However much the music industry has changed over the years, it is fair to say that musicians from previous decades would be astonished to find their creations transformed into an asset class. This investment in music royalty payments has been brought about by Hipgnosis Songs Fund Limited, a London investment trust which aims to redefine the way songs are valued, appreciated, and monetised. In their search for return amid what then seemed perennially low interest rates, prominent private equity firms and investors found themselves intrigued by Hipgnosis' distinctive strategy for investing in song catalogues. But tightening economic conditions now threaten the viability of the nascent asset class and its ability to generate consistent returns.
This article will explore the background of Hipgnosis and its remarkable impact on the music industry, while also considering its recent stagnation and future prospects.
Background to Hipgnosis
Named after the art group that designed album artwork for Pink Floyd among others, Hipgnosis was founded in 2018 by Nile Rodgers and Merck Mercuriadis, a music industry executive who once managed Elton John. In creating the fund, Mercuriadis has said that he had two motives: to establish songs as an asset class to be reckoned with while generating returns for Hipgnosis’ shareholders, and to change the songwriter’s position in the economic equation so that they are paid more money.
Mercuriadis has also stressed that music royalties are an 'inflation-proof' asset class. People live their lives to the 'soundtrack' of their music, regardless of the overall performance of the economy. For example, spending on music is weakly correlated with consumer spending in general, outpacing it in the US by a factor of 2.4x since 2016.
This potential for investment in music to generate steady income at a relatively low risk is made clear in Hipgnosis’ investment strategy. Mercuriadis outlines how the fund targets songs that were extraordinarily successful upon release and also of great cultural importance. As of today, Hipgnosis's portfolio includes more than 65,000 songs, including 23 out of the top 100 most streamed songs that had been streamed on Spotify more than 1bn times by June 2022. The fund owns the catalogues of the likes of Blondie, Shakira and the Chainsmokers. These songs endure, and therefore have huge investment potential.
Besides Elton John, Mercuriadis had managed multiple artists, such as Guns N' Roses and Beyoncé, during his tenure as CEO at Sanctuary Music Group. As a result, Mercuriadis had personal connections and industry expertise, which he used to appeal to investors, demonstrating that he would use his specialised knowledge to convince artists to sell their copyrights to the fund. The strength of these copyright protections was also attractive to investors. Then, with a diverse collection of songs in one fund, the royalties were to be aggregated into consistent cash flows to provide shareholders with dividends.
Hipgnosis immediately caught investors' attention. It raised £200m through its IPO on the Main Market of the London Stock Exchange in the same year as its founding, as well as £1.3bn since then in further offerings. The company entered the FTSE 250 Index in 2020, and its revenue soared from $7.2m in 2019 to $200m in 2022.
What attracted investors was the promise of consistent, low-risk returns in a time of low interest rates. When the returns on safe assets like government bonds are unattractive, investors are forced to turn to more unorthodox asset classes. Convinced by Hipgnosis' rationale, many firms that had never properly invested in music before began to engage in the market. Notable instances of this would be KKR acquiring a music catalogue from Kobalt Music Group for $1.1bn and Apollo purchasing the songbook of Luis Fonsi, the artist behind Despacito, which topped US music charts for 16 consecutive weeks in 2017. According to Midia Research, total music catalogue dealmaking skyrocketed from $368mn in 2019 to $5.3bn in 2021.
In October 2021, Blackstone acquired an ownership stake in Hipgnosis Song Management, which advises Hipgnosis Song Fund, thus taking control of Hipgnosis. Blackstone then set up a separate $1bn fund, Hipgnosis Song Capital.
Hipgnosis now relies on Blackstone for funding. In October last year, Blackstone backed the fund’s debt-financed share buyback programme after its share price fell 30% in six weeks. How Hipgnosis got into this position stems from financial difficulties that relate to the company's early success. The eye-catching headline revenue growth cited above was powered by acquisitions, concealing how Hipgonsis' pro-forma revenue (excluding the gains from new song purchases) had been steadily falling since 2020.
This highlights a downside to Hipgnosis’ strategy of prioritising investment in songs with immense success upon first release. Over time, interest inevitably fades. For example, Hipgnosis' top 10 of 2018 included Sweet Dreams (Are Made Of This) by The Eurythmics and Don’t Stop Believin’ by Journey. These are songs that have endured. But the list also included songs from The Chainsmokers, Justin Bieber and Shawn Mendes, whose endurance is altogether less likely. Research backs this up: royalty income is generally at its highest in the first year after release, before declining over the next 5-10 years.
The main problem facing Hipgnosis however is higher interest rates. Investors in music royalties securitise future revenue streams from the royalties as collateral against their debts. To calculate the current value of those future revenue streams, Hipgnosis uses a discount rate (an interest rate used to calculate the catalogue's value), which is inversely related to the current value. However, despite soaring interest rates, which are generally accepted to negatively affect valuations, Hipgnosis has not increased the discount rate, which has remained at 8.5% since 2019. Reduced valuations, of course, would severely hamper the fund's ability to finance more debt.
Rising interest rates are also worrying given Hipgnosis' track record of acquiring credit to stay afloat. Herbert Smith Freehills has now advised the company on refinancing revolving credit facilities on three occasions: in 2019 for £65m, in 2020 for £150m and in 2022 for a five-year commitment of $700m. This reliance on debt to maintain steady returns seems unviable given the end of the era of free money.
The transformation of songs into an investable asset has clearly presented both successes and complications. Evidently, however, that success is undermined when examining Hipgnosis' pro-forma revenue, while the future of the fund remains uncertain in a higher-rate environment. Of course, music as an asset class remains to a degree insulated from key macroeconomic headwinds. Besides the risk that the rising cost of debt chops away at shareholder returns, industry executives acknowledge that music is at least immune to the inflation, supply chain problems and geopolitical risk currently disrupting markets.
What's more, Hipgnosis is still active. In January, Hipgnosis acquired Justin Bieber's whole back catalogue for $200 million, while in March it partnered with Recreational Music to bring its catalogue to millions of gamers and developers. However, it remains to be seen how much success Hipgnosis can have while paying 6% interest on its debt without the option of risk-free borrowing.