Music royalties fund Hipgnosis strikes a discordant note

Hipgnosis, a fund hoping to profit from song royalties, sounds beguiling. But is best avoided for now, says Max King.

With bond yields so low, the hunt continues for reliable sources of income that can be packaged up into a fund. The main stipulation for these funds to be regarded as "alternative assets" is that their returns are deemed to be "uncorrelated" to equity markets: insensitive to the economic cycle.

Merck Mercuriadis, a music-industry professional, had the bright idea of creating a listed company, Hipgnosis (LSE: SONG) that would buy up the rights to songs and then collect the royalties from music streaming, which has largely replaced physical ownership and permanent downloads as the preferred way to listen.

Songs' enduring appeal

After the excitement of first release, endless radio play and chart-topping success, the popularity of "hits" fades but does not disappear. Many songs have enduring appeal that lasts for decades, perhaps enhanced by their use in films, TV and advertising. For example, the release of the film Bohemian Rhapsody gave a huge boost to Queen's songs.

Yet management of long-term music rights requires very different skills from short-term promotion. The income streams are usually small and the performing artist or production company is happy to sell the revenue stream. Hipgnosis raised an initial £200m in the summer of 2018 to buy these rights and a further £424m subsequently.

It bought 43 catalogues with around 11,500 songs for an average 12.6 times revenue, resulting in an 8% yield. From this must be deducted management fees to Mercuriadis's company of 1% per annum, but the net return of 7% may be enhanced by the moderate use of debt for acquisitions. Dividends of 5p a share provide a yield of 4.9% on a share price of 103p.

The target return above 10% per annum requires growth in income and here the story gets more difficult. Christopher Brown, the funds analyst at JP Morgan Cazenove, thinks that streaming can grow music industry revenues by 10% per annum until 2030, but there is no certainty that Hipgnosis will match this.

Predicting the success or failure of new artists and songs is a challenge that defeats most industry experts; to predict the popularity of past successes many years ahead is even more difficult.

Some hits go on forever, some disappear without trace and some achieve immortality from a slow start. For example, Mark Savage of the BBC points out that Pumped Up Kicks by Foster The People only reached number 18 in the UK when it was released in 2010, but was the most streamed song from 2010 last year with 21 million plays. Overall, 90 billion songs were streamed in 2018, an increase of 33.5% on 2017.

Skewed towards the big hits

Hipgnosis's recent interim results showed how skewed revenues from downloads and elsewhere are towards a small number of songs: 0.5% of the portfolio accounts for 43% of income.

Presumably, the copyrights for sale to Hipgnosis are the ones with the least certain future as owners will want to hang on to the most promising royalty streams.

Nevertheless, Brown, along with many hipsterish City fund managers, is an enthusiast, despite the limited record. Others point out that though the growth of streaming looks assured, the business model and the quality of the catalogue are not proven. The interim results were good, but a breakneck pace of expansion is always a cause for concern. This is a beguiling story, but best avoided for now.

Finally, the name Hipgnosis is not quite as millennial-hip as it sounds. Hipgnosis was the name of a highly successful design studio that produced many of the iconic album covers of the 1970s, including Pink Floyd's Dark side of the Moon. Their songs are not in the catalogue of the new Hipgnosis.

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