J.P. Morgan simply wrote a glowing endorsement of Hipgnosis Songs Fund. Right here’s why.

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MBW Reacts is a sequence of brief remark items from the MBW workforce. They’re our ‘fast take’ reactions – via a music biz lens – to main leisure information tales.

J.P. Morgan issued a glowing analysis observe on UK-listed Hipgnosis Songs Fund on Monday (September 19).

“Given the long-term progress potential of the asset class, and the upper high quality (in our view) portfolio relative to [Round Hill Music], we imagine SONG presents compelling worth,” mentioned J.P. Morgan, sustaining its ‘obese’ score on HSF’s inventory.

J.P. Morgan’s analysis observe on Hipgnosis Songs Fund was a thundering vote of confidence in HSF’s enterprise, following a latest flurry of enterprise media scrutiny.

Particularly, a run of three related latest articles within the Financial Times on HSF every questioned points of Hipgnosis Songs Fund, together with:

  • The very fact HSF hasn’t purchased a catalog previously 12 months;
  • The truth that it’s refusing to lift new funds;
  • The influence of present macro-economic pressures on HSF’s worth, and its funds.

We’ll get to some vital element behind all three of these shortly, and what J.P. Morgan has to say about them.

However first issues first: Stated protection of HSF has led to some follow-up reporting, which in flip has led to the wonky conclusion in some quarters that ‘Hipgnosis has burned via its money’.

As a lot as that concept would possibly deliver glee to these with the knives out for Merck Mercuriadis’ firm, in actuality it’s flat-out unsuitable.

That’s as a result of Hipgnosis Songs Fund is not Hipgnosis; it’s one a part of a three-pronged Hipgnosis group.

That group has already spent roughly $300 million on music catalogs in 2022. Sources recommend that the present plan for this Hipgnosis group is to spend one other $300 million by the top of the 12 months.

Briefly: Hipgnosis, the group, has entry to all capital it must do each conceivable artist/songwriter copyright acquisition in music.

It stays to be seen, nevertheless, how a rising fee atmosphere would possibly complicate this image, with rates of interest now at their highest point since 2008 within the US and UK.

Understanding Hipgnosis

To know the Hipgnosis group – and why it nonetheless has a possible pipeline of billions of {dollars} in its M&A arsenal – we first have to refresh our recollections of the three Hipgnosis-branded corporations:

  • Hipgnosis Songs Fund (HSF): a UK-listed FTSE 250 firm that has acquired over $2 billion in catalogs so far, which have collectively been given an independent valuation of $2.7 billion;
  • Hipgnosis Songs Capital (HSC): a personal fund, fully-funded by Blackstone, that has spent round $300 million buying copyrights in 2022 alone, from the likes of Justin Timberlake, Kenny Chesney and the Leonard Cohen property;
  • Hipgnosis Track Administration (HSM): a ‘music administration’ and Funding Administration firm that advises on the investments of HSF and HSC, and manages the property of each.

In essence, firm (iii) – Hipgnosis Track Administration – chooses which catalogs to spend HSF’s and HSC’s cash on.

Over three years (2018-2021), HSM constructed up a portfolio for Hipgnosis Songs Fund of ≈65,000 copyrights from writers akin to Mark Ronson, Purple Scorching Chili Peppers, Neil Younger, Lindsey Buckingham, Difficult Stewart and lots of others.

Nonetheless, final summer season, HSM confirmed that its major supply of capital for offers had successfully switched to firm (iii): Hipgnosis Songs Capital.

The preliminary dedication to HSC from Blackstone was a billion dollars (a mixture of fairness and debt). Sources recommend this dedication continues to be anticipated to multiply over the subsequent few years.

It’s this fund (HSC) that has spent $300 million on music rights in 2022 to date by way of HSM – and which is predicted to spend someplace close to that once more within the the rest of the 12 months.

Rising rates of interest, nevertheless, are more likely to put a cap on the multiples any music firm is keen to pay for copyright buyouts within the present atmosphere.

Until potential sellers are keen to drop their desired a number of to this stage, we may even see one thing of a cool-down within the music M&An area within the months forward.

(There’s a flip-side to this case: Some artists and songwriters might certainly be keen to promote at a decrease a number of than their friends achieved in recent times – as a result of as soon as they’ve cash within the financial institution, high-interest charges and a battered inventory market arguably create an funding market the place mentioned cash can shortly acquire in worth.)

Why is Hipgnosis Track Fund not elevating cash?

For informal observers of Hipgnosis Songs Fund (HSF) – which has spent over USD $2 billion on catalogs since being based in 2018 – the present halt in its spending exercise might come as a shock.

But for HSF buyers, and people extra intently watching the corporate, it’s not precisely surprising.

Hipgnosis Songs Fund informed its shareholders when it raised $215 million final July that it was placing a cease on additional raises till Q2 2022 on the earliest.

The next month, in August 2021, HSF informed buyers that it was “fully invested”, following acquisitions of a number of catalogs (utilizing that $215m) together with music by the Purple Scorching Chili Peppers and Christine McVie of Fleetwood Mac.

