into the portfolio this should have a dramatic effect on the income that SONG benefits from. Currently, much of the portfolio is administered by other companies on fixed-term contracts. When these roll off, we understand that Kobalt will likely replace them, a process which is expected to be completed for the current portfolio over the next two to three years.
Aside from the manager aiming to increase the income stream from the portfolio, it also seeks to provide capital growth for SONG’s shareholders. SONG’s manager – The Family (Music) Limited (of which more in the Management section) – is in talks to enable SONG to acquire a US-based music portfolio-administration and management business which will bring a significant additional resource to bear on the SONG portfolio. This business will provide an in-house portfolio-administration service (comparable to the services provided by Kobalt) in the US, with the objective of pursuing efficiencies in the collection of payments and active management of the songs that SONG owns. Each team member has responsibility for specific songs (with approximately 500 songs per employee), thereby ensuring the correct royalties are collected and also promoting songs for ‘synchronisation’ income (a.k.a. adverts, movies, etc.). Such efforts, if successful, can have a meaningful impact both on the income earnt from a song, but also can help to boost its long-term popularity and therefore value.
The portfolio as it stands now has a good blend of vintages. In our view, having a blend across the ages is important. ‘Golden oldies’, for example, are likely to be relatively low risk, with steady royalty payments expected over many years. However, as time goes on, it might be expected that as each generation passes on, what is classed as a golden oldie will change. After all, it might not be so long before Alien Ant Farm might be considered for Smooth Radio! As such, having songs from more recent times is potentially a good way to build longevity into the portfolio. Given expectations of decay rates for recent vintage songs are likely to be relatively high, the crucial determinant of whether a song (of any vintage) is a financial success for SONG will be how conservatively these assumptions were built in at the time of purchase. So far, as we discuss in the Dividend section, the indications are good – with revenues ahead of expectations up to the end of March 2020.
That the portfolio has intrinsic value is suggested by the continuing corporate activity in the music-publishing sector. At the end of 2019, Tencent invested $3.4bn in a 10% stake in Vivendi’s Universal Music business. More recently, Warner Music IPO’d on 03/06/2020, implying an EV/EBITDA multiple of 20.2x. Subsequent to this the shares have rallied, and at a $30 share price they imply a multiple of 23.6x. Although clearly very different businesses, SONG’s historical valuation multiple of 13.9x (and current valuation of 15x) compares favourably to corporate valuations elsewhere. In terms of cash flow, SONG is currently generating 12.5% of Warner Music’s income from only 1% of Warner Music’s asset valuation.
As we discuss in the Management section, the manager has assembled an advisory board to help originate new catalogues, as well as to provide other revenue-maximising advice. In such a specialist investment asset class, the network of the manager and advisory board will be a key determinant of ensuring the trust is able to continue to acquire high-quality songs. Clearly, the presence of so many industry insiders should give the manager good access to what might otherwise be a relatively difficult asset class to invest in. So far, the team have demonstrated their ability to invest the fund’s capital relatively quickly – no mean feat in a market where there are no formal brokers or ‘exchange’ for royalties. We understand that the manager has identified a pipeline of £1bn, of which 25% is ‘off market’, and 18% of which the manager is in exclusivity.
The trust does not anticipate using structural gearing. However, SONG has recently received shareholder approval to take the maximum gearing from 20% to 30% of net asset value. This is envisaged to be used for working capital and short-term bridging purposes only, pending further equity-capital raises. This provides the headroom to help with the acquisition of song catalogues in the pipeline.
This is a relatively tried-and-tested approach to growing a fund where the underlying investment assets are primarily yield-based and hard to access or lumpy. Examples include the infrastructure funds and the renewable-energy infrastructure funds which have grown successfully in this way.
There are of course risks to this approach. If sentiment goes against the fund or if any of the investments purchased perform poorly at a time when the fund is relatively highly geared but has not yet raised equity to repay the short-term loan, then the fund may find it hard to raise new equity. In such a scenario, the negative effect on the NAV would be magnified and/or the fund could find itself being a forced seller of assets in order to repay the loan.
As at 31 March 2020, net debt was £45.9m. Post-year end SONG entered into an agreement to increase its credit facility to £150m (and may request a further increase of £50m, subject to certain conditions). This means that currently SONG has gearing of 6.5% of NAV, with potential gearing (under the current credit facility and extension) of 28%.
SONG’s manager aims to provide total returns over the medium to long term of greater than 10%, with a high dividend yield and the prospect of capital growth. The annual results for 31 March 2020, which we hope will provide more colour on the portfolio, are expected to be published in July – at which point the trust will have been listed for two years since its IPO in July 2018.
