Blackstone-backed song rights machine suffers growing pains

When Merck Mercuriadis, the former manager of stars like Beyoncé and Elton John, created an investment vehicle and listed it on the London Stock Exchange in 2018, it made a bold statement.

The songs were a better investment than oil or gold like the music The streaming business continued to boom, he said. He had the “extensive music industry relationships” needed to take advantage of the revolution, and if investors trusted him with his money, they could get in on the ground floor.

Hipgnosis grossed over £1bn and for a time acquired catalogs at a breakneck pace from the likes of Blondie and Neil Young.

Since embarking on the buying spree, Hipgnosis has been committed to transforming popular music, with all its creativity and stardom, into a trusted asset class. Royalties from songs he owned would be packaged into a regular income stream in the form of dividends to investors, including the Church of England and Investec’s wealth management arm.

But Hipgnosis Songs Fund, which was formed in an era of rock-bottom interest rates and rising stock markets, has since become an example of what can happen to exotic investments when the market turns.

To fuel its growth, HSF has repeatedly turned to investors for cash to make new acquisitions, but has since burned through its funds and is unable to raise more as its share price has fallen.

Its catalog’s pro forma royalty income, a move that takes the momentum out of acquisitions, has fallen for the past two years and the cost of servicing its $600 million debt is rising. He hasn’t bought a new song in over a year. Some artists who had hoped to sell their catalogs to Mercuriadis are growing impatient.

In addition to the London-traded fund’s shareholders, Mercuriadis has a new investor to answer to: the world’s largest private equity group, black stone.

Enter Schwarzman.

By the end of August 2021, HSF had run out of firepower.

A month earlier it had raised £156m for deals, the ninth time in three years it had turned to investors. But the breakneck pace of fundraising and deals has made it difficult to assess the company’s underlying performance. At the time of the July 2021 fundraiser, Mercuriadis told investors it would not ask for more cash for at least a year.

In a matter of weeks, he spent the entire tour on songs by the likes of the Red Hot Chili Peppers, the Kaiser Chiefs and Elliot Lurie, the head writer of Looking Glass, the early ’70s American pop-rock band.

During the self-imposed moratorium, Mercuriadis looked elsewhere for cash. In October of last year, he sold out his private management company, The Family (Music), to Blackstone. The vehicle, which receives advisory fees from the London-listed fund, has been renamed Hipgnosis Songs Management.

Blackstone did not disclose the terms of its investment in HSM, which is still owned by Mercuriadis, who retains a minority stake.

Blackstone also established a $1 billion private fund, with $350 million of equity and $650 million of debt, giving Mercuriadis a new source of capital to buy more song copyrights. The fund, called Hipgnosis Songs Capital, also pays fees to HSM.

However, in recent months, several artists have complained that Mercuriadis has been unable to complete potential transactions that were being discussed, according to people briefed on the negotiations. One warned that the inability to complete those deals was damaging Mercuriadis’s reputation in an industry where personal relationships are prized. Mercuriadis blamed the delays on the US Federal Reserve’s implementation of a series of interest rate hikes, the people said.

In the six months beginning in October last year, when Blackstone took control of HSM, the London-listed vehicle reported “aborted deal expenses” rose to $1.6m, four times the previous level. . That includes the cost of doing due diligence on potential deals the fund didn’t sign.

Stephen Schwarzman, the billionaire founder of Blackstone, was embroiled in a dispute between Mercuriadis and a Grammy Award-winning artist, according to two people briefed on the fight. The songwriter, who asked to remain anonymous because negotiations were still active, told Mercuriadis that Schwarzman had been approached about a stalled deal to buy his catalog, the people said.

“We have a fiduciary responsibility to our investors to always ensure that our underwriting is accurate,” Mercuriadis said in a statement to the Financial Times. “Changes in interest rates have meant that some operations have had to be resubscribed and revalued. This is not unique to Hipgnosis or the music industry.”

He added, “We believe in communicating directly with songwriters and giving them the real facts. Our reputation in the songwriting community is built on actions, not words. We are trusted by the songwriting community and are their preferred choice because we have achieved our success with them and not at their expense.”

Blackstone declined to comment.

‘Decay’

Mercuriadis has used Blackstone’s $1 billion fund to sign deals with Leonard Cohen, Justin Timberlake, Nile Rodgers, Nelly Furtado and country singer Kenny Chesney. You’ll also use it to buy the Pink Floyd back catalogue, which you’ve coveted for a long time, if you win a auction which is expected to close soon.