Q2 2022 has now been and gone, which suggests HSF is free from its self-imposed moratorium on elevating cash. However market situations don’t seem like they did final summer season.

Particularly, with the twin shocks of a steep rise in inflation plus the warfare in Ukraine, public share costs throughout the board have been hit exhausting.

Publicly traded music compares haven’t been proof against this development: Hipgnosis Songs Fund is down 20% YTD in 2022; Universal Music Group is down 27%; Reservoir is down 33%; Warner Music Group is down 42%; Spotify is down 50%; Believe is down 58%.

It’s due to this fact unlikely that corporations like these would select to lift new fairness (by way of share points) at present inventory costs as it might injury the holdings of current shareholders. In accordance, HSF has opted not to take action.

One other barrier to Hipgnosis elevating cash proper now: these rising rates of interest.

HSF presently has a debt stack of $600 million. The price of servicing that debt will increase with each rate of interest rise.

That being mentioned, HSF confirmed to shareholders this week that it has now secured a brand new debt refinancing bundle. J.P. Morgan was impressed with this information, saying this refi is “anticipated to decrease [HSF’s] facility value and enhance its dimension”.

As MBW defined in November, HSF – as long as it has the funds obtainable – can opt to acquire a 20% stake alongside HSC (by way of the latter’s billion-dollar-plus pot of Blackstone cash) in any catalog buyout proposed by HSM.

Why is Hipgnosis Songs Fund’s Professional-forma income declining?

One main subject raised by financial media outlets in latest weeks: The ‘Professional-forma’ income (PFAR) of Hipgnosis Songs Fund declined YoY in HSF’s FY 2022 (to finish of March 2022).

On the floor of it, this definitely seems to be troubling: ‘Professional-forma’ income (PFAR), which HSF voluntarily publishes, reveals the royalty income earned by catalogs in a calendar 12 months primarily based on royalty statements acquired, regardless of whether or not the songs had been owned by the corporate over the interval analyzed. It’s a ‘pure’ like-for-like reflection of how catalogs are performing.

You’d anticipate a specific amount of decline every year in ‘Professional-forma’ income at an organization like Hipgnosis Songs Fund as a consequence of newer catalogs; i.e. catalogs which are nonetheless ‘leveling off’ from their industrial peak earlier than they hit a long-tail plateau.

In flip, you’d anticipate these declines to be offset by an increase in earnings from older catalogs which have already hit that plateau.

For instance, inside HSF’s catalog of songs, you’d anticipate Form Of You (launched in 2017) to nonetheless be on a powerful decay curve, however you’d anticipate classics from Neil Younger, Lindsey Buckingham, Bon Jovi and so on. to be growing annual income as they experience streaming’s progress.

So what went awry inside HSF’s ‘Professional-forma’ income in FY 2022? In a phrase: Covid.

Performing rights societies throughout the globe usually account to publishing rights-holders 12 to 18 months behind the second of consumption. Inside HSF’s numbers proper now, that lag is essential.

If you happen to return 12 to 18 months from the top of HSF’s newest fiscal 12 months (March 2022), you land on the coronary heart of the best stage of destructive influence that COVID lockdowns had on all companies.

Thus, there’s a considerable quantity of efficiency revenues from all over the world – music being performed in bars, eating places, retailers, nightclubs, and the entire dwell performances by artists – that may have been there in ‘regular’ situations however usually are not mirrored in HSF’s numbers.

“We anticipate a really robust bounce again in [Hipgnosis songs Fund’s] efficiency earnings.”

J.P. Morgan

This Covid-driven income deficit is arguably extra pronounced for corporations like HSF than it’s for the main music corporations, as a result of HSF is only within the catalog enterprise; it doesn’t have a streaming money bump from new frontline hits to offset the destructive influence from Covid lockdowns.

J.P. Morgan this week famous why it was unworried by the ‘Professional-forma’ decline in Hipgnosis Songs Fund’s numbers for FY 2022, stating: “We anticipate a really robust bounce again in [HSF’s] efficiency earnings (ex the efficiency ingredient of streaming, which is classed by SONG as ‘streaming’ however in actuality is a mix of mechanical and efficiency), which was late to point out up within the PFAR numbers, but additionally late to get better given the lag vs UMG and WMG.”

The early indicators of that restoration had been really already there inside HSF’s FY 2022 numbers:

  • For the complete calendar 12 months 2021, HSF’s PFAR was certainly down 5.3% YoY;
  • However within the second half of 2021 alone (July- December), HSF’s PFAR was up (vs the primary half of 2021) by double digits (+11.6%, see under)

(How a lot HSF buyers actually care concerning the PFAR vs. the corporate’s potential to pay its anticipated dividends is one other matter. At its AGM this week, Hipgnosis confirmed it might pay its interim 2022 dividend in October on the anticipated worth, and reiterated it was on track to pay its full-year dividend, additionally on the anticipated worth, in March 2023. J.P. Morgan appeared happy by this information.)

Hipgnosis Track Administration x Blackstone

One other query mark raised by latest reporting factors particularly to Hipgnosis Track Administration (HSM) and Blackstone’s stage of involvement within the firm.