Over the long term, NAV and total returns are expected to be relatively uncorrelated with other asset classes, and particularly with equity markets. At the same time, it is worth remembering that equity-market sentiment will affect SONG’s share price, which could mean that the shares fall to a discount to NAV at times of pessimism. This has clearly been the case over recent months, which we illustrate in the graph below. The NAV has so far been relatively uncorrelated, but the share price was negatively affected during the COVID-19-induced stock market rout in Q1 2020. As we discuss in the Discount section, SONG was not alone in seeing a sharp sell-off in the share price, with many other funds that offer exposure to alternative asset classes also seeing significant sell-offs in their shares before recovering much (or all) of the lost ground. As the market becomes more familiar with the investment qualities of SONG’s asset class, one might hope that discount volatility becomes less of a feature in the future.
shareholder returns since launch
As the graph above illustrates, SONG has delivered strong NAV returns since launch. The most recent NAV announced on 03/06/2020 showed an increase of 14.3% since the last published NAV as at 10/01/2020. Based on an NAV for 31 March 2019 of 116.7p, this represents an NAV total return (including dividends paid) since IPO of 22.7%. The most recent NAV increase was primarily thanks to an 8.6% like-for-like increase in the value of the royalty portfolio. Exchange rates have been a contributing factor, but the bulk of valuation movements have been down to revenues exceeding expectations. Valuations are provided by an independent valuer using a discounted cash-flow valuation. The discount that the valuer uses has been a constant 9% since the IPO of the trust.
The trust’s management company The Family (Music) Limited has indicated that were it not for the coronavirus-induced market uncertainty, in its opinion the valuer could have used a lower discount rate. It further speculated that when the outlook is less uncertain (the valuation date of 31 March 2020 was right in the middle of the storm), it might choose to use a narrower discount in the future. Nevertheless, this is by no means certain to happen, and there is no indication as to what amount the discount rate could change by. However, based on a sensitivity analysis provided by the management company, a 100-basis-point (i.e. 1%) decrease in the discount rate would increase the valuation of the portfolio by 18%; likewise, a 100-basis-point increase in the discount rate would decrease the valuation of the portfolio by 15%. It is worth noting that any gearing employed by SONG will clearly amplify these moves – for good or for bad.
Aside from the discount rate, the main driver of returns for SONG shareholders is the income. Adjusted earnings per share (i.e. excluding amortisation of the portfolio of songs) were 10.7p over the 12-month period to 31 March. This represents 2x cover on the dividend target of 5p. In the recent NAV announcement, the board expressed delight “that the performance of these catalogues to date has been ahead of both management’s high expectations and the performance targets set at the time of IPO”.
COVID-19 and the reduced economic activity resulting from the lockdowns have affected most businesses, but in varied ways. According to the manager, streaming services have seen a surge in listening to vintage songs as people look for a sense of “positivity and normality”. Overall streaming subscriptions continue to increase, but this will be to some extent offset by the absence of the public-performance and live-income elements of royalty payments. Overall, the board expects that income growth from streaming will exceed any lost earnings from these areas.
Going forward, we believe that the trust’s ability to deliver strong total returns will depend on three key factors:
- the extent to which a song performs (in revenue terms) in line with what the manager believed at the time of purchase
- the manager's ability to generate higher returns through management activities
- the 'market' rate on song catalogues (or the discount rate used in valuations)
As regards the last point, this is the only real ‘market’ risk. SONG has revealed that the average valuation on acquisition has been 13.7x historical revenues, but the current valuation implied by the NAV is c. 15x. The latter multiple implies a gross income return of 6.7% before fees.
Time will tell with regards to the other two drivers of returns. With the portfolio still in ramp-up mode, and a number of initiatives – such as transferring administration to Kobalt – still to happen, we think there is plenty of potential in the portfolio. We look forward to the publication of the annual report and accounts, which should provide significantly more granularity on the shape of the portfolio as well as its underlying performance so far.
SONG’s objective is to provide an attractive and growing level of income, together with the potential for capital growth. At launch, the fund aimed to pay a full-year dividend of 3.5p, which would rise to 5p in the second year. So far SONG has achieved these objectives, with SONG now paying quarterly dividends of 1.25p in its second year of existence. In the year to the end of March 2020, adjusted earnings per share (excluding amortisation) were 10.7p per share, representing over 2x cover of the full-year dividend of 5p.
We understand that SONG expects to be able to grow its dividend over time though the active management of the portfolio, but also from the tailwinds for the industry that we discuss in more detail in the Portfolio section. In the year to 31 March 2020, revenue from the portfolio increased to £64.7m, with cash receipts from royalty statements on average 2% higher than expected at the time of acquisitions. In absolute terms, royalties grew by 6% year on year, excluding those songs which were expected to decay over time. The manager has been targeting acquisitions towards those songs that they think will be more likely to benefit most as recorded-music and song-publishing revenues grow through the uptake of paid streaming.
The current dividend of 5p per share equates to an income yield of 4.4% at the share price on 16 June 2020, which compares with the global equity-income sector average yield of 4.1%, 4.9% for infrastructure funds, and 4.4% for the renewable infrastructure funds (Source: JPMorgan Cazenove as at 12/06/2020). At a time where the dividend picture for many equity-income funds looks uncertain, we think it noteworthy that the board reiterated the dividend target of 5p per share for the current financial year (with one quarterly dividend remaining).
The trust’s investment adviser is The Family (Music) Limited, which was founded by Merck Mercuriadis, former manager of globally successful recording artists such as Elton John, Guns N’ Roses, Morrissey, Iron Maiden and Beyoncé, and hit songwriters such as Diane Warren, Justin Tranter and The-Dream. He is also a former CEO of Sanctuary Group plc.