But his original London-listed fund is facing increasing challenges.

To buy more songs, you need to raise new capital. But it is effectively prevented from doing so due to the drop in its share price. By the time the pause in raising new funds expired, its shares had spent around six months trading below HSF’s net asset value of $2.2 billion, a stock valuation derived from the fund’s appraisal of the fund’s assets. an external agent, which HSF has introduced to investors. That means raising new capital would dilute existing shareholders and, in the words of an HSF spokesman, “destroy value.”

HSF pays an annual dividend yield of about 4.6 percent, according to investment bank Stifel, funded by royalties that are paid automatically when songs are broadcast, played on the radio, performed live, performed by another artist or are used in a television program. or video game.

Those constant returns were attractive when interest rates were near zero, but less attractive when investors can earn higher returns than before on lower-risk assets like government bonds.

If HSF’s costs were held constant, its revenue would have to rise about 20% above its level in 2021 to cover dividend payments for the year to March 2023, according to Stifel calculations.

“The dividend is one of the key attractions for shareholders,” said Sachin Saggar, an analyst at Stifel. “[Hipgnosis] I wouldn’t cut it unless it was a last resort.”

HSF said last month that it intended to continue targeting a dividend of 5.25 pence for the year to March 2023, in line with the 2022 level.

HSF executives believe operating costs will fall because it is not signing deals and the fund is reviewing its debt structure in a bid to lower its interest payments, according to a person close to the company.

Executives expect revenue to be boosted by still-live growth in music streaming, as well as the impact of the reopening of bars and clubs and the return of live shows after the coronavirus pandemic shutdowns. coronavirus, the person said. The company is also in line to receive a windfall from a US court ruling that increased royalty payments.

But some of the revenue decline is likely tied to a phenomenon known as the “decline” effect, Saggar said. New songs tend to generate higher royalty payments in the first six years after their release, before stabilizing at a lower level. HSF is exposed to newer songs: At the end of December, 43 percent of revenue was generated by songs less than 10 years old.

Some critics argue that the investors who were attracted by the dividend did not fully appreciate the inherent risk of the business. Michael Sukin, a longtime entertainment attorney who has represented the estates of Elvis Presley and The Rolling Stones, said some investors “really have no idea how music catalogs make money.”

rising valuations

An apparent bright spot for the London-listed fund is that an outside broker has raised its net asset valuation, allowing it to report strong returns to investors. Barry Massarsky, a veteran music economist who values ​​catalogs including HSF’s, said his 65,413 songs were worth $2.69 billion in March, up from $2.55 billion in September 2021. That was partly due to which Massarsky concluded that the songs were not decaying as much as expected. said a person familiar with the matter.

A higher valuation means the company could borrow more money, which it could potentially use to fund the dividend. HSF can borrow up to 30 percent of its catalog value and, based on the $2.2 billion valuation derived from Massarsky’s figures, could increase the debt from $600 million to $660 million before reaching the limit. .

If Massarsky were to write down the value of the fund, it would prevent HSF from borrowing more. One reason to do so would be to account for the effect of interest rate hikes by adjusting the “discount rate” that Massarsky uses in his calculations. HSF said in July that a 0.5 percent increase in the discount rate would reduce the value of its catalog to $2.02 billion, a drop of about 10 percent.

HSF is still valued using the same discount rate as a year ago, even after central banks have since embarked on an aggressive series of rate hikes to curb the worst inflation in decades.

“If we had to make changes with every ripple in the market, that would create instability in our market,” Nari Matsuura, a partner at Citrin Cooperman, which acquired Massarsky Consulting, said in July.

Matsuura told Music Business Worldwide in May that his company was “protecting all of our customers” by not raising the discount rate because it meant “valuations would not go down.”

She told the FT: “We have updated our calculation for the current direction of interest rates, and the 8.5 per cent discount rate still accommodates that increase.”

If HSF were to run into financial difficulties, Blackstone could purchase its portfolio in whole or in parts. “There is a scenario where the ETF has to cut the dividend due to its leverage issues,” in which case the share price would suffer “severely,” analysts at Stifel wrote last month.

In any case, Blackstone “has the upper hand”, analysts said, as it can buy assets at attractive prices or collect the fees paid to HSM, the advisory vehicle at the top of the network of companies. HSM generated $16.5 million in fees from HSF last year.

The note was titled “Blackstone: Heads I Win, Tails You Lose.”

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