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The Music never stops
I tried to dig deeper into the enormous music industry and look at the underlying mechanisms that make it what it is today and how music is turning into an investable asset class in its own.
I was very reluctant to pay for music until last year, when I finally bought my Spotify subscription. Since then, there’s been no turning back. I realised how important a part music plays in our lives. Music in the shower, in the car, in the gym, at your house-party, its like an eternal stream of consciousness going everywhere with you without you even realising its there. This week I tried to dig deeper into this enormous industry and look at the underlying mechanisms that make it what it is today and how music is turning into an investable asset class in its own. Lets jump right in.
There’s much more to what you see as the face of the song, the artist, The Ed Sheerans and the Lady Gagas of music. It usually starts with a songwriter, which in some cases can be the performer himself. Then steps in the publisher which helps the creators with publishing and getting the song out there ready for recording. Here, the song copyright (which includes the song and the melody) is created that makes sure the song is not used in any form without the rightful owners getting their share. The publishers here pay an advance fee to the songwriters and buy the license to their catalogue(s) to further license it out to the labels, which we’ll come to in a moment. Think of it as a real-estate agency buying the asset from the original builder.
The labels (Sonys, BMGs and Universals of the world) purchase this license from the publishers and get the product (the song) to the distribution stage. They hire artists and performers, pay producers and artists to record the song and then take over the marketing and distribution responsibilities. Here the recording copyright (which includes the song you hear) is created that allows the labels to license the song to be reproduced in ANY form, be it in a movie, an ad, streamed over Spotify or Apple Music, played on the radio etc. But where’s the real dough $$$ ?
The artist might have created the ‘art’ but the real value creation takes place when that art is actually priced by the market forces. By paying an upfront fee to the publishers and getting the license to the raw material (the song), the labels ensure they keep most of the upside from the final product in the form of recurring revenues from the song recording. Imagine this, every time a song is played in any form in any part of the world, the labels are being paid for whatever their contract terms suggest.
The labels pay the publishers in advance for the license and right to the song along. The publishers in turn pay their songwriters or artists and buy their catalogue out. All in all, every time a song is reproduced in any form, the labels get a fee along with some royalties trickling down the value chain to publishers and songwriters. But how much is it?
Out of every 1 EUR made in the digital world of music, 30 cents are kept by the tech company (Spotify or Apple Music), 58.5 cents are usurped by the record companies and the rest 11.5 cents left for publishers and songwriters.
Analysis company Music Business Worldwide estimated that label companies are making almost 1m USD an hour via streaming services! This asymmetrical relationship has led artists voicing their contention with how the business model is structured.
Hignosis to the rescue
Merck Mercuriadis knows a thing or two about music. The former manager of stars like Elton John, Guns N' Roses, Morrissey, Iron Maiden and Beyoncé, Mercuriadis founded the Hipgnosis Songs Fund in 2018 (LSE:SONG). The fund has converted music rights and intellectual property related to music into an investable asset class and allowed investors to get a pure-play exposure to the music asset class.
Its an exciting place to be for a music fan as the fund was established on the premise to level the playing field between the record companies and the artists by valuing music (pun intended) for what its worth. The fund buys rights and catalogues directly from songwriters and publishers paying them a higher fee and bringing in more transparency to how much they are actually owed in royalties. With the advent of streaming, there are almost 60bn micro-transactions taking place every single day which is hard to keep track of. Firms like Kobalt Capital are playing their part by giving a platform to keep track of every transaction and allow artists signed up with the firm to access the data and carve-out the value they should be paid for.
Hipgnosis has so far spent almost 1.2bn GBP racking up rights to almost 58,000 songs and catalogues from Neil Young, Jimmy Iovine, Shakira and Bob Rock (Enter Sandman, anyone?!). It goes on saying,
"Since launch we have now acquired 117 Catalogues, comprising over 57,836 Songs, for an aggregate consideration of £1.18 billion, representing a blended acquisition multiple of 14.76x historic annual income"
It recently entered the US music industry by buying Big Deal Music, acquiring catalogues from Shawn Mendes and One Direction in the process. According to Mr. Mercuriadis, the man himself,
Great, proven songs have predictable, reliable income. It is better than gold or oil. Music has gone from a discretionary luxury purchase to a utility purchase. People would rather bite off their right arm than give up their music subscription.
Looks like the buying spree isn’t ending anytime soon. The fund plans to invest another 1bn GBP and expand its portfolio of songs. Universal too, paid a nine-figure sum to acquire Bob Dylan’s entire catalogue recently. Even KKR, the PE giant has jumped in and bought Ryan Teddar’s (One Republic’s lead and hit songwriter) catalogue of songs for 200mn USD.
So what now, one might wonder. A decade or so ago, things were different. But with increasing access to capital markets and availability of data, technological innovation has become mainstream. The internet that eroded the record companies’ business via file sharing (and hence piracy, Napster etc.) has given the industry a new life on that back of this move towards digital, mobile and streaming apparently. Songs are now prized assets that investors, retail and institutional alike, want to hold and invest in.
The macro environment is a friend too, I think. Interest rates are at an all time low, as are the opportunity costs for taking risks. Investors are in constant search for alternative assets, and this one, unlike any Shitcoin offers a reliable income stream backed by the streaming wave, which made up 56 percent of the global music industry’s 20bn USD revenues last year.
Technology also makes it easier to track relevant data and monitor trends in songs, via social media, API’s and other digital content. With more transparency, identifying what songs could take off next might be easier now. But what is the stream of that cash flows actually worth is not devoid of any complexity still. Sadly for investors, Hipgnosis does not disclose how it valued for what it paid for the catalogues.
So far, its trading at the net asset value, which means the markets believe Hipgnosis is worth the value of its music assets, around 1.2bn GBP. Revenues are up substantially too, from 9mn GBP in March 2019 to 87mn GBP in September 2020, with a decent chunk of it flowing to its bottom line.
The company has gathered experts in the music industry on its Board, according to its website. For acquisitions, it has relied on equity and fund raises so far. Weighted-average shares outstanding are up from 202 mn to 560 mn over the same aforementioned period.
Buying into Hipgnosis would be a bet on the management’s ability to identify songs that could produce a stream of cash flows (like Bon Jovi's Livin' On A Prayer, which saw a streaming income growth of 44%) then pay the right amount for it. This is like managing an all-weather portfolio of sorts, that can be relied upon in any environment. The competitve advantage lies in having experts from the industry, both in the UK and the US on the board, managing their catalogue book and looking for the right artists and the music to sustain the funds growth.
Hipgnosis is surely going head-to-head against the record labels who're all in to cash in on this wave. Add to that uncertainties in to valuations around royalties and rights.Yes, the streaming wave is here to stay. And Hipgnosis has just begun, while the competition is heating up. But can they keep up the pace?
Until next time,
The Atomic Investor