The Family (Music) Limited has an advisory board of music-industry experts and is broadly intended to help with acquiring song catalogues, providing a broad range of expertise to the manager on different genres of music. The advisory board includes award-winning members of the artist, songwriter, publishing, legal, financial, recorded-music and music-management communities. Members include Nile Rodgers, The-Dream, Giorgio Tuinfort, Starrah, Nick Jarjour, Dave Stewart, Bill Leibowitz, Ian Montone and Jason Flom.
The Family (Music) Limited has a growing team who support Merck Mercuriadis (CEO) in securing new investments for the portfolio, monitoring royalty and/or fee income via SONG’s various portfolio administrators and developing strategies to maximise the earnings potential of the songs in the portfolio through improved placement and coverage of songs. We understand that SONG is in the process of acquiring a US-based music portfolio-administration business which will bring a significant number of personnel to bear on the SONG portfolio. The objective is to put dedicated resource behind the songs that the trust owns, with the aim for 500 songs per employee.
SONG is Guernsey-domiciled and is traded on the premium segment of the main market of the London Stock Exchange. With current net assets of just over £700m, SONG is a constituent of the FTSE 250, and according to the manager is amongst the highest yielders in this index at a time that many companies are having to cut or cancel their dividends entirely.
The trust publishes NAVs twice a year, reflecting the revenues of the catalogues which are also accounted for twice a year. The music-royalty industry traditionally works on a 90-day accounting cycle, with royalty statements for January to June settled on 30 September, and statements for the period July to December settled on 31 March. The ‘fair value’ of these songs will be evaluated by an independent company (Massarsky Consulting) using a minimum of three years’ historical normalised revenues, and using expected industry trends. The valuer then uses a DCF methodology to calculate a value which is compared with recent prices for similar transactions (if available) and other factors. This ‘fair value’ NAV will differ from the IFRS NAV, which reflects the amortised cost of songs written down over their expected economic life. We believe the market will focus more on the ‘fair value’ NAV than the IFRS NAV.
At the time of writing, the most recent ‘fair value’ NAV was announced on 03/06/2020, showing an increase of 14.3% since the last published NAV as at 10/01/2020. The NAV increase was primarily thanks to an 8.6% like-for-like increase in the value of the royalty portfolio. Exchange rates have been a contributing factor, but the bulk of valuation movements have been down to revenues exceeding expectations. The current discount used by the valuer is 9%, which has remained unchanged since IPO. At a share price of 114p, the shares therefore trade at a very slight discount.
The graph below illustrates that over the life of SONG, a premium rating has been more usual. SONG was not alone in seeing a sharp sell-off in the share price in Q1 2020, with many other funds that offer exposure to alternative asset classes also seeing significant sell-offs in their shares and significant widening of discounts. In most cases, they have subsequently recovered much (or all) of the lost ground since then. As the market becomes more familiar with the investment qualities of SONG’s asset class, it might be hoped that discount volatility becomes less of a feature in the future, but it is worth remembering that a combination of fear and market illiquidity can lead to significant and rapid de-ratings of listed funds. According to a regulatory announcement at the time, Merck Mercuriadis bought £50,000 worth of shares at 93.3p on 17/03/2020, taking his total holding to 344,392 shares and showing his confidence in the trust at the time.
discount to 'fair value' nav
It is worth noting that should the shares slip to a meaningful discount over anything other than the short term, there is no formal discount-control mechanism. However, the board has stated that it “will be mindful of the share rating and will consider buybacks should there be sufficient cash available”. A long-term term discount control is the provision that a continuation vote is proposed five years after the IPO, and every five years thereafter.
The manager charges a base management fee based on market capitalisation (rather than NAV), tiered at a rate of 1% p.a. up to and including £250m, 0.9% p.a. from £250m to £500m, and 0.8% in excess of £500m.
In addition, the manager is entitled to 10% of any total shareholder return (share-price performance plus dividends paid) over and above a 10% hurdle, subject to a high-water mark. The performance fee is paid in shares, which are locked up for 18 months. The total fees are capped at 5% of NAV p.a.
The OCF for the financial year ending March 2020 was 1.52%, down from 1.7% thanks to the increased size of the trust. The board has stated that it expects the OCF to continue to fall as the trust gains size and acquisitions start to tail off. The published KID RIY is 2.4%.
Music Royalties are in our view a relatively problem-free area as regards ESG. That said, revenue collection is relatively opaque, which might pose some ESG risks. We understand that the manager sees the reputation of a performer or writer as an important part of the sustainability of revenues, and so will not invest in catalogues that feature questionable artists.
On the other side of the coin, the manager recognises that artists are protective over their legacies and want the comfort of knowing that their songs will be used in line with their tastes/beliefs. According to the manager, when compared to the major publishing houses the trust is viewed as a safer alternative which can protect this legacy. As such, the manager would like SONG to be seen as a protector of writers’ rights, and an advocate for their role in the creative process.
The manager has also recently committed to the UN Principles for Responsible Investment and to the UK Stewardship Code, in so far as they are applicable to SONG’s investment portfolio.