Hipgnosis Songs 19 September 2019

Hipgnosis Songs Fund (SONG) is a £409m market cap listed fund, aiming to achieve income and capital growth by owning songwriters’ music royalties. The managers (The Family (Music) Ltd) believe that, aside from being able to buy these royalties from songwriters on a gross yield of c. 8%, investors should benefit from trends and active management, which will increase the level of income (and capital value) over time.

The managers are aiming for total returns of greater than 10%, and 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. Merck Mercuriadis leads the management team, and he is clearly a music industry “insider”; we understand his relationships have been key to accessing the quality of the portfolio that SONG has built up so far.

Having spoken to the team, they tell us that royalties from the copyright of songs tend to be relatively predictable – certainly after the first three years when the “buzz” has largely subsided. We discuss the intricacies of music royalties in more depth in the portfolio section, but it is worth noting that these are long life assets, with copyrights in some cases lasting for 70 years past the death of the writer. The catalogues acquired by 31st August have seen revenue growth (excluding post 2016 releases) of 49% from streaming sources, and 19% overall.

Streaming is increasingly being recognised as a huge growth area for the music industry, not only opening up the potential market (by reducing distribution barriers to zero), but also significantly increasing and extending the length of a song’s earning potential. JPMorgan predicts that global music industry revenues will surpass the peak of the late 1990s, with 10% p.a. compound growth expected through to 2030. The number of people paying for a streaming music service is rapidly increasing with 255m paying subscribers for streaming services currently (according to the IFPI Global Music Report 2019), and which JPMorgan predicts will grow to north of a billion. Notwithstanding this, the managers intend to apply significant resource towards the management of the fund’s songs, and to boost revenues and the capital value of the portfolio using more intensive, active management.

In its first year, SONG has delivered what it promised at launch. Recognised net revenues from the portfolio from incorporation on 8 June 2018 to the financial period end on 31 March 2019 were £7.2m, equivalent to a 6.1% gross yield on the £120m invested component of the portfolio over the period - in line with projections at launch. The company has paid its target dividend of 3.5p over the first year (in four instalments). As we examine in the dividend section, the company has a stated aim to pay dividends of 5p in the current financial year.

Since launch to 31 March 2019 (the last reporting date), the fair value NAV has risen from 98p to 103.27p. Including dividends paid, this means that the total NAV return has been 6.4% - a strong performance during a period in which the fund has been sitting on cash as it builds the portfolio up. The shares are trading at a small premium to fair value NAV, which means that total shareholder returns (including dividends) to the end of August has been 8.5%.

The prospective dividend of 5p per share equates to an income yield of 4.8% at the share price on 31 August 2019, which compares with the Global Equity Income sector average yield of 4.1%, 4.1% for infrastructure funds, and 5.1% for the renewable infrastructure funds (Source: Numis).

Having spoken to the manager, we understand that music royalties are relatively predictable and uncorrelated with equity markets. With rights extending in some cases for 70 years past the death of a writer, these have the potential to be significantly longer life assets than infrastructure or other alternative income assets classes. Coming at a moment in time when revenues from streaming are leading to a resurgence in the fortunes of the music industry, SONG looks to provide a very interesting combination of a solid income with the prospect of capital growth.

The company is still in the early stages of its life, but the manager has high ambitions to grow the fund to £1bn and greater. So far, they have executed well in terms of putting capital to work and appear to have some high quality songs.

Now that the managers are fully invested and have got to critical size, they have started publishing quarterly fund factsheets, which will help to give more clarity on the underlying portfolio. The shares trade at a modest premium of 2.2% to the last fair value NAV of 103p. Given the returns potential and the fact that this is the only UK-listed share giving exposure to music royalties, in our view, SONG deserves this premium.