Hipgnosis Songs Fund (LSE:SONG) is a FTSE 250 fund that buys the publishing rights to songs. Revenue is earned each time its music is streamed, downloaded, or broadcast.
Over the past year, its share price has fallen by nearly a third. The directors point out that it’s currently around 45% lower than the net asset value (NAV) of the fund.
Is now the time to buy?
Back catalogue
The Hipgnosis collection is an impressive one.
The fund owns the rights to 65,413 songs by 146 artists. It claims to have 74 of the 304 songs that have been streamed over one billion times on Spotify.
Now that’s what I call expensive
It’s a costly business acquiring intellectual property rights.
Since it started in 2018, the fund has spent $2.2bn buying songs. Some of this has been funded by equity — $1.3bn has been raised so far — but a large proportion has been funded by debt.
At September this year, the fund had borrowings of $596m. Using current exchange rates, this equates to nearly half of its current market cap of £1.06bn.
Conscious that we are in an era of rising interest rates, the directors have recently re-structured the debt and entered into a series of interest rate swaps, to provide certainty over future borrowing costs.
What about the losses?
Until examining its accounts more closely, I was nervous about the fund’s losses.
In 2022, net revenue was $168m but operating expenses were $185m.
However, the biggest expense incurred ($106m) was for the amortisation of its catalogue of songs. This is a non-cash item necessary to write-off the music rights over their estimated useful economic lives. Accounting standards limit this period to 20 years, even though Hipgnosis claims that, on average, each song has at least 100 years of remaining copyright protected revenue.
Assuming it doesn’t purchase any more songs, within 18 years, its existing catalogue will have a book value of zero. But, there will still be several more decades during which these songs will be generating revenue. The company will then be highly profitable.
Because of this mismatch, cash generation (rather than profit) is a much more important measure.
In its first four full years of trading, the fund has generated $225m of cash from its day-to-day activities.
Some of this has been used to pay a healthy dividend. For the past nine quarters, this has been 1.32p per share, giving a current yield of 6%.
What should I do?
With an impressive catalogue of music rights and revenue rising predominantly from an increase in the popularity of streaming, I’m tempted to invest.
I like the fact that the most recent independent valuation of the fund’s songs gives a fair value of $2.67bn, a 35% premium to its book value of $1.98bn.
The directors have also promised not to raise any more cash (and presumably buy any more songs) until the share price is above the NAV of the fund.
But I don’t like the fact that, last year, nearly all of the fund’s cash generated from its operating activities was used to pay the dividend ($84m).
It appears to me that the current level of dividend is not sustainable and therefore I won’t be investing. For this reason, Hipgnosis is not my Christmas Number One.
