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Rock ‘n’ roll yield

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Music publishing rights are a proven inflation-sensitive cash-flow asset, and Martin Steward finds that fast-changing music consumption habits are generating not threats, but opportunities

New York fund managers are ten-a-penny, but Nashville? That would be unusual.
But it makes perfect sense for Round Hill Music Royalty Partners, dedicated to investing in music rights, affiliated with the publisher Round Hill Music, and currently raising a new $200m fund. Here in Europe (and, yes, also Nashville), Kobalt Capital pursues the same model, raising third-party capital to buy music rights, affiliated with the publisher Kobalt Music Group.

“When you first mention this the reaction is, ‘Music? Really? What about piracy and falling sales of CDs?’” says Kobalt Capital CEO Johan Ahlström. “Investors with experience of other royalties understand – but, generally, our first task is to explain the difference between producing records and publishing music.”

The point is echoed by Dutch pension fund asset manager APG, whose opportunity fund has long invested in music, drug, oil and gas and other royalties. Imagem, the music publisher it set up in 2008, owns Stravinsky ballets, Rodgers & Hammerstein numbers and Michael Jackson hits, and as fund manager Dempsey Gable says: “Imagem typically receives less than half of its royalties from recorded music.”

A recording is owned by a record company which makes money each time that recording is bought as a CD or downloaded. The music itself is owned by the composer or publisher – Imagem, Kobalt, Round Hill or indeed many record companies. They make money with each CD sale and download, but also each use in an advertisement, movie or a computer game, each cover by an X-Factor contestant or boy band, each play in a coffee shop, each reprint in a sheet-music collection and each mobile-phone ringtone.

And a single use is a gift that keeps on giving. A film producer makes a one-off payment to use a song in a movie; but then every cinema and TV station has to pay a separate royalty for each showing of that movie. The cinema chain and broadcaster (or nightclub, concert venue or coffee shop) will tend to pay a one-off master use licence covering a set amount of time, which is divided up between the respective rights owners. Global royalties total some €7.5bn a year – growing fast and valued somewhere north of €100bn.

You can see why the 60% decline in CD sales post-iTunes has barely dented these revenues. TV advertising use has held up through the recession, the biggest decline has been from DVD sales, all more than balanced by new revenues from downloads and computer games. Users of the legitimate streaming services that pay royalties are now paying very low download fees, reducing the incentive to steal, while huge unpaid use is being monetised through agreements between Youtube and the bigger publishers.

“A big international hit can have as many as 20,000 income sources, globally,” Ahlström estimates. “That’s great, but it also makes it challenging to collect.”

This brings us to the issue of adding value, an effort encompassing three things: administration, synchronisation and sourcing.

Administration is making sure you get all the royalties due. Royalties are netted by national collection societies set up by songwriters and publishers, but to get that money the owner of the music has to register it properly with all of those collection societies.

“When you acquire a catalogue you have to let all these societies know,” says Josh Gruss, CEO at Round Hill, whose president used to work at the US society, BMI. “And if there are hiccups it really helps to have deep relationships.”     

Digitisation is making collection more efficient, but up-to-date infrastructure can better exploit this efficiency.

“Kobalt has become an IT company like Visa, really, with a centralised electronic hub connecting to all the collection societies,” says Ahlström. “That’s how we tend to collect 20-25% more revenue once we take over a catalogue.”

‘Synchronisation’ is getting your songs into hit games, movies, TV slots and albums. The size of the royalty will depend on whether your song is the main theme or background muzak, or whether it is played on prime-time or the night shift, so publishers maintain dedicated synchronisation teams. Gruss again emphasises technology – in this instance the database that his colleague, ex-head of IT at Warner/Chappell Music, Michael Lau, developed to categorise songs by everything from the emotions they evoke to restrictions on their licensing.

Music publishers also have an advantage when it comes to sourcing, most obviously in ‘co-publishing’, where a composer exchanges exclusive rights to his songs for an advance. These deals usually last 3-5 years, with the publisher reserving the right to extend until the advance has been amortised. Kobalt launched its fund partly because co-publishing dealflow outpaced its own balance sheet.

But sourcing older hidden gems can add value, too. Bandleaders Gene Simmons and Paul Stanley exert a tight control over the Kiss empire, but Gruss reveals how he bought some iconic songs from an ex-guitarist and co-writer. “Often, songwriters retire with their songs as their main asset,” he says. “They have tax issues, they get divorces, they sink all their money into their pet-project musical that doesn’t go anywhere.”

Round Hill even owns rights in six Beatles songs after tracking down their US publisher, virtually inactive since the 1960s. Gruss says there was no office phone number, let alone a website.

“As soon as we bought the songs we got a big use by a Canadian phone company that made a lot of money – simply because they suddenly became accessible,” he recalls.
“Money for songs that were never registered in Europe, say, has been flowing into suspense accounts for years. We find these all the time.”

These three sources of added value would have to be outsourced by non-publishers, which Gable at APG reckons can take three percentage points off annual returns. And that 3% headstart also enables bigger publishers to bid a little higher for the highest-quality assets.

So what kind of asset class is this? It is, by nature, conservative and long-term (the last-surviving writer’s lifetime plus 50 or 70 years). Compare drug royalties, which have a 20-year life, the first five of which are the high-risk trial phase. Some songs enjoy a spike in royalties if they are hits, but all settle into very stable income-generation for the remaining decades – some high-income classics, most lower-income. Surprises tend to be on the upside, as forgotten favourites go viral after an advertisment or cover version.

Investors can diversify between established assets and venture-like co-publishing. But even conservative managers like Imagem or Round Hill will do lower-risk co-publishing with established songwriters: Round Hill has bet on future songs from Marti Frederiksen, for example, who has written for Aerosmith and Carrie Underwood and is described by Gruss as “prolific”, with “a history of getting songs on big records”.

“We have songs from the 1970s that are well-established, but also new songs that One Direction do,” says Gable. “We can get spikes from commercials, as we did recently with ‘My Favourite Things’, but most songs’ income is fairly predictable and once you diversify you get a pretty even stream.”

Return estimates range from about 5-7% for the most conservative and less aggressively administered portfolios, up to 20%. Kobalt, the more venture-focused manager featured here, targets 12-14%. Gruss cites industry expectations of 10-13% – and the fact that this appears to be an inflation-beating asset class. “Our fund is a yielding vehicle that distributes to LPs semi-annually,” he says. “This is definitely a current-income play.”

Gruss notes that publishers have often deployed leverage to purchase and ‘flip’ assets within five years, sometimes after private equity buyouts, but the search for long-term yield is attracting different investors.

“Groups like ourselves, Bicycle Music and Kobalt are at the beginning of a new phase,” says Gruss. “So many investors are looking for sources of uncorrelated income.”

Ahlström, whose investors are mainly family offices but is now talking with pension funds, concurs. “Royalties are a fixed-income alternative,” he says. “If I get put into the hard-core private equity or hedge fund bucket I’m in the wrong place.”

The only thing hard-core in these portfolios, one might say, are the tunes.


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