Virtually a 12 months in the past, Hipgnosis introduced its partnership with Blackstone, with the funding large absolutely funding Hipgnosis Songs Capital (HSC), whereas making an undisclosed funding into Hipgnosis Track Administration (HSM).

MBW has accomplished some digging, and understands that Blackstone owns 51% of HSM, with Mercuriadis and his household proudly owning 35% and long-standing Hipgnosis allies, together with Nile Rodgers, proudly owning the rest. As CEO, Mercuriadis runs the corporate.

Critics of this mannequin would possibly recommend that Blackstone’s majority (51%) possession of HSM may give the personal, Blackstone-funded Hipgnosis fund (HSC) unfair choice throughout the Hipgnosis group (the general public fund, HSF, is owned by many different exterior buyers, together with the Church of England).

On a extra constructive observe, Hipgnosis’ strategic significance to Blackstone is definitely highlighted by advantage of the controlling stake that Blackstone determined to accumulate in HSM. (Plus, as talked about, HSF – as long as it could discover the cash – has blanket co-investment rights on every little thing HSM sources and seeks to accumulate.)

Whatever the Hipgnosis group construction, the importance of getting Blackstone as a dedicated investor in music rights shouldn’t be underestimated.

Blackstone had $881 billion in complete property beneath administration (AUM) in FY 2021, and can possible have someplace near a trillion {dollars} in complete property beneath administration by the top of FY 2022.

As talked about earlier: Hipgnosis’ entry to piles upon piles of personal capital just isn’t in query.

A controversial low cost fee – and a few very well timed headwinds

One other side picked up in latest reporting from the Monetary Instances and others was the best way during which Hipgnosis Songs Fund (the UK-listed firm) is independently valued each six months.

To worth HSF, the corporate turns to a gaggle of music trade consultants inside Citrin Cooperman. This group beforehand operated as Massarsky Consulting earlier than being acquired by Citrin Cooperman earlier this 12 months.

Questions have been raised over Citrin Cooperman’s insistence that an 8.5% ‘low cost fee’ stays adequate for music valuations regardless of quickly rising rates of interest within the US, UK and elsewhere.

To maintain it easy: If this low cost fee was to be elevated by Citrin, it might decrease the worth of Hipgnosis Songs Fund on a NAV (Web Asset Worth) foundation.

J.P. Morgan, although, says it continues to be glad with the 8.5% low cost fee, and sees no want for adjustment.

The funding firm mentioned in its analysis observe this week: “We really suppose an 8.5% low cost fee regarded massively conservative earlier within the 12 months till US lengthy charges began to rise… now we imagine it seems to be affordable given the still-big threat premium and decrease beta of music because it has grow to be a subscription-based utility annuity stream.”

After all, with heavy inflation, a dwindling inventory market, and the Fed ratcheting up these rates of interest, corporations like Hipgnosis Songs Fund are having to deal with some substantial macroeconomic headwinds immediately.

But J.P. Morgan notes that there’s additionally a widespread variety of ‘tail-winds’ serving to enhance the long run prospects for HSF (and the broader Hipgnosis group).

The J.P. Morgan analysis observe this week, penned by Christopher Brown and Adam Kelly, famous the latest ‘CRB III’ decision, which upheld higher mechanical charges for songwriters and publishers within the US for the years 2018-2022.

Because of this, the likes of Spotify, Amazon Music and different streamers are having to pay one-time cash to publishers with a view to fulfill retrospective charges on this interval: Warner Music Group, for instance, recently reported a $17 million windfall from the CRB III catch-up course of in calendar Q2.

J.P. Morgan additionally likes the look of the recently-inked ‘CRB IV’ agreement between publishers and streaming companies within the States, which might set the mechanical headline fee paid to pubcos at 15.35% of every streamer’s US income.

“We’re optimistic about income [at Hipgnosis Songs Fund] over the approaching 12 months, with [many] constructive drivers.”

J.P. Morgan

If ratified by the Copyright Royalty Board judges within the US, this may barely enhance the mechanical fee paid to publishers from 2023-2027 within the US because of CRB III.

What’s extra, the historic energy of the US greenback vs. the British pound works in Hipgnosis Songs Fund’s favor on the subject of paying its UK dividends (the vast majority of the corporate’s revenues are generated within the US).

Mixed with HSF’s debt refinancing, this run of stories has put J.P. Morgan in a buoyant temper.

The funding agency’s observe this week mentioned it was “optimistic about income [at HSF] over the approaching 12 months, with [many] constructive drivers”, together with an anticipated enhance in streaming subscription income and potential worth rises on companies like Spotify.

J.P. Morgan can be eager on the influence that the Mechanical Licensing Collective (MLC) is having within the States, forecasting that it “ought to result in increased payouts from US streaming [to HSF], with extra environment friendly, commission-free collections from DSPs”.

Moreover, J.P. Morgan means that HSF will profit from some “first time contributions to come back from rising digital platforms, not hitherto in SONG’s proforma annual income”.Music Enterprise Worldwide

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