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

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MBW Reacts is a collection of quick remark items from the MBW group. 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 consider SONG gives compelling worth,” stated J.P Morgan, sustaining its ‘chubby’ 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 current flurry of enterprise media scrutiny.

Specifically, a run of three related current 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 prior to now 12 months;
  • The truth that it’s refusing to boost new funds;
  • The influence of present macro-economic pressures on HSF’s worth, and its funds.

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

However first issues first: Mentioned 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 convey glee to these with the knives out for Merck Mercuriadis’ firm, in actuality it’s flat-out fallacious.

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 tip of the yr.

In brief: 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 setting 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 reminiscences of the three Hipgnosis-branded firms:

  • Hipgnosis Songs Fund (HSF): a UK-listed FTSE 250 firm that has acquired over $2 billion in catalogs to this point, which have collectively been given an independent valuation of $2.7 billion;
  • Hipgnosis Songs Capital (HSC): a non-public 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 Tune Administration (HSM): a ‘track administration’ and Funding Administration firm that advises on the investments of HSF and HSC, and manages the belongings of each.

In essence, firm (iii) – Hipgnosis Tune 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 equivalent to Mark Ronson, Purple Sizzling Chili Peppers, Neil Younger, Lindsey Buckingham, Tough Stewart and plenty of others.

Nonetheless, final summer time, 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 this point through HSM – and which is predicted to spend someplace close to that once more within the the rest of the yr.

Rising rates of interest, nevertheless, are prone to put a cap on the multiples any music firm is prepared to pay for copyright buyouts within the present setting.

Until potential sellers are prepared to drop their desired a number of to this degree, we might 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 example: Some artists and songwriters might certainly be prepared 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 stated cash can shortly acquire in worth.)

Why is Hipgnosis Tune 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 traders, and people extra intently watching the corporate, it’s not precisely sudden.

Hipgnosis Songs Fund instructed 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 instructed traders that it was “fully invested”, following acquisitions of a number of catalogs (utilizing that $215m) together with music by the Purple Sizzling Chili Peppers and Christine McVie of Fleetwood Mac.

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

Specifically, with the twin shocks of a steep rise in inflation plus the conflict 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 firms like these would select to boost new fairness (through share points) at present inventory costs as it will harm the holdings of present 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 stated, 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 improve its dimension”.

As MBW defined in November, HSF – as long as it has the funds accessible – can opt to acquire a 20% stake alongside HSC (through 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 current 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 actually seems troubling: ‘Professional-forma’ income (PFAR), which HSF voluntarily publishes, reveals the royalty income earned by catalogs in a calendar yr based mostly on royalty statements obtained, no matter 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 certain quantity of decline annually in ‘Professional-forma’ income at an organization like Hipgnosis Songs Fund because of newer catalogs; i.e. catalogs which might be nonetheless ‘leveling off’ from their business 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 robust decay curve, however you’d anticipate classics from Neil Younger, Lindsey Buckingham, Bon Jovi and so on. to be rising annual income as they trip 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 sometimes account to publishing rights-holders 12 to 18 months behind the second of consumption. Inside HSF’s numbers proper now, that lag is essential.

In case you return 12 to 18 months from the tip of HSF’s newest fiscal yr (March 2022), you land on the coronary heart of the best degree of unfavourable 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 all the stay performances by artists – that may have been there in ‘regular’ circumstances however aren’t mirrored in HSF’s numbers.

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

J.P. Morgan

This Covid-driven income deficit is arguably extra pronounced for firms like HSF than it’s for the main music firms, as a result of HSF is solely within the catalog enterprise; it doesn’t have a streaming money bump from new frontline hits to offset the unfavourable 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 sturdy bounce again in [HSF’s] efficiency earnings (ex the efficiency factor of streaming, which is classed by SONG as ‘streaming’ however in actuality is a mixture of mechanical and efficiency), which was late to indicate up within the PFAR numbers, but additionally late to recuperate given the lag vs UMG and WMG.”

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

  • For the complete calendar yr 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 traders actually care in regards to the PFAR vs. the corporate’s capability to pay its anticipated dividends is one other matter. At its AGM this week, Hipgnosis confirmed it will pay its interim 2022 dividend in October on the anticipated value, and reiterated it was on the right track to pay its full-year dividend, additionally on the anticipated value, in March 2023. J.P. Morgan appeared happy by this information.)

Hipgnosis Tune Administration x Blackstone

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

Nearly a yr in the past, Hipgnosis introduced its partnership with Blackstone, with the funding large totally funding Hipgnosis Songs Capital (HSC), whereas making an undisclosed funding into Hipgnosis Tune Administration (HSM).

MBW has executed 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 non-public, Blackstone-funded Hipgnosis fund (HSC) unfair choice inside the Hipgnosis group (the general public fund, HSF, is owned by many different outdoors traders, together with the Church of England).

On a extra optimistic observe, Hipgnosis’ strategic significance to Blackstone is unquestionably highlighted by advantage of the controlling stake that Blackstone determined to amass in HSM. (Plus, as talked about, HSF – as long as it might discover the cash – has blanket co-investment rights on all the things HSM sources and seeks to amass.)

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 whole belongings beneath administration (AUM) in FY 2021, and can seemingly have someplace near a trillion {dollars} in whole belongings beneath administration by the tip of FY 2022.

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

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

One other side picked up in current reporting from the Monetary Occasions 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 business consultants inside Citrin Cooperman. This group beforehand operated as Massarsky Consulting earlier than being acquired by Citrin Cooperman earlier this yr.

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 will decrease the worth of Hipgnosis Songs Fund on a NAV (Web Asset Worth) foundation.

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

The funding firm stated in its analysis observe this week: “We truly suppose an 8.5% low cost fee regarded vastly conservative earlier within the yr till US lengthy charges began to rise… now we consider it seems cheap given the still-big threat premium and decrease beta of music because it has change into a subscription-based utility annuity stream.”

In fact, with heavy inflation, a dwindling inventory market, and the Fed ratcheting up these rates of interest, firms like Hipgnosis Songs Fund are having to sort out some substantial macroeconomic headwinds right now.

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 current ‘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 so as 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 yr, with [many] optimistic drivers.”

J.P. Morgan

If ratified by the Copyright Royalty Board judges within the US, this can barely improve the mechanical fee paid to publishers from 2023-2027 within the US on account of CRB III.

What’s extra, the historic power of the US greenback vs. the British pound works in Hipgnosis Songs Fund’s favor with regards to paying its UK dividends (nearly all of the corporate’s revenues are generated within the US).

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

The funding agency’s observe this week stated it was “optimistic about income [at HSF] over the approaching yr, with [many] optimistic drivers”, together with an anticipated improve in streaming subscription income and potential value 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 greater 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 return from rising digital platforms, not hitherto in SONG’s proforma annual income”.Music Enterprise Worldwide

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