When the board of Hipgnosis Songs Fund (HSF) slashed the value of the company's catalog by 26% last week, it admitted something investors had long believed. Although the London-listed royalty fund had amassed an enviable collection of songs since launching in 2018, changes in market conditions and the very nature of some of those royalties may have been worth a significantly lower fair value since then.
A new valuation from Shot Tower Capital put the music rights portfolio — which includes Neil Young, Shakira and the Red Hot Chili Peppers, among other A-list artists and songwriters — at $1.8 billion to $2.06 billion . As recently as September 30, the list was given a fair value of $2.62 billion by long-time HSF valuation expert Citrin Cooperman (formerly Massarky Consulting). Six months earlier, it was said to be worth $2.8 billion.
HSF's new board hired Shot Tower after investors voted Oct. 26 against going ahead and a partial catalog sale — essentially a vote of no confidence in both the previous board and investment adviser, Hipgnosis Song Management. Shot Tower will give the HSF board its final due diligence by March 25th, and HSF will update those findings by March 29th.
Some longtime critics of HSF's previous valuation found validation in Shot Tower's lower number. Stifel analysts claimed the new figure shows HSF “overpaid for the listings,” they wrote in a March 4 investor note. To date, HSF has spent approximately $2.2 billion on acquisitions. It raised more than 1.3 billion pounds ($1.67 billion) from an IPO and seven successive offerings and has drawn $604 million from a revolving credit facility.
Such a large drop in valuation suggests that different experts had different views of both the catalog's revenue and the riskiness of that revenue. Shot Tower estimated HSF's net income after third-party royalties and administrative expenses to be $121.7 million for the 12-month period ended June 30. Accounting firm BDO estimated a similar amount — $119.4 million for the 12-month period ended Sept. 30 — for an analysis of earnings quality.
The higher valuation of $2.62 billion appears to be based on higher annual net income. A July 2023 investor presentation put HSF's annual revenue at $134 million (based on a fair portfolio value of $2.8 billion and an implied historical net issuer share, or NPS, multiple of 20.89). That's $12.3 million more than Shot Tower's figures and $14 million more than BDO's estimate. The difference in annual revenue, however, explains only part of the difference in valuations.
The discount rate also appears to have played a role in HSF's lower valuation. Shot Tower used a weighted average discount rate of 9.63% for the entire catalog, more than 1.1 percentage points higher than the discount rate used for previous valuations. Experts Advertising sign spoke with called the rate “on the high side” and “a particularly high number.” Some other recent valuations used a lower discount rate. Discount rates and valuations are inversely related: A higher discount rate will produce a lower present value of cash flows and vice versa.
Until this week, HSF was valued at an 8.5% discount to the September 30, 2020 valuation conducted by Citrin Cooperman. FTI Consulting's valuation of a Kobalt portfolio used in an asset-backed securities (ABS) offering in February used a discount rate of 8.5% for songs older than 18 months (and 11.75% for songs aged 3 to 18 months). FTI's valuation of the portfolio behind Concord's $1.65 billion ABS used a discount rate of 8.25% for catalog songs (and 11.75% for frontline recorded music content and options for future releases).
HSF's discount rate has been a point of contention among analysts and investors in recent years. When HSF cut the discount rate to 8.5% in 2020, analysts complained that the valuation increased even though the investment manager had not yet added value and market assumptions had not changed. When rates started to rise in 2022, analysts questioned why HSF stuck with the 8.5% discount rate.
The discount rate depends on the riskiness of these future cash flows. Perfectly safe income is discounted using a risk-free rate of return, such as the 10-year US Treasury rate. Because no business is without risk, a company's revenue would be worth a higher rate. If a company carries debt, its borrowing costs—also greater than the risk-free rate—will also be built into the discount rate.
Shot Tower's discount rate took into account several factors, according to the press release, which could explain how it arrived at 9.63%. For example, Shot Tower found that 65% of HSF's revenue comes from passive rights where the company does not control publishing, management or licensing. In many cases, HSF only owns a songwriter's share and not the publisher's share or the producer's rights to a recording. Investors could assume that HSF had more control over management, distribution and licensing: In HSF's annual report for the year ending March 31, 2022, it said it had 100% ownership of 96% of the songs in its catalog (138 of 146 lists).
“There is a lot of value in this audit,” explains one industry insider. Strategic buyers – typically music publishers and record labels – will pay a premium to control the management and licensing of a song or the distribution of a recording. Passive rights are usually traded at a discount because they carry more potential agent risk (co-authors, for example) and potential collection risk (such as when rights are redirected by a label rather than taken by a PRO). With the writer's share, “you're much more along for the ride,” says this insider. Producer rights acquired by HSF — such as RedOne, Jimmy Iovine and Timbaland — are also passive.
For a company looking to bolster its credibility with investors, Shot Tower's valuation was a double-edged sword. The lower figure confirmed the long-held belief of some investors that the portfolio is worth less than HSF had claimed. But the downgrade further hit HSF's share price. Shot Tower's lower valuation prompted HSF's board to pledge to use its cash to pay down debt rather than continue the dividend it suspended in October. So while the lower valuation better reflected HSF's market cap, the continued dividend loss was the likely reason behind the stock's 11% drop on the day of the announcement